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SIMON BROWN: I’m chatting with Siboniso Nxumalo, the chief investment officer, Old Mutual Investment Group, or OMIG. Siboniso, I appreciate the time today. US News recently wrote an article asking if the stock market was going to crash in 2023 or 2024. Is this a fear that has found its way into the market? Certainly there’s been fear around a potential US recession. Are we now worried about a market crash as well?
SIBONISO NXUMALO: Generally, Simon, when there is a recession it is priced in the market in the form of a crash. But let’s go back to this article and this idea of why there would be a recession in 2023 and 2024.
Basically after 2008, the global financial crisis, what happened was interest rates obviously collapsed to almost zero in the developed world – in America in this particular instance that we’re talking about – and stayed flat for a long time; and the government threw in a lot of stimulus in the form of what they call ‘quantitative easing’ into the market. So the market was supported, and at that time we saw some really great market returns.
Covid kind of interrupted that a little, but the government came back with the same playbook where they threw [in] even more money. This time they gave individuals actual cheques [during] Covid, while people were staying at home. And interest rates again went back down to zero.
And so that period of easy money was very supportive for company revenues, for company profits; and also, because there was no inflation, costs weren’t increasing materially. Therefore, if your revenues are growing materially because they’re supported by strong markets, and your costs are not growing, your earnings and your profitability are going to be great.
And that’s what happened. That’s what easy money did; [it drives] markets higher.
Obviously now we are in a different world, Simon. Interest rates have increased very quickly. And so, when interest rates increase, that’s going to put pressure on markets. It puts pressure on consumers because your cost of debt is higher; it puts pressure on companies because your cost of debt is higher. And obviously there’s a wage cost too, because wages have got to match the increase in inflation – which means the profitability of companies starts coming under pressure. We’re starting to see that now.
And if that then plays out into the fall, then that is likely to lead to a compression in profits or earnings or the profitability of companies going negative, which then, combined with a recession would lead to some form of market crash.
SIMON BROWN: The take on the recession – we’ve been hearing lots of talk around a recession. The debate was ‘Hard or soft?’. There was a fair bit of consensus that it would happen in 2023. It hasn’t arrived, but that has kind of been kicked out to 2024. What’s your take on the likelihood of it, and other perhaps emerging risks as we look into the next year?
SIBONISO NXUMALO: Simon, Let’s explore the question of why this long-anticipated and spoken-about recession hasn’t happened.
Again, if we go back to 2021 where people were given lots of cash physically in the US and yet were staying at home, what happened is what built up – and you can see this globally if you look at even a country like South Africa – is that because we weren’t going out partying and enjoying life, we weren’t spending. And so people built what was called ‘excess savings’.
So people’s savings in balance sheets actually went up and people then had a surplus of cash. Those savings in America have taken a long time to actually come out and be consumed by the higher costs driven by the higher interest rates and higher inflation. That then has distorted or delayed a potential recession.
So as we are sailing to 2024, those excess savings have now been consumed by the higher costs – obviously driven by the high inflation. That then is what makes 2024 a little more dangerous, with a higher probability that this feared recession might land in 2024.
SIMON BROWN: If we start to look more broadly, obviously the global environment is important; that’s where investment opportunities lie for investors. And for a local investor the local environment is equally important. What’s happening in the local market that has been influenced by the global environments, looking into the new year?
SIBONISO NXUMALO: Well, Simon, I’m going to talk about China on this particular one. China is the second-largest economy in the world but, in terms of South Africa, China actually has a disproportionate influence. Why? China is and has been for probably the last two decades a dominant consumer of commodities. We are a commodity-producing nation, and so all these commodities, if we can get them out on rail, most of them end up going to China. And so China’s important in that.
And if we look at our stock exchange, resources will occupy about 30% of our stock exchange, which are largely driven by Chinese consumption. Then you’ve got Naspers/Prosus, which will occupy around 12% of our stock exchange. And we’ve got Richemont, the luxury goods company which also is largely driven by Chinese consumers.
