The Confidential Report - June 2017
6 June 2017 By PDSNETThe successive new record highs on Wall Street since last month have motivated us to set down our underlying philosophy and understanding of where the stock markets of the world are right now, in the context of where they have been in the past. We believe that, without the framework that we set out here, it is difficult to make sense out of what is happening in the markets day to day.
Wall Street
The S&P500 index has made a new series of record highs since last month – closing at 2439 on Friday last week. To get a good understanding what this means and how it came about, you need to first understand the [glossary_exclude]long[/glossary_exclude]-term context of exactly where the world economy and more particularly, the US economy, is in relation to its history. Without this deeper understanding, you will be as confused as most economists and analysts seem to be in the face of this relentless and apparently unstoppable upward trend on Wall Street.A Bit of History
Firstly, we need to go back to the crash of 1929 and the great depression. What few people still remember is that that crash was actually anticipated by a Russian economist, Nicolai Kondratiev, in his book “The Major Economic [glossary_exclude]Cycles[/glossary_exclude]” which was published 4 years before the 1929 crash in 1925. What Kondratiev said was that roughly every 54 years there would be a collapse of commodity prices in the world economy. He traced this cycle back 300 years, but it had already been recorded thousands of years earlier on the Hamurabi stela which dates from 1770 BCE. This 3700-year-old stela talks about periodic economic booms and busts known as “Jubilees” which come roughly every 50 years. This idea is echoed in the Old Testament in the book of Leviticus (25, 8-13). We believe that this historical cycle corresponds to the economically active life-span of man. In other words, you become economically active in your early twenties and you cease to be economically active in your middle to late seventies. My father was born in 1915 and went through the great depression during his most formative and impressionable years. This set the tone for his entire generation’s attitude towards money. He hated debt of any sort. His philosophy was summed up by the phrase, “if we can’[glossary_exclude]t[/glossary_exclude] pay cash for it, then we do without”. Everyone who experienced the great depression first hand had a deep and immovable fear of debt. They avoided credit cards, trade accounts and overdrafts – in both their personal and business lives. The impact of this over the next 50 years was enormous. But by 1987 the influence of this generation was waning rapidly. Those that were still alive were in their mid-seventies. As their influence faded, so debt levels began to creep up again – personal debt, business debt, international trade debt and government debt. Kondratiev’s commodity price cycle is really a cycle of debt clean-outs. It seems that every generation has to learn for itself that debt levels cannot keep going up for ever. At some point the piper always has to be paid.Another Bit of History
After the 1929 crash and during the Great Depression, John Maynard Keynes published his book “The General Theory of Employment Interest and Money”. In this book he argued that the Federal Reserve Bank had adopted exactly the wrong approach after the collapse of Wall Street in October 1929. He argued that instead of adopting a “tight” monetary policy, what they should have done was to inject additional funds into the economy to compensate for the wipe-out of wealth on the stock market. The tight monetary policy they adopted, said Keynes, caused the cycle of bank collapses and unemployment that came to be known as the Great Depression of the 1930’s. Fast forward to 1987, Ronald Reagan is a second-term Republican President and in October the S&P500 [glossary_exclude]index[/glossary_exclude] falls 23% in a single day. This is more than double the fall on “Black Monday” (that was 9% on 28th October 1929). The Republicans very much wanted to win the election in 1988 and so they called in their recently appointed Governor of the Federal [glossary_exclude]Reserve Bank[/glossary_exclude], Alan Greenspan. Greenspan was an avid student of John Maynard Keynes and he told Reagan that he knew exactly what to do to avert another Great Depression. What he did was to gather the leaders of the G7 (the seven largest economies in the world at the time) and persuade them that they had to pump money into their economies to compensate for the collapse of their stock markets. They did exactly that - and the results were nothing short of spectacular. The stock market stopped falling in March of 1988 and, 23 months after the 1987 crash, it reached a new all-time record high. So successful was this cash-injection policy that Greenspan repeated it at every stock market bear trend for the next 19 years that he was Governor and his successors (Ben Bernanke and Janet Yellen) have continued in a similar manner. The problem is that in the 1980’s it took tens of billions of dollars to turn the world economy around. In the 1990’s it was hundreds of billions and in the noughties it was trillions. In other words, each successive cycle required a more and more powerful stimulation to avoid the inevitable debt clean-out. And debt levels went higher and higher. The US government debt was $3,5 trillion in October 1987. Today it is about $20 trillion. If you really want to scare yourself witless go to the web site: https://www.usdebtclock.org/The Sub-Prime Crisis
