The big slumber on the Top 40 Index

Equities, as the historical beaters of inflation, have lost steam and many retail investors and pensioners now begrudgingly keep an equity portion in their portfolios. Local and global market forces have beaten the life out of many of South Africa’s largest and most traded shares.

The FTSE/JSE Top 40 Index, a local benchmark index ranked by market capitalisation, delivered capital growth of 3% per year over the past five years and a total return of just over 5%. Given that consumer prices rose by 5.9% per year over the same period, investors in the Top 40 Index lost out to inflation, even when dividends are considered.

Bonds, or listed debt by government and companies, returned an annual 8.16% over the past five years, according to Bloomberg data. 

In addition to the largest shares’ lacklustre performance over the past five years, several long-standing constituents dropped from the index, while the recent resource price boom benefitted only a few mining stocks. Of the 42-member *Top 40 Index during the final quarter of 2014, only 19 delivered capital growth to investors over the last five years. The other 23 shares delivered declines ranging from 98% for Steinhoff to 5.34% for Absa Group. Some issues were of an international nature while others were geographical and company-specific.

The Fed yanked the carpet

One of the main reasons for the share price malaise among the index constituents was the US Federal Reserve’s (Fed) interest rate hiking cycle which ended last year. Investors from developed economies, conscious of the risk of investing in emerging markets with all their political and policy uncertainties, theoretically favour less risky developed-market assets.

“During the US interest rate hiking cycle that ended in 2018, periods of sell-offs in emerging markets had a negative impact on SA’s 40 largest and most liquid stocks,” says Kwaku Koranteng, head of institutional business at Absa Multi Management. “The negative impact varied depending on the company, its sector and geographical reach.”

For instance, Naspers** performed well over this five-year period, while other listed companies, such as SA miners (up to 2016) and companies in the healthcare sector were negatively impacted, he says. Investors in the three private-hospital shares would have lost at least a third of the value of their capital since 2014.

Mediclinic, Netcare and Life Healthcare, the three largest private-hospital chains in SA, dropped out of the Top 40 subsequent to 2014. Naspers delivered capital appreciation of 304% to investors as its turn-of-the-century bet on Chinese gaming giant Tencent paid off.

Nico Els, fund manager at Ashburton Investments, says that the emerging-market sell-off in assets happened very late in the US interest rate hiking cycle. 

The MSCI Emerging Markets Index, which comprises more than 800 companies in 23 emerging countries, reached its lowest point in January 2016 – a month after the Fed started increasing interest rates.

“Capital flows into emerging markets started to turn only between the fifth and sixth interest rate hikes in the US,” Els says. Higher US interest rates lure investment flows to its capital markets, which leads to an appreciation of the US dollar. This dynamic kicked in belatedly, because the world economy grew robustly in 2016 and 2017, he explains. The clouds, coincidentally, started gathering shortly after Donald Trump became president of the US. 

Els says that interest rates in the US may have been increased more than was justified because of the country’s economic growth rate. Furthermore, Trump implemented significant fiscal stimulus by cutting corporate taxes in the US shortly after reaching the White House. He also expanded infrastructure investment, which boosted economic output to a pace faster than the world average, which in turn led to a stronger US dollar, explains Els. This turned the investment climate against emerging markets as money flowed back into the US.

SA has liquid financial markets that, like other major emerging markets, are vulnerable to negative sentiment that may impact emerging markets, explains Koranteng. 

“During the US interest rate hiking cycle, investors may go back to investing in the US dollar, negatively affecting emerging markets such as SA, and by definition its largest and most liquid stocks,” he says.

Emerging markets, including SA, perform well when there is global economic growth, explains Els. “This is especially the case when world economic growth outpaces US economic growth,” he says. The key determinant of boosting investable emerging market assets is the US dollar. “A weak US dollar is positive for emerging markets,” Els says.

Stocks rattled by the higher interest rates included Anheuser-Busch InBev (AB InBev) and British American Tobacco (BAT). Both companies have significant exposure to emerging-market consumers and rely on those economies to perform well in order to yield high returns to investors. AB InBev (previously listed as SABMiller) fell 27.57% over the past five years. BAT dropped 15.5% over the same period.