So you could actually see how half of our market in South Africa is driven by what happens in China.
Now what is really coming through in China is that the Chinese population has peaked and Chinese property – which in China has been used as a store of value – is coming under pressure. China has over-invested and over-built over the last two decades, using commodities to obviously build, especially [with] steel in terms of that.
So China starts slowing down – especially the commodity-consuming old economy of China. As that comes down, what happens then to commodities? What happens to commodity prices? Now, as a country which obviously is a commodities manufacturer, that is not good for South Africa. So we are going to have the Chinese slowdown have a direct impact on the South African economy.
But the South African economy in 2024 is also heading towards an election. For the first time there’s a risk that the dominant party, the ANC, might not get an outright majority, [and] then it has a very short period of time to try and figure out a coalition government.
Now, with the other coalitions we have had in the provincial spaces in South Africa, we’ve seen that those haven’t actually been functional and so we have that uncertainty, again, of a political year in South Africa.
The other side of it is that our state-owned entities are under immense pressure, because they’ve been completely dysfunctional.
Simon, we are a country that is structurally looking really weak in a global world that is also looking weak, so we are expecting South Africa to continue to come under immense pressure.
Yes, cyclically we could see a bounce because it looks like load shedding is getting slightly better off a really bad base. So cyclically we could see South Africa come up. You could probably make some money in South Africa from the domestically focused small-cap companies, but generally as a country we aren’t very optimistic about South Africa. Actually we are very nervous about South Africa.
So stock picking in South Africa starts counting quite a lot. You’ve got to buy the right companies in South Africa.
SIMON BROWN: Taking that into account – and I take your point, I want to dig into the right companies in a moment – should investors then start looking for some downside protection, or do you still just focus on maximising return?
SIBONISO NXUMALO: You are always trying to maximise return, Simon, but maximising return depends on where you are in the market cycle.
In this particular instance in South Africa we have been buying – especially in our multi-asset funds – government bonds. Government bonds in South Africa are yielding a very attractive return on a risk-reward basis.
So we would rather have government bonds, and we’ve been decreasing our equities exposure in South Africa.
Now the equities we’ve been buying in South Africa have also been very slightly different. We’ve been staying away from the more cyclical equities in South Africa and we’ve been buying more defensively orientated equities. I told you a negative story about the US, the biggest economy in the world, I told you a negative story about China, the second-biggest economy in the world, then I’m telling you a negative story about South Africa. So caution is warranted.
Therefore, if you look at our top two tilts in terms of the active weights that we have in the market, they are British American Tobacco and Anheuser-Busch.
British American Tobacco is one of the largest tobacco companies in the world, very defensive, very diversified in many regions in the world, and it’ll grow. But it’s looking very attractive with a very attractive dividend yield.
Anheuser-Busch, the biggest brewery beer company in the world, bought out South African Breweries back in the day.
Again, whether or not the market is good or bad, people are going to consume those products – tobacco and beer in this particular instance.
And so yes, we are looking at the world, we’re saying we are getting great returns on government bonds, both in South Africa and internationally; so we’ve bought quite a lot of government bonds. But we are also then seeing great returns or better risk-adjusted returns in the more defensively orientated names rather than the cyclically orientated names. Therefore we’ve been buying shares that are a little more defensive in their nature.
SIMON BROWN: And this is almost a return – not a return, but a coming back of classic defensives and of diversification. You have always diversified. You never go all-in on one stock. But the rise of bonds has been one of the stories of 2023, and you’re obviously expecting it to continue into the new year.
SIBONISO NXUMALO: Yes. We definitely are because we believe, at this moment where we are in the cycle, that the return off capital is preferred to the return on capital.
So in a normal market, from the bottom of the 2020 Covid recovery up until the end of last year our funds were very aggressively positioned because we believed that the return on capital would be rewarded. At this moment, we are seeing a lot more risk and a lot more challenges in global markets. And so the return off capital – preserving client’s capital – is much more important at this particular moment. And hence we can talk about seeing greater risk-adjusted yields in the market.
