South Africa’s challenges will not come from Brexit but rather lower levels of economic growth. The companies we are invested in will endure this slower period of growth while the large discounts at which they trade relative to intrinsic value provide for compelling future returns.
Read the transcript of this video below.
South African markets
Events that affected the markets
So, if we look at the second quarter of 2016, undoubtedly one of the biggest events (certainly not only this year, but probably since the global financial crisis), was the British referendum which sent markets tumbling. The interesting thing, of course, is that just one week later, markets have actually recovered quite strongly and are in fact above the levels pre-referendum.
From a South African perspective, the stocks that had been hit in the sell-offs included the property stocks that have significant operations in the UK, such as INTU and CAPCO. And then the financial stocks like Investec, which has a 40% exposure to the UK.
From a South African perspective, the impact of Brexit, I think, is going to be fairly muted, particularly from a growth perspective. The challenges that we have are unlikely to come from Europe; but are more likely to arise from the mining sector in South Africa; which saw a significant downturn in the first quarter of this year flowing into the second quarter as well. Another challenge will come from the agricultural sector, which has been impacted by the drought.
In spite of the negative growth that was reported in the first quarter of 2016 of -1.2%; South Africa managed to avoid a credit downgrade, for now. I think if one looks at the volatility in the markets and the uncertainty obviously created by the Brexit, it did result in some of the defensive stocks outperforming. These include sectors like gold, pharmaceuticals, healthcare and tobacco. In our view, stocks in these sectors are already expensive and so they just continue to get more expensive. The areas that were hit the hardest were ones that are obviously more cyclical and exposed to the economic cycle. They include construction, some of the financial services stocks and South African industrial stocks as well.
How these events and factors affected performance
In terms of the performance of our local funds for this year, we continue to outperform our benchmarks. I think this was helped firstly by the continued outperformance of the value investment style. What also helps us as well as a non-benchmark cognisant manager, is that we do well in an environment where mid and small caps tend to outperform. In fact on a year-to-date basis, we’ve seen significant outperformance from mid caps which are up over 20% and small caps strongly outperforming the Top 40 Index (which is up only marginally for the year). If you look at the quarter, it was slightly tougher. We did a little bit worse than our benchmarks. Stocks that contributed nicely to our performance in the second quarter included Anglo American on the back of the recovery in metal prices; our investment in Adcorp; Sun International; as well as one of the smaller cap stocks, Altron.
I think with only one week behind us in terms of Brexit, it is very difficult to sit here and know how things are likely going to unfold over the coming months and the coming years. What we do know is that the dust hasn’t settled and there will be a lot of uncertainty. The one interesting thing that does come out of this is that we are likely to ensure a much lower interest rate environment for longer. That is good news for South Africans because it probably means that we are closer to the end of the interest rate hike cycle, with possibly one more interest rate increase this year. The other factor that of course is going to play itself out over the next quarter is the local elections. Again, we don’t know how these are potentially going to pan out or what the impact is going to be on stock markets. However, having said that, there are significant opportunities for us that will likely come out of this uncertainty. We will continue to capitalise on the mispricing opportunities that arise from the current environment.
By Ricco Friedrich