BY EQUITIES ALWYN VAN DER MERWE, DIRECTOR OF INVESTMENTS
May 2013 Newsletter
The biggest driver of the prices of South African equities is risk perception.
One can generally put local shares in two baskets: those that deliver a steady or a predictable profit stream and those that grow their earnings in a cyclical or unpredictable fashion. In the current uncertain macro environment, investors are prepared to pay high prices for certainty and they are penalising shares that display a volatile earnings pattern. Surely, this substantial value gap must provide an opportunity to sell expensive shares and buy the cheap ones?
Steady growth
During the years of high-commodity prices, when China grew at 10%, investors generally favoured cyclical counters as they provided a passport to the upside associated with the strong growth momentum of the region. At the same time, investors viewed the steady but lower growth associated with non-cyclical industrial counters not as safe, but as boring. Following the financial meltdown, investors have fundamentally changed that view. Steady growth now represents safety and cyclical earnings are viewed as dangerous or risky. Since 2007, to illustrate this, a typical basket of defensive shares has outperformed a typical basket of cyclical shares by approximately 4.5 times.
Within SPI, we have debated this at length: a strategy that switches from the arguably expensive defensives into the cheaper shares that would resonate well with value or even contrarian investors. The timing of this switch, however, is critical. We witnessed selective value managers make this switch 18 months ago as the gap in valuation was visible even then. These managers have paid dearly – their portfolios have under performed significantly over the period.
Earnings
At SPI, we have gradually started with the ‘big rotation’. Earlier this year we added Billiton. This company has a superior – though cyclical – earnings track record. We suspect the ‘herd’ is pricing this share as if the earnings are unlikely to recover. In fact, analysts are still downgrading the earning expectations globally. Despite Billiton’s enviable track record, the market is prepared to pay significantly higher multiples for the earnings of defensives, like SA Breweries, British American Tobacco or Tiger Brands.
A similar argument can be made for shares like Steinhoff, Impala Platinum or Astral. Although we have started the rotation, it remains a cautious one. We are well aware analysts are generally still downgrading the earnings of cyclical shares. We are also acutely aware of the risks inherent in macro-economic trends. We are mindful that the rotation is likely to dilute the quality of our clients’ portfolios. However, the recent sell-off in these cyclical shares provides wonderful opportunities to rotate – not for the sake of playing to a theme, but simply because the value gap between these respective shares is compelling.
This article was taken from Mastermind, the official monthly newsletter of Sanlam Private Investments, a division of Sanlam Ltd. May 2013. Visit the SPI Website
Related Content
