Political events often seem to have a significant impact on currencies and markets, making the compulsion to act after an event strong. Investors fear the longer-term effect which normally is overstated and difficult to predict. For investors with a reasonable time horizon however, the volatility is often a good investment opportunity.
Political events often seem to have a significant impact on currencies and markets, making the compulsion to act after an event strong. Investors fear the longer-term effect which normally is overstated and difficult to predict. For investors with a reasonable time horizon however, the volatility is often a good investment opportunity. But the focus must be on the valuations of companies, not the event. A classic example was the 2008 and 2012 US presidential elections (Obama won both elections) when the market tumbled pre- and post-election day. However in the subsequent 4 years post the 2008 and 2012 elections the S&P500 posted an average annual gain of 13.3% – better than 9 of the previous 12 administrations. Why? Because when he was elected, the market was undervalued and the economy was down and out. The valuation of the market and macro-economic factors proved to be more powerful than whatever the market thought about Obama as a president when he was elected.
Many investors waited to see what the new president’s policies would be, but looking back, November 2008 and 2012 were great opportunities to invest more in good companies.
Figure 1 (above) shows however, that the British pound reacted totally differently especially when contrasted against the rand post Nene-gate. Both suffered unexpected negative events, but reacted totally different against the US dollar. What then does Brexit prove?
The Brexit effect
The pound was weak during the run-up to the referendum but the subsequent fall shows that the Brexit vote was unexpected and the market only realised the implications afterwards.
The key words here are unexpected and valuation. When the unexpected occurs and valuations are high, currency and equity markets will react negatively.
But the size of the move was because the vote was “a game changer”. Economic life before and after voting day would be different.
The only way one can protect oneself against an event like this is to be diversified and ensure the valuations of the companies in your portfolio don’t reflect too much optimism.
But Figure 3 also highlights the significant effect of dividends over the longer-term and highlights that whilst the short-term effect of an unexpected event can be severe, over the longer term company dynamics assert themselves. Note: a portfolio constructed with good dividend yielding companies would have generated much higher returns than the FTSE.
After many years in the investment world my own observation has been that most people sell, buy, withdraw or invest after the market has reacted to an unexpected event, taking their cue from the market rather than seeing the event as creating an investment opportunity.
How will the market react to the outcome of today’s US presidential election?
Trump favours tax cuts and Clinton tax increases. Trump has also advocated reduced regulation and has called for ending Dodd-Frank . So it seems a Democrat victory means more pressure on banks whilst a Trump presidency (Republican) should be more capital friendly (but also more unpredictable). The personalities of the two are so different that the presidencies will be very different. With Trump what you see is what you get – you just won’t like what you get, not that you like what you get with Clinton either.
Yet, there is enough happening in the US economy that the probability is high that as far as the market is concerned, over the next 4 to 8 years these forces will have a bigger impact than either Hillary or Donald.
This means: Focus on companies and their valuations, that’s what we do. Well managed companies in a diversified portfolio will adjust to the policies of both Clinton and Trump.
What about financials?
We concluded our financial team’s quarterly strategy sessions on Friday and most emerging market banks reported excellent results (loan growth between 12% – 25% year-on-year) which highlights the higher growth rates most emerging markets are experiencing. European banks have so far surprised with better than anticipated results, but returns on capital (ROE’s) generally remain below 10%.
The quarter 3 USA bank results were solid
Loan growth in the US banks remain strong (4% to 6% year-on-year) whilst the combination of improving cost:income ratios and share buy-backs is generating shareholder value growth at 8% per annum. In fact, US banks have grown shareholder value at a compound rate of 10% over the past 5 years despite the regulatory and environmental headwinds.
Our conclusion in terms of potential returns based on current valuations and the past 5 year (and longer) track records are as follows:
“In our selected financials universe emerging market banks and Euro/US/UK insurers stand out in terms of our forecasted three-year returns (30% – 60%), as do the UK challenger banks (60%). US banks show the least upside (18%-30%) but that includes only a 0.25% interest rate hike in December 2016 and possibly one other in 2017.