By the end of 2017, investors started pricing in a riskier world economy as the likelihoods of Trump’s implementation of trade tariffs against Chinese imports and the UK’s disorderly exit from the EU rose sharply. These uncertainties saw investors flee to safe dollar-denominated assets, which led to a strengthening of the currency, explains Els.

It is a challenge to determine with “high conviction” how and when the US-China trade war will dissipate, as there are unpredictable political factors at play, says Koranteng.

The trade war between the world’s two largest economies affects a significant portion of their bilateral trade. The US imposed levies on more than $360bn of Chinese imports (just larger than SA’s GDP) and China retaliated with tariffs on $110bn of US goods.

Global economic growth is linked to the current geopolitical risks of the US-China trade spat and a messy UK exit from the EU, says Hannes van den Berg, fund manager at Investec Asset Management.

“Geopolitics is affecting the capital expenditure decisions of companies,” says Van den Berg. “Companies are holding back on expansion.”

The implication of a global decrease in capital expenditure for some of the Top 40 Index’s constituents is lower demand for resources, such as copper, he explains. Lower expenditure by corporates in emerging markets would necessarily lead to slower economic growth and dampened consumer demand. In such an environment, sales of luxury goods and beer, for instance, would be negatively affected, he says.

Richemont, which owns luxury brands such as Cartier, Van Cleef & Arpels and Montblanc, saw its share price increase by just 17.3% over the past five years. The company’s Asia-Pacific region is responsible for 38% of its €13.989bn in sales. 

Rand-hedge stocks usually do well when the rand tanks, due to the companies’ offshore sales generation – but these delivered mixed results since 2014. Although the rand weakened by 35.9% over the last five years – from R11.12 per dollar to R15.02 at the time of writing – some of the large rand hedges didn’t keep up.

BAT, Steinhoff, Capital & Counties, MTN, SABMiller/AB InBev and Sasol cost investors dearly (see table). Bidvest, on the other hand, which spun off its food business into BidCorp, saw share price growth of more than 90%. Mondi’s price appreciated by 69% over the past five years. 

“Rand hedges play a valuable role during times of rand weakness due to their economic exposure to different currencies and economies, but they do not all perform in a similar positive manner,” says Absa’s Koranteng. 

Bad choices

Some of the big players, which aren’t traditional rand hedges, ventured overseas in what Van den Berg describes as an effort to de-risk their business.

“South African companies have struggled to compete globally,” he says. “Labour and property costs abroad are different to what we are used to in South Africa.” Some of the costly overseas adventures include Sasol’s Lake Charles Chemicals Project in Louisiana. Starting estimated costs of $8.1bn in 2014 have now ballooned to $12.9bn.

Aspen Pharmacare, which shed almost three quarters of its share price over the last five years, ventured offshore aggressively. Expanding debt and the impairment of R2.88bn intangible assets over the past two fiscal years saw the company sell a chunk of its business in Asia as well as its nutritionals division. Impairment is accounting-speak for writing off an earlier cash overpayment for an asset.

Woolworths’ misfortune in Australia, through its subsidiary David Jones, cost shareholders almost a quarter of the value of their investments from 2014. Similarly, MTN’s struggles in Nigeria, among others, saw shareholders lose more than 60% of their capital since then.

“The execution of some of these international expansion programmes, often funded via debt, has had negative consequences for many SA companies,” says Absa’s Koranteng. “This was driven by economic concerns in SA and the desire to make these companies global.”

*The FTSE/JSE Top 40 index (J200) has a fixed number of 40 constituents. However, due to the dual-listed structure of Investec Ltd and Investec Plc, the index has 41 instruments. Previously, Mondi had a similar dual-listed structure. The Investec instruments are weighted separately in the index, but for ranking purposes their market caps are aggregated to determine the position in the index universe.

**finweek is a publication of Media24, a subsidiary of Naspers.

This is a shortened version of our cover story that originally appeared in the 24 October edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

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