Podcast: Is it time to replace fear with FOMO?
In this episode, the Denker Capital portfolio managers chat to Nigel Barnes about the current and near-term prospects within the local and global areas that they cover.
Hello everyone, and welcome. We have quite a big crowd in the room today because I’m joined by all of the portfolio managers from the team here at Denker Capital. Going around the table – we have Kokkie Kooyman, Claude van Cuyck, Jan Meintjes, Madalet Sessions and Jacobus Oosthuizen.
We have 11 or so weeks to the end of the year. So I thought it might be a good idea to get the team around the table and really just ask one question: ‘What do they see as the prospects for the year and how this might impact any material changes they make to each of their portfolios?’
So it’s a uniform question to each of you. Let’s start at home. Claude, could I throw this to you? I’m going to ask everyone to keep their response quite short and then we’re going to come to Madalet at the end to wrap up from a multi-asset perspective.
Claude van Cuyck:
The first point to make is, from a prospects point of view, the near-term outlook is likely to remain very challenging and pretty volatile. We’ve seen high inflation across the board and in particular if we look at food inflation, which if you listen to the likes of Pick n Pay and Shoprite, they’re talking about food inflation at around about the 10% level. So if you add this to high energy costs and rising interest rates, there’s no doubt that is likely to squeeze the SA consumer.
We must keep in mind that if we look at food, energy, and the cost of credit, it forms a pretty large proportion of the consumer’s budget. So the impact will be felt, especially over a period where we typically move into a fairly busy festive season. So in a nutshell, I think we’ll start seeing that negative impact coming through in terms of retail sales data over the coming quarters.
To add to that, if we look at the impact of the Transnet strikes on the resources sector, that’s also something we need to keep in the back of our minds. We’ve been unable to export key commodities, including platinum, gold, and the likes of iron ore. And that will rub off on the fiscus.
But having said all of that, this is not new to us. South Africans, I think, have dealt with these issues many times over. So I think, very much, it would be business as usual. And we must also keep in mind that the market is forward-looking, so a lot of these impacts are already reflected in share prices, and already reflected to a large extent potentially in the currency as well.
On the second part of your question in terms of the material changes, we haven’t made any significant changes. A lot of these risks we factor into our thinking and overall positioning in the portfolio as part of our risk management process. We also run pretty diversified portfolios across industrials, financials, resources, also mid, small and large cap stocks. And we do have the benefit relative to our peers that we do have larger exposure to what we believe are fairly attractively valued small and mid-cap shares.
The final point to make, where we have had made a few changes in the portfolio is the recovery that we’re seeing in the hospitality sector. So if we look at quick service restaurants, activity levels have increased quite dramatically. We see that benefit coming through, we believe, in the likes of Famous Brands. Hotel occupancies are improving on the back of both business and leisure travel. That, we believe, will be good for the likes of City Lodge. And then the recovery in the gaming sector. And that together with the improved activity we’re seeing in hotel occupancies should benefit companies like Sun International. So all three of those counters we have added more recently to the portfolio, and hopefully our clients will see the benefit of that over time.
Okay, great, Claude. Thank you. Jan, as part of the local equity team, from a small and mid cap perspective, what would you add to what Claude has told us?
I think Claude has covered most of it. I think it’s true that the world is a different place compared to maybe six months or so ago. Interest rates are now expected to go quite a bit higher. The cost of living is now pushing through on to the SA consumer as well. So there has in the last few months been a lot of talk around the health of the consumer and how that comes through to company earnings. So from that point of view, we are seeing some stress out there from the consumer point of view.
But we do believe that focusing on good quality companies, companies with strong balance sheets, these companies are often well placed to continue to thrive in this environment. So from that point of view, I think banks are probably very well placed. They’re well provided, strong capital, and they’re getting the benefit from the endowment effect of higher rates.
The credit retailers could probably be under a bit more pressure. But as Claude has said, the recovery in a number of the leisure stocks is something that we see as an opportunity. We continue to see value in small and mid caps, a lot of the stocks that I cover. You will notice that all the names that Claude mentioned are in that small and mid-cap space, and I think from that point of view, it is a part of the market that is a little bit isolated from some of the global headwinds that we are seeing.
We’ve had some very good updates from some other small and mid cap stocks like Kaap Agri and CMH. We’re looking forward to their results in the next few days. And I think those companies will continue to do well, despite a slightly tougher environment.
Thank you, guys. Jacobus, over to you now. Global headwinds? – As Jan says, it’s been a challenging year from a global perspective. Your thoughts?
It’s been a challenging year. I think that’s what you could expect after ten years of easy money in the system. We’re coming from very low interest rates, massive liquidity injections in the global money system, and we’re experiencing the unwinding of that. So we’re seeing a lot of volatility.
The market is very much fixated on when the Fed will pivot to a more dovish policy. And so it’s all about when will inflation and interest rates peak? So we think it’s going to be very difficult to bring inflation under control. We’re dealing with structural issues like deglobalisation, tariffs, sanctions, labour constraints. We think governments’ ability to service high interest rates is very limited and also in the political world the ability to push up rates sufficiently to bring inflation under control is going to be very limited.