Simon, I keep adding ‘risk-adjusted’ because there’s always risk and therefore our job is to find opportunities that are attractive relative to that risk. In this particular market we are finding bonds on both a domestic and a global basis highly attractive.
SIMON BROWN: I take the point. There’s no investing without that risk. It’s how we manage that risk that’s so important.
A last question. As an investment house very much sort of basing on themes, if we are looking into 2024 are there those themes? Having chatted to you for the last 10 minutes or so there seems to be caution, there seem to be bonds which are a good risk-adjusted return. Would those be your key themes or are there some others that I’ve missed?
SIBONISO NXUMALO: We look at the world in two dimensions, Simon. We call them theme and price. Price has been the valuation of an asset – what’s the price of an asset? And the theme is then whether it’s a macro industry company or ESG-related theme that will drive a rerating in the assets we’re investing in.
So in our world we do a lot of work on themes, and there are four themes that we are currently seeing in the market.
The first one is what we call a global cycle down. What do we mean by that? We are saying actually that’s where that recession comes in, in that interest rates have risen quite materially and they usually have a lagged impact, so it’ll take, from the peak, 12 to 18 months, depending on the cycle, for interest rates to actually bite. We are yet to see that bite and that’s where the risk of a recession and interest rates rising are not good for risk assets – which are equities. Hence we are [in] cash, bonds and obviously defensive names.
The second theme we’ve seen is higher long-term inflation. We think that if you lived in the developed world, in Europe and America, for four decades you’ve seen inflation generally trending downwards. We think that that is over, that the world has changed. Covid also assisted in that change in the sense that we’ve seen that the decline in inflation, the structural decline, because China emerged as the manufacturer of the world; everything was made in China.
But actually Covid taught us that those supply chains are not sustainable. And therefore we are starting to see different countries diversifying where they’re manufacturing goods, and that is going to lead to higher inflation because they are not manufacturing at the lowest cost.
So we are seeing sustained higher inflation, which means we’re seeing sustained higher interest rates – which is again not good for equity markets. And there’s going to be a higher cost of capital, which is also not good for equity markets.
The other one, the third theme, is what we call a multipolar world, and that we are entering a world of a lot of uncertainty. We’ve got the US which we are saying, hey, is recessionary. Then we’ve got China, the old economy of China in terms of [being] infrastructure related, is going to come under immense pressure. But actually we are still kind of constructive on China and the consumer. So actually we’ve owned Richemont, we own Naspers/Prosus because we think the Chinese consumer should be resilient, but we are underweight commodities because we are fearful that the more industrial-related drivers in China are going to change.
And then the final [theme] is that we see South Africa as a long-term loser, in that South Africa has some real structural challenges, and we can see these playing out.
We are especially trapped in a low-growth scenario. Our SOEs [state-owned enterprises] are failing, there’s a lot of political uncertainty in the country – and it’s going to take quite a while for us to change.
Part of that change, Simon, is that in South Africa we are starting to see some form of reform, and it is driven by this notion we would call ‘privatisation via stealth’, that Eskom fails as a state-owned entity, and what we are then starting to see is the privatisation of electricity generation; people put on solar panels and companies and mining companies invest in their own generation. That is privatisation, but it’s by itself. Again, it’s going to improve but it takes time.
We’re seeing the same thing, then, with Transnet. The private sector is starting to get involved in solving government’s problems.
These are good things because private companies can deliver. They want to deliver, they are incentivised to deliver, but it takes time to orientate around that.
So we think South Africa is going to go through some tough years, but it’ll come out on the other side. If the private sector is allowed to obviously assist in its recovery, it’ll come out actually on the better side. South Africans know how to survive.
SIMON BROWN: That is one thing as South Africans we do immensely well. We can see that from the results that come out of the JSE. Tough times, but the CEOs and their teams are managing it.
We’ll leave it there. Siboniso Nxumalo, chief investment officer at Old Mutual Investment group, I really appreciate the insights.
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