In 2008, following the sub-prime crisis, the Federal [glossary_exclude]Reserve[/glossary_exclude] Bank of America, in its efforts to stimulate the economy, just ran out of money. But that was no problem. Taking a leaf out of Robert Mugabe’s book, they began to print it. They literally created massive quantities of money and injected it into the US economy. Other economies followed suit. Europe is still printing and injecting 60 billion euros a month. Altogether the central banks of the world have created and injected at least 12,5 trillion dollars into the world economy. This creation of money (known euphemistically as “quantitative easing”), combined with holding interest rates at [glossary_exclude]close[/glossary_exclude] to zero percent for at least 7 years, is finally having the desired effect of turning the US economy around. At last scared consumers and businesses are beginning to spend again. Up to now they have been sitting on cash, hoarding it in case things got bad again. It has been estimated that the non-financial companies of the world alone are sitting on about $7 trillion. In South Africa alone non-financial companies are currently hoarding about R600 billion.Now
But now, finally, after eight years and the most powerful stimulation in history, the US economy is beginning to show definite signs of life. The better-than-expected increase in the non-farm payroll in April of 211 000, followed rapidly in May by the creation of a further 253 000 jobs – means that the US economy has created almost half a million new jobs in just two months. This is a [glossary_exclude]clear[/glossary_exclude] indication that, once again, the mighty US economy is stirring into life. Of course, smart investors all over the world have known about this for a [glossary_exclude]long[/glossary_exclude] time. They knew that, sooner or later, all that cash which was sloshing around in the world’s financial system would begin to be spent. Because of that understanding, they have been bidding the S&P500 up since March 2009 in anticipation of the economic boom that is now finally starting to happen. As people slowly regain their confidence they will spend more and more. That will create even more jobs and bigger profits for companies – who will employ more people and pay those people higher salaries – which will result in even more spending. We believe that the non-financial companies of the world will not only spend the $7 trillion that they have been sitting on for the past six years, but they will borrow five times that amount and spend that too. As confidence grows, we will see a series of amazing asset bubbles such as the world has never known before. The Dutch tulip mania of the 1637 and the excesses of the early nineteen-twenties will pale by comparison. Right now, many analysts, both inside America and outside, appear to be confused and bewildered by the relentless progress of Wall Street (and all stock markets world-wide). They fearfully describe equities as over-priced and speculate about the top of the market and a new [glossary_exclude]bear trend[/glossary_exclude]. They find it more and more difficult to justify the prices at which shares are trading based on the profits of the companies which they represent. That disconnect between earnings and share prices will be a feature of markets during this great [glossary_exclude]bull trend[/glossary_exclude]. What is amazing is that none of these analysts appear to have considered the impact of the unprecedented monetary stimulation that has been applied to the US economy over the past 8 years – and to other major economies world-wide. It’s as if they believe that, now that quantitative easing is coming to an end the $12,5 trillion that has been injected into the world economy is somehow irrelevant to Wall Street, and other asset markets – a part of history - but it is not. We believe that Wall Street is heading into the greatest bull market that the world has ever seen – driven by:- The most powerful monetary stimulation in history (which is still on-going in Europe and elsewhere).
- The massive decline in oil prices since 2014/15.
- The enormous business and personal efficiencies being introduced almost daily by technologies such as high-speed internet connection, smart phones, driverless electric cars and rapid advances in battery technology.