Friday’s US jobs report was unexpected
Average hourly wages of workers climbed 2.8% in October from a year earlier, the fastest growth in seven years (“Tight US Job Market finally delivers“, Bloomberg, 4 Nov 2016). Other data highlights the increasing probability of more than the two interest rate hikes in the US and the pound’s fall also increases inflationary pressures in the UK. Neither possibility is factored into possible returns. Were they to happen, we would see higher 3-year returns than those quoted above.
“Side comment – with the probability (and it is a high probability based on more than 30 years; experience) of returns like that, I simply cannot understand investors who remain invested in low yielding high risk interest bearing investments.”
But there is a big difference between winners and losers
Figure 4 below highlights the historical difference between winners that continue to grow shareholder value through both dividend pay-outs and growth in shareholder value, vs losers.
I chose a few of our large and small cap developed market winners and contrasted them against those that we’ve consistently avoided. To showcase why we’re 48% invested in emerging market banks I’ve included one of our emerging market banks (no prize for spotting which one it is).
If you invested a $100 on the 1st of January 2011 in each of the 8 companies below, they delivered very different results today (as at 7 November 2016).
We’re in for a volatile 12 months. A new US president and the risk of more game changing events like Great Britain and the possibility of Italy leaving Europe, or the European Union as we know it changing, is a very real possibility.
None of this is good for the business confidence so needed to generate growth. But valuations of many companies are becoming attractive and imply that the current negative outlook will persist indefinitely.
Don’t take your cue from the market by reacting with or after the market when the unexpected occurs. Good managements are paid a lot to continuously change their sails to adapt to and optimise changing conditions. Focus on their track records and what they’re doing, it’s much more rewarding
Kokkie is responsible for managing the award-winning Sanlam Global Financial Fund. He established SIM Global in 2004. Prior to joining Sanlam Investment Management, Kokkie spent five years managing the local and global financial fund at Coronation Fund Managers. Before joining Coronation, Kokkie spent 10 years at Old Mutual Asset Management in various investment management roles of escalating responsibility, ending his career at Old Mutual as the head of the financial services sector. He has received the prestigious UK-based publication, Investment Week’s Fund Manager of the Year award 4 years in a row (2010, 2011, 2012, 2013) in the category financials. Adding to this the Sanlam Global Financial Fund also received the award for the Best Specialist fund for 2012. The SIM Global Best Ideas Feeder Fund (the SA-registered feeder fund for the offshore fund), then still managed by Kokkie, received the Personal Finance Raging Bull Award for its 3 year performance to 31 Dec 11 for the Best Foreign (SA Domiciled) Equity Fund. The Sanlam Global Financial Fund won the 2012 Morningstar award for its performance in the Sector Equity Financial Services category. Kokkie also manages the Nedgroup Investments Financial which is has been awarded the Raging Bull award for the Best domestic Equity Financial Fund for the past 5 years.
Some post notes
A hung election: Don’t ignore the possibility of a “no outcome” or a contested election: Remember Al Gore. We could have a repeat in 2016.
Brexit going forward: The decision of the Supreme Court judges opens the possibility of a softer Brexit and a delay in the invoking Article 50 (after which exit negotiations start). Hence the market’s positive reaction. As Figure 2 shows, a hard Brexit is now the market’s base case, hence we think the UK is becoming an increasingly interesting market in terms of valuation and prospects.
Thuli Madonsela and the Gupta’s: A truly remarkable lady. Think of the loyal and dedicated team that worked through nights and over weekends to complete the investigations AND write a comprehensive 335 page report – against an impossible deadline with no hope of a bonus or any recognition.
South Africans are seriously indebted to every member of her team, she showed remarkable leadership skills.
And hats off to deputy finance minister Jonas who chose integrity and a clear conscience and walked away from a more than R600 million pay-out.
If the Gupta’s could offer that type of pay-out – imagine the size of the amounts they were planning to “steal” from tax payers. Per the public prosecutors report they told the deputy finance minister they made R6 billion off the state and offered him the payment of R600 million because they wanted to increase this.
Now if that money had been allocated to schools and universities…