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Quarterly Commentary April 2017 “The two most powerful warriors are patience and time.” – Leo Tolstoy Apologies: Firstly, our sincere apologies – our new investment statements are not ready. Producing an accurate statement in a simple, easy to read format that appeals to all clients, as well as incorporating the different management houses, currencies, shares, exchange traded funds/notes, asset classes and regions, is proving to be a lot more challenging and time consuming than we expected. Markets at a glance: 1. South Africa: Standard & Poor’s and Fitch downgraded South Africa’s credit rating in light of the cabinet reshuffle by President Zuma. 2. South African Rand: The Rand was just 2.3% higher against the US Dollar and flat against the British Pound this past quarter. 3. JSE/FTSE: The JSE is up 3.78% year to date including dividends. 4. Allan Gray: We had another tough quarter, while experiencing some positive effects from President Zuma’s decision to dismiss Pravin Gordhan. 5. Coronation Fund Managers: The aggressive Coronation Global Emerging Markets Fund had an excellent quarter. The more conservative strategy, which has a large weighting in USD cash, rebounded after the political decisions by President Zuma – but was still negatively affected by the stronger Rand. 1 6. Investec and ABSA Stockbrokers: All our Investec and ABSA portfolios are overweight USD cash, and were therefore also held hostage by the resurgent Rand. 7. Franklin Templeton: Our US Dollar Franklin Templeton portfolios hit all-time highs. South Africa The big news of the quarter was the dismissal of Pravin Gordhan and a host of other ministers by President Zuma in a major cabinet reshuffle. The Rand has slipped nearly 12 percent since March 27 when President Jacob Zuma recalled then-finance minister Pravin Gordhan from an international roadshow before firing him later that week. Despite the loss, the Rand still trades well above its lows of 2016. Please see graph below. Courtesy: INET Bridge 2 We have absolutely no idea where the Rand is headed – but the actions of President Zuma confirm our worst fears. We feel there is significant risk in holding certain South African assets, other than Randhedged shares with a global footprint. It should however, be borne in mind that on aggregate, roughly half of the JSE’s Top 40’s profits are made outside of South Africa. However, most South African assets are still historically expensive in our opinion. To exacerbate the situation we find ourselves in, interest rates in South Africa are at multi decade lows as well. Please see the chart below. 1985 1998 There is a common misconception that the South African Reserve Bank determines the interest rate. They only set the interest rate – ultimately the market (and investor confidence) determines our interest rate. We need look no further than the interest rate shock we experienced in 1985 – see chart above – at the time of the infamous Rubicon speech and the Asian crisis in 1998. I am sure many of you do not need reminding. No central banker would hike interest rates so aggressively, unless the market forced his hand. 3 The Reserve Bank recently stated that "the risk is that the rand could follow a more depreciated path than expected, which would, other things being equal, raise inflation". Furthermore, after a prolonged period of quantitative easing (printing money), the US is now in an interest rate tightening cycle. Additionally, the president of the Peterson Institute for International Economics, Adam Posen, has told the Telegraph that "The Fed is going to be far more aggressive than people think. Our view is that there will be three to four more rate rises this year," This would be a negative for a commodity dependent economy like South Africa. Political uncertainty and credit downgrades certainly do not help. If this local crisis has legs and foreign investors lose confidence in South Africa as an investment destination, there is a strong likelihood that interest rates could rise rapidly. Lastly, our in-house stockbroker Johan Calitz, points out that South Africa is one of the most economically unequal societies in the world and that unless something is done to address the unemployment and education crises, the situation is unlikely to improve. Unfortunately, President Zuma’s decisions are probably going to affect those who least can afford the ramifications of the latest developments: The poor. This would exacerbate the gulf between the haves and the have-nots, further fuelling the flames of discontent. Factoring in all the risks above, South Africa may well be on the cusp of a perfect storm. One can only hope, that the uncanny ability of South Africa to always rise to the occasion to address her challenges will be echoed in the current situation we are facing now. In the meantime, we continue to tread cautiously with an overseas bias for all our clients and by extension our business. Nothing we have seen in the past couple of weeks gives us any reason to change that approach. 