Nolwandle Mthombeni | Equities were always risky - now it's a whole other ball game

nolwandle mthombeni bw
nolwandle mthombeni bw
  • Equities are one of the riskiest asset classes. 
  • Is the outlook any better? 
  • Each industry has had its fair share of structural changes. 
  • It's best to take a long-term view. 

Market returns over the last five years are a vexing reminder that equities are one of the riskiest asset classes.

Even after the inordinate rally in the first week of June that saw the market gain over 7%, year to date the returns are near flat. If indeed the market is forward-looking, is it saying that the outlook is better now? Is the worst behind us?

Arguably the worst was when the economy was effectively shut down and thousands of households saw income diminish or even disappear. At this point, the market sold off in anticipation that companies on our bourse would be unable to deliver earnings growth in the near term. It is all about growth expectations. If a company is not growing, then nor will its value.

There is an investing precept that equity market investors need to be in it for the long term to get the desired returns. This generally means an investment horizon of over 10 years. Looking back at where the ALSI was trading exactly a decade ago, total returns have been significant in the last decade. Better than most asset classes.

The picture is quite different looking at performance from a starting point of five years ago. This leads me to wonder what a long-term investor can expect over the next decade and where the growth will come from.

The state of the economy is fundamental to the expectations around equity market performance. However, we find ourselves in an economic rut which makes it harder for corporates to sustain growth.

The state of the economy is fundamental to the expectations around equity market performance. However, we find ourselves in an economic rut which makes it harder for corporates to sustain growth.

Beyond our economy’s structural challenges and the smokescreen of Covid-19, many South African companies are operating in far different environments compared to that of 10 years ago. Each industry has undergone tremendous transformation in the last decade, from digital disruption and competition to regulation. These have charted new paths of growth for all the companies concerned and it is worth looking at a few of these.

The banking sector benefited from the oligopolistic structure that synchronised growth within the sector. Reform and regulation helped strengthen the banks which made them even more appealing to foreign investors.

Then came digitisation and fintech. This lowered barriers to entry and instead of choosing the red, blue, or green bank, clients are now choosing between the big banks and new entrants. This will shape how banks navigate the next decade when we come out of this economic crisis, as competition comes back to the forefront.

Our clothing retailers were among the most profitable in the world. Then along came the foreign nationals, such as Cotton On and H&M, that ate their lunch right in front of them. Discounting became the word of the day and margins became eroded. Along the way, the demise of Platinum Group and Stuttafords forced the incumbents to rethink the way they operate.

Some expanded offshore, but it seems that came with its share of woes. The crackdown by the NCR on credit retail also dealt a blow and created a big gap between the cash and credit retailers. The impact of this was seemingly short-lived after becoming challenged in courts.

Online retail has failed to gain meaningful traction due to the mall culture in South Africa. It seems the most considerable change has been competition, and this has impacted pricing within the clothing retailers. Over the next 10 years, I imagine not much will change as there’s little evolution in clothing retail. If anything, what happens to Edcon could potentially influence the next big change. Till then, it will be business as usual, and they will be at the mercy of consumers.

It would be amiss to not mention the property sector which has been the worst-performing asset class this year. In the last decade, not only have the number of malls and shopping centers grown exponentially but also the size of the malls constructed.

Oversupply of retail space

The oversupply of retail space is now biting landlords as they have faced downward revisions to rentals. The bargaining power shifted to tenants. The lockdown has made many tenants consider a turnover based rental agreement. If tenants get their way, property may no longer be the stable income yield asset class that it has been and will be more subjected to the health of tenants. One thing is for sure though, South Africans will still prefer shopping in malls.

The telcos will no doubt have a very different future compared to the last decade. MTN and Vodacom have had significant pricing power and dominant market share. Cell C appeared to be an adept competitor when it came to the market, however, having too much debt cut its reign.

Within the last decade, tech and social media companies have dominated global headlines. A smartphone has become a necessity as opposed to a luxury, with WhatsApp most likely the main form of communication in our country. These factors provided a tailwind for our telcos, despite increased competition within the industry. The "data must fall" campaign caught the attention of the regulator, which did not bode well for the big players.

After much resistance, they eventually capitulated and agreed to lower pricing. Technology is ever-evolving and with smartphone penetration still low in many of the regions our telcos operate in, there is still room for growth. In South Africa, competition will continue to intensify as Telkom stealthily continues to invest in its network and pick up market share. This is one sector that’s likely to have more shake-ups.

This list goes on. Each industry has had its fair share of structural changes. Over the last few years, the low-hanging fruit has largely been picked in efforts to eke out growth in a period where the economy is barely expanding.

To invest in equities, you need to have a long-term outlook, as not only is economic outlook far from rosy but also because within each industry the landscape has truly changed. The waters are murky for now, the easy wins are few and far between, but equities’ higher risk is expected to generate higher returns. For better or worse we should all be in it for the long term.

* Nolwandle Mthombeni is an analyst at Mergence Investment Managers. Views expressed are her own. 

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