So we are seeing a lot of opportunities in the market due to this because of the higher cost of money. There are a lot of forced sellers in this market, and we see a lot of the companies that could actually benefit from this environment are selling off. Two examples are Ashtead and Ferguson, which we think both could benefit a lot from capex spend in the US and from onshoring, as manufacturing capacity is brought from Asia back to the US and Europe.
We can just think about recent developments around semi chips, where the US is putting a lot of sanctions on manufacturers in Asia. A lot of that capacity will have to come back to the US and Europe. And these two names will actually benefit from that, and they’ve sold off to the rest of the market. So we think it’s one of those markets where good companies get sold off due to no reason, and we’ve been buying more of those two specific names.
Brilliant, thank you. Kokkie, to you now. Jan mentioned the endowment effect of rising rates on the banking sector. I know that’s something you’ve been talking about for a while now. From a global perspective in the financial sector, what your thoughts?
I must say, in the 35-odd years that I’ve been in the market, I’ve never seen the bank sector as strong in terms of capital and reserves, and as healthy in terms of their loan books, ever. And that’s largely thanks to all the regulatory changes post 2008, and at the same time, being as undervalued in terms of the price to NAVs.
So clearly, the market is following the traditional pattern of selling banks when you’re heading into a recession because of the fear of bad debts, but missing the changes that have taken place. And the results coming through now again, and that will come through this month, will clearly show that, but the market is still driven by fear of the bad debts.
We do know that [based on past experiences] once this cycle ends and the recession has passed its peak, many banks should rally strongly. So we think that will happen, because then you get stronger loan growth and then the market sees that the bad debts weren’t as bad. So we’re really confident about it and sleep well at night at the moment.
The outlook is still poor, so hence the market’s emotionality, and especially in the UK, where the recent changes have almost changed it into a dog show. Liz Truss might be gone by the time we send this podcast out. And how do you invest in times like that? But UK banks are already down 35% in a few weeks, so the market reacts immediately. UK banks are almost now rather a buying than a selling opportunity because of what the market has already done.
So in terms of our own changes, we’ve made very few changes. We actually did sell a bit of UK banks in the run-up, getting worried about what could happen, never anticipating it could be that bad. And with hindsight, we always should have done more. We should have cut half the position. We’ve moved that into countries like Brazil, Indonesia, that are quite far away from the war, far away from the UK, benefit from their resources, from food, inflation.
So, yes, in terms of the rest we’re doing now, we’re actually really happy with the portfolio we’ve got. The results that are starting to come through show that. And so the outlook is, now, I think we’re way past the part of the cycle where you want to withdraw money or increase cash. You’re getting much closer to where the risk/ return is positive, so you want to replace fear with FOMO, as in the next part of the cycle, we think you’re going to be missing out.
Once it turns, and it can happen very quickly if China exits Covid, sees quite a strong rebound or if the war ends (that’s unlikely but we’ve been surprised before), I think where the valuations are now, you’re much more poised for a positive shock than negative. I think the negative shocks are already priced into the bank sector.
Thanks Kokkie. Madalet, let me come to you now. I think just overall, each member of the team has talked about the challenging environment but have all also talked about the opportunities that exist. You run the multi-asset business here at Denker Capital, so you in effect talk to each of these guys on a day-to-day basis, and the building blocks make up what you do. How do you see things?
I’m very grateful that everyone started with all the risks and then moved on to the opportunities. That’s nice. It shows that people have heard me – risks are important. What do I think? I think if you look at the market, by and large, the market no longer really worries about long-term inflation risks, which I think is quite surprising.
We worry about it, and so our multi-asset portfolios continue to try and mitigate against inflation risks. But also, as you heard from everyone in the room, there are opportunities out there and we try and bank them. So we are on the margin allocating additional capital offshore to the equity markets.
As you well know, we don’t know what the future is. The future is definitely different from what the market used to think it would be. But you are now buying that future at 20/20-odd per cent cheaper than it used to be. And so it is inappropriate to have had an equity allocation in December, have taken some losses on that and not reallocated capital into that position.
So on the margin, we are increasing our exposure to risky assets, but doing so in a measured way, all the while trying to protect, not downside so much as specifically inflation risk to investors, which is a hidden downside. If your portfolio is not maintaining the run rate of the inflation, you are actually losing capital for your investors. And so we are desperately looking for assets to help us do that while banking the opportunities.
Okay. Thank you. Claude, as you said, markets are forward-looking. Thank you all for your thoughts as we run up towards the end of the year. You’ve got to… What was it? Change fear for FOMO, Kokkie? I quite like that one. Thank you all. All the best for the rest of the year, and I’m sure we’ll speak to you all again over the next few weeks.
The opinions expressed in this podcast are those of the participants and do not necessarily represent those of Denker Capital. This podcast does not take the circumstances of a particular person or entity into account and is not advice in relation to an investment. Please do not rely on any information without appropriate advice from an independent financial adviser. The value of investments may go down as well as up, and past performance is not a guide to future performance. Denker Capital is an authorised financial services provider in South Africa (FSP number 47075).