S&P500 2008 to 2017 - Chart by ShareFriend Pro
The [glossary_exclude]long[/glossary_exclude]-term channel (8 years old now) and its direction cannot really be argued. In the context of this overwhelming market [glossary_exclude]thrust[/glossary_exclude], the machinations of Donald Trump are almost irrelevant. He is taking credit for a boom in the US economy and S&P500 which was set in motion before he even considered running for office. South Africa is in a similar situation. Our economy will be/is being dragged up by the world economy more-or-less irrespective of what President Zuma is doing. In other words, what we are saying is that, in your preoccupation with the latest Zuma scandal or machination, do not lose sight of the fact that you are in the middle of what will almost certainly turn out to be the greatest economic boom and stock market [glossary_exclude]bull trend[/glossary_exclude] in history.The Elimination of the Bears
One of the most interesting aspects of a great [glossary_exclude]bull[/glossary_exclude] market is a process that we call “The Elimination of the [glossary_exclude]Bears[/glossary_exclude]”. As the [glossary_exclude]bull[/glossary_exclude] market progresses and shares trade for ever higher prices, periodically, a share market expert such as an economist or an investment analyst will stand up and publicly proclaim that the market is at or very [glossary_exclude]close[/glossary_exclude] to its top. He will advise investors to sell out and protect their capital against the inevitable [glossary_exclude]bear trend[/glossary_exclude]. Then a few months later, when the [glossary_exclude]bull[/glossary_exclude] has made a further series of new highs and everyone who listened to him has missed out on share market opportunities, he will be discredited and forgotten. But then a new “expert” will pop up with the same story, proclaiming that this is now definitely the top and with the same advice to investors to liquidate while they still can. And he too will be relegated to the scrap heap as the market moves inexorably higher. And so the process goes on, with one bear after another being eliminated. Until, of course, a point is reached where no one any longer has the courage to call the top of the market. All the bears have finally been eliminated. When you see that, you must run for [glossary_exclude]cover[/glossary_exclude], because then you are indeed very [glossary_exclude]close[/glossary_exclude] to the top! In this context, it is interesting that at the recent Financial Analysts Conference in Philadelphia, Yale Professor Robert Shiller, who is ranked as one of the 100 most influential economists in the world, suddenly changed his tune – from being a consistent bear he has suddenly found bullish inclinations and suggested that the S&P could still go up 50% from its current levels. Shiller developed the much-followed “Cyclically Adjusted Price to Earnings Ratio” or CAPE. This ratio is calculated by dividing the S&P500 [glossary_exclude]index[/glossary_exclude] level by the average of the previous ten years of earnings from the 500 companies which make up the S&P. Consider the [glossary_exclude]long[/glossary_exclude]-term chart of the CAPE ratio:
Source: https://www.cnbc.com/2017/04/27/robert-shiller-high-valuations-make-stocks-dangerous.html
Based on this chart, Professor Schiller says that the S&P is dangerously over-priced - but now he has unexpectedly announced could go 50% higher. We believe that the CAPE is actually showing that this great [glossary_exclude]bull[/glossary_exclude] market is just getting off the ground. It should exceed the peak of 2000 comfortably and go on to new record highs as the relationship between company earnings and share prices breaks down completely. We have to wonder what Shiller will say when the S&P surpasses even that level. As indicated in our earlier writings, based on point & figure methods, we believe that the S&P will rise well above 3000 in time.
The report that President Donald Trump asked FBI [glossary_exclude]director[/glossary_exclude] Comey to drop an investigation into his erstwhile National Security Advisor, Michael Flynn had a huge impact on Wall Street – causing the S&P to drop by 1,7% in a single day. This shows that politics in America can have a direct and immediate effect on the share market, just as it has had in South Africa. The current political leadership in the two countries has been described as a “kakistocracy” meaning, according to the Oxford English Dictionary, political leadership by the “worst possible citizens”. In a well-run country, politics very seldom has an impact on the markets.
The growth in the S&P so far this year has been led by tech shares which are up 17% so far. And this growth has been stimulated in better-than-expected earnings figures. The real question is how much of this growth is due to the perception the Trump will reduce taxes. But the tax cuts he is proposing will probably only impact the profits of S&P companies next year so they are unlikely to be a major factor in the S&P yet. The threat to his presidency posed by the Comey letter is having a [glossary_exclude]clear[/glossary_exclude] short-term impact at least, but that seems unlikely to be sustained, given that strong bullish sentiment is more likely a result of the groundswell growth of the US economy at large.
