Download current investment positioning

CURRENT INVESTMENT POSITIONING : OPPORTUNITIES EXIST FOR GROWTH BUT
EXERCISE CAUTION
The equity markets have been extremely good to our clients over the past five years with the
past three being particularly strong. This has left the normal, late bull market, combination of
less value yet more appetite for risk. There are opportunities for growth but we believe that
investors need to be cautious. The environment of too much money chasing too few assets
continues and may well drive investment markets higher but downside risks have increased.
We have therefore increased the cash and bond portion in our balanced portfolios to just over
40% to compensate for the worse risk reward balance and in anticipation of better
opportunities to buy. We currently only hold fixed interest instruments with a short duration.
In rational economic thinking, as a price moves higher, demand declines with supply
increasing. In investment markets the reverse often happens. As prices move up the number
of buyers of equities increase and the number of sellers decrease. Empirically, one can track
the detailed international investor flow statistics. We find that these are not predictive indicators
but rather coincident indicators, in that flows go where the strong historical returns currently
exist and not where the best future returns can be found. This causes investment markets to
move too far in either direction and can lead to instability.
In the words of Benjamin Graham: “One needs to buy when Mr Market wants to sell assets to
you cheaply and sell to him when he wants to over pay for assets.” As an investment firm we
seek to buy interests in companies that are trading below their intrinsic worth and are rather
sellers of overpriced counters. Experience has taught us that eventually reality prevails and
investors who overpay are exposed to the risk of losses.
The factors that currently concern us in the investment markets and cause us to have
an elevated level of caution:
SOUTH AFRICA
The current investment climate is short of good value opportunities therefore any company
with remotely good fundamentals is being bid up well beyond what could be considered
intrinsic value. The South African economy is not growing, we have large current account and
budget deficits combined with some internal political problems. It is difficult to justify current
valuations based on fundamentals. Due to the slowing Chinese housing market, we are also
negative regarding the prospects for the diversified miners.
USA
The massive amount of money that has been printed by central banks is lifting the values of all
assets and can continue to do so in the short term. This has been a major tailwind to
investment markets over the past couple of years but this is in essence a crisis intervention
policy with dangerous long term risk. The major tool for the Fed to control interest rates in the
USA, namely the Fed Funds rate is now close to ineffective in enabling the Fed to lift rates in
the economy when the time comes. Due to the vast amounts of cash in the system, banks
have very little need to borrow overnight money from the Fed. The Fed is experimenting with
other types of tools to achieve these purposes. It is clear that the USA economy has largely
recovered from the effects of the Great Recession but that the Fed is misreading the slowly
recovering jobs market and allowing inflationary forces to develop. This may require increasing
interest rates a lot faster than the market is discounting. International investment markets will
react badly to increasing USA interest rates.
CHINA
As China marches towards being the largest economy in the world, it is becoming increasingly
likely that they may have some type of major dislocation in this process. A large part of their
economic growth over the past six years has been driven by fixed investment, which in turn
has been driven by huge amounts of new lending. However, proportionally less extra growth is
being generated by each extra Yuan of lending.
Capital has been very inefficiently allocated by the still largely centrally controlled Chinese
economy. There is currently a large adjustment taking place as these imbalances are rectified.
Furthermore a speculative housing bubble is busy deflating.
EUROPE
Europe continues to be mired in a low growth, low inflation swamp. It is very difficult to see
simple solutions for them in the short to medium term. A re-emergence of difficulties in some of
the major European economies is a distinct possibility.
EMERGING MARKETS
Emerging markets are no longer the one way bet that they used to be. A variety of problems
ranging from low growth rates to political instability are a reminder to investors that a healthy
risk premium is needed when investing in Emerging Markets.
GEOPOLITICAL FACTORS
Any one of the potential flash points such as Ukraine, China Islands and conflict in the Middle
East could rapidly escalate in to something more damaging to investment markets.
Positive South African factors:
Winston Churchill, referring to Americans, made the comment that they could be trusted to do
the right thing after having exhausted all other options. We believe that this may apply to the
ANC government as there are signs of movement in the right direction regarding matters that
could have a major impact on the economy. The commissioning of Pravin Gordhan to fix local
government, the potential break up of Eskom and the ANC relaxing its stance on investor
unfriendly mineral legislation, are some healthy moves.
Finding and developing hydrocarbons is a huge potential tailwind for our economy. Large
international players have success rates as high as 60% when drilling for oil and gas, so the
potential for finds off our coast must be taken as significant given the amount of drilling activity.
The potential discovery of shale gas is another economic game changer for South Africa.
The quality of South African corporates remain very high and we continue to find good
opportunities for our clients even within this elevated risk environment.
Kind regards
ROB SPANJAARD \ Portfolio Manager
T \ +27 41 373 0905 W \ www.rezco.co.za
A \ The Zone Loft Offices, 31 Tyrwhitt Avenue, Rosebank, 2196