4 Franklin Templeton Franklin Templeton, one of the largest and most respected asset managers in the world, houses the bulk of our USD portfolios. Franklin Templeton is listed on the New York Stock Exchange with a market capitalisation of $23 billion. We have had a very successful relationship with them since 1996. The main reasons why we support them are that: We can invest in their funds or strategies at no upfront charge, we enjoy same day pricing and we have access to almost every asset class in a diverse range of regions throughout the world. I am pleased to report that after a lean period of underperformance – our portfolios are reaching all-time highs in USD terms. This is owed to being overweight emerging markets, which have outperformed developed markets over the past 15 months. One of our largest holdings, the Templeton Global Bond Fund, has also rebounded nicely since its lows of last year (see chart below). As I alluded to in the September commentary last year, patience is one of the most important qualities an investor can have. Courtesy: INET Bridge 5 In the following section, we raise concerns about equity valuations in America. Despite the decent performance in our USD portfolios, we remain extremely vigilant - markets have a habit of making you look extremely foolish when you least expect it. American Markets There are numerous valuation metrics investors use to determine the value of a share or an asset. My favourite metric is the Shiller P/E Ratio. Below is a chart of the top 500 shares in America. It quite clearly illustrates that American shares, according to the Shiller P/E Ratio, have only been more expensive on two occasions – Black Tuesday at the start of the Great Depression and the Tech Bubble of 2000. Tech bubble Courtesy: www.multpl.com For any investment, the price is what you pay and value is what you get. 6 The most commonly used ratio is called the Price-to-Earnings (P/E) ratio, which divides the price of a share of a company by the annual earnings per share of that company. Normally, you want to buy a healthy, growing company when its shares are trading at a low P/E ratio so that you receive plenty of future earnings for the price you pay. However, it is not that easy! Earnings fluctuate throughout good times and recessions. This plays havoc with the P/E Ratio and can thus confuse or deceive even the most experienced investors. Robert Shiller, a professor of economics at Yale and a Nobel laureate, popularized a specific version of the cyclicallyadjusted price-to-earnings (CAPE) ratio to help smooth these fluctuations out and to illustrate a more consistent representation of the ratio between price and earnings. In short, it gives you an average P/E ratio over a 10-year period and thus considers the various business cycles over a decade. In a simple cricketing analogy, this would be like judging a top batsman on his record over a 10-year period, rather than just one season. If one studies the graph above, it is quite evident that American shares are historically expensive. Furthermore, Allan Gray/Orbis note in their latest quarterly commentary that American companies are making up the largest weightings in the global indexes seen over the past 30 years. We believe this is unsustainable and that “this time is not different”. American shares are pricey - do not be fooled by the compelling evidence that Wall Street and analysts present to you urging you to ignore the facts and simply take a long-term outlook. Whilst we are finding excellent value in emerging markets, particularly Chinese internet shares and in Asia, global markets will always be held hostage by the American markets. If the American market tumbles and reverts to the mean, you can be assured that other markets will follow, irrespective of the value on offer. We thus remain cautiously optimistic on our preferred markets. 7 Rounding Off I would like to thank each and every client this past 6 months. It is not easy to see your positions go against you. As the Rand strengthened our portfolios suffered – yet the response from our clients was absolutely fantastic. You have bought into the concept of defending one’s wealth in international terms – and that there are more opportunities if one invests globally as opposed to just South Africa. President Zuma’s actions are not unique to South Africa. South Korea recently had a leadership crisis and Brazil, Russia and Turkey have all suffered from crises in the past 3 years. This affirms our belief that diversification should be the cornerstone of any investment portfolio. Our portfolios did very well recently – this underscores the importance of not having all your investments in one country. We are not sure what lies ahead, but we would again like to thank our clients for their patience. Kind Regards Mike Carruthers SecureWealth (Pty) Ltd is an authorized financial services provider, License Number 6148 Nothing contained herein is or should be construed as advice given or received. 8