South African Politics
The decision by Cosatu to ban President Zuma from addressing any of their meetings is a huge and embarrassing blow to him and to the ANC. Cosatu had already said that he should step down and his attempt to address their May Day celebration turned into a farce. It is also significant that the ANC leader addressing the May Day [glossary_exclude]rally[/glossary_exclude] in Durban was booed off the stage. Durban is the center of Zuma’s Natal stronghold. Clearly, Zuma is losing the [glossary_exclude]support[/glossary_exclude] of the people. He is clinging onto power by packing out key state positions with sycophants. But without the underlying [glossary_exclude]support[/glossary_exclude] of the people, he cannot hope to remain in power for [glossary_exclude]long[/glossary_exclude]. The real question is whether he will take the ANC down with him. Following the [glossary_exclude]failure[/glossary_exclude] of the second NEC motion of no confidence to unseat him, this looks increasingly likely. Mr Zuma has had a dinner with Business Leadership SA (BLSA) and the CEO initiative to try to repair the damage which he caused by his cabinet re-shuffle. The meeting was described as “cordial”, but the damage done to the relationship between government and business will take more than a dinner to resolve. BLSA had refused to meet with the new Finance Minister before his trip to the World Economic Forum. In general the CEO initiative has blamed Zuma for destroying their efforts to avoid a ratings downgrade. Our new Minister of Finance’s choice of Chris Malikane as an advisor appears dangerous. Malikane’s statement since adopting his new role flies in the face of his own peer-reviewed papers and economic common sense. He speaks of changing the constitution by violent uprising in [glossary_exclude]order[/glossary_exclude] to implement widespread nationalisation and expropriation of land without compensation. In effect, he wants South Africa to go through the same process as Zimbabwe. He also apparently has links to the infamous Gupta family. Hopefully, his radical views will not find expression in economic policy, just as they have not yet found expression in his academic papers. The new Minister of Energy has come clean about the sale of South Africa’s oil stocks in December 2015. The then Minister, Joemet-Pettersson stated categorically that the sales were a routine “[glossary_exclude]rotation[/glossary_exclude]” of oil stocks. The new Minister says they were not. The sale was done at $28 per barrel which was considerably below the ruling price of the time. If the stock were valued at $50 per barrel which is roughly where oil is today, the loss in selling at $28 would be about R3bn. Apparently, those responsible are to be held accountable. The application by Petro SA to be placed into business rescue is another headache for the new minister. Petro SA made a R14,6bn loss last year and expects a further R2,2bn loss this year. By entering business rescue, the directors will avoid [glossary_exclude]liability[/glossary_exclude] for trading recklessly. It is hard to see what value Petro SA adds to the South African economy. The move towards various populist remedies is gathering [glossary_exclude]momentum[/glossary_exclude] with the Zuma camp seeing this approach as the best way to reverse their growing unpopularity. Among other moves, the parliamentary enquiry into the Financial Services Charter has resulted in strongly worded statements about the concentration of financial power in the hands of the big four banks. Mr. Zuma’s success in getting control of the Ministry of Finance still leaves him vulnerable to the banking sector, especially now that he has signed the new FICA regulations into law. The reality is that the banking sector in this country is world [glossary_exclude]class[/glossary_exclude] and has won recognition internationally. Efforts to interfere with the ownership of banks would have far-reaching negative consequences for South Africa. Compliance with the Employment Equity Act requires large companies (mainly those listed on the JSE) to employ people in similar ratios to the demographics of the South African population. The fact that half of the 192 companies referred for prosecution in terms of the Act are listed on the JSE should be a concern for investors. At the moment nearly 70% of top management in listed companies is white. That percentage is coming down and the percentage of black representation is increasing, but not quickly enough to satisfy the Department of Labour. Once again it would appear that business may be forced to comply, which may have negative consequences, at least in the short term. As the ANC loses power we can expect them to become more and more populist in an effort to win back grass roots [glossary_exclude]support[/glossary_exclude]. BEE and populism are rapidly becoming synonymous in South Africa. Cyril Ramaphosa’s apology to the families of the 34 miners killed at Marikana shows that he is aware of the damage which his e-mails about this matter have done to his chances of replacing Zuma as president of the ANC (and the country). This is an unusual effort to do some political damage control. The ANC have made almost no attempt to address the enormous damage done to their party by Zuma’s various actions or his blatant connection to the Gupta family. Perhaps this shows a heightened political awareness and concern about [glossary_exclude]support[/glossary_exclude] within the party. Protest action has become endemic in South Africa and it is often coupled with xenophobia. Black people living in the squatter camps that have proliferated in the New South Africa, still do not have running water, water-borne sewerage, electricity, proper housing and a multitude of other basic necessities – even after 23 years of ANC rule. The unemployment [glossary_exclude]rate[/glossary_exclude] hovers around 27% and the economy grew at a measly 0,3% last year. The ANC, which has frequently talked about creating jobs, has in fact destroyed hundreds of thousands of them by attacking various sectors of the economy (like mining). The steel sector is on the brink of collapse due mainly to [glossary_exclude]cheap[/glossary_exclude] Chinese imports and the construction industry has been reduced to a fraction of the size it once was. The fact that South Africa may well avoid recession in 2017 is due to a recovery in commodity prices and not any policy reform. Zuma’s refusal to resign despite widespread calls from almost every level of society means that the democracy will have to endure the current situation (or worse) for the next two years. Hopefully by then a change in leadership will herald a new era of economic growth. The re-appointment of Brian Molefe as CEO of Eskom would have set a really bad precedent for South Africa. He was implicated in the shady dealings around Tegeta and the Guptas by the Public Protector. Until that issue is resolved he should not hold any office and should not be a member of parliament. But he is clearly part of the Zuma faction and protected as a result. Eskom owes more than R300 billion most of which is covered by government guarantees. It is by far the most important parastatal. It should also be remembered that it was Molefe who objected to the Independent Power Producers Program.The Rand
On Thursday 18th May, the rand suddenly lost about 3% of its value against the US dollar. The cause of this sharp drop was a new political scandal which broke in Brazil. This shows the emerging economies’ currencies are grouped together by international currency traders. The Brazilian real fell by 7% and its stock market was off 10% on the news. The potential for emerging economies to have political disruptions is not limited to South Africa, it seems. Happily, the rand has regained most of what it lost and looks set to go stronger on US dollar weakness.The Economy
The first real evidence of the damage caused by the firing of Gordhan as Minister of Finance and the downgrades is evident in the Purchasing Managers Index (PMI) for April. In the first three months of the year the index had climbed steadily to 51,9 – indicating an improving economy. The April figure came in at 44,7 – a massive drop. Confidence will probably pick up as consumers and businesses become accustomed to the new status quo, but there can be no doubt that South Africa’s nascent recovery was snuffed out just as it was getting going. This is further supported by the leading indicator which fell 0,4% in March. Trevor Manual has stated that the National Development Plan (NDP), which he helped to build, is failing. Jeff Radebe, the current Minister in the Presidency, is indignant, but the facts speak for themselves. South Africa is nowhere near the growth of 5,4% per annum required to meet the NDP’s projections. The inflation [glossary_exclude]rate[/glossary_exclude] (the consumer price index) for April month came in somewhat lower than expected at 5,3%. This is in contrast to March’s 6,1%. It is also within the target [glossary_exclude]range[/glossary_exclude] of 3% to 6%. The cause is clearly the drop in food inflation because of the much improved harvest this year and a fall in fuel prices. Consumer demand is also under considerable pressure and confidence levels are [glossary_exclude]low[/glossary_exclude] following the downgrade. Unfortunately, there is still little room for an interest rate cut, but if the rand remains stable or strengthens, we could expect cuts later in the year. The Monetary Policy Committee wants to see evidence that the CPI will remain inside the target [glossary_exclude]range[/glossary_exclude] before cutting rates. South Africa’s currency rating is under threat and a further downgrade could result in a massive movement of capital out of South Africa. This is because much of the capital is provided by institutions that invest in “index funds”. These are funds that mimic various international indexes by buying exactly the same instruments in exactly the same proportions. South Africa has already been removed from the JP Morgan investment grade[glossary_exclude] emerging market bond[/glossary_exclude] index and JP Morgan will remove it from three more indexes at the end of May. If the rand is downgraded further it could fall out of various currency indexes which would force fund managers to sell rands to match the index. This would result is a sharp drop in the rand against international currencies like the US dollar, the British pound and the Euro. Coronation and Allan Gray – two of the largest fund managers in South Africa have both reduced their exposure to SA government bonds because of increased political risk. The bonds now [glossary_exclude]offer[/glossary_exclude] an attractive yield of 8,7% and there has been overseas buying at these levels. About R35bn has been raised through the sale of bonds this year. The impact of Gordhan’s firing and the subsequent downgrades will be significantly mitigated by a resurgence in mining and agricultural production. The first quarter of 2017 should show some positive growth in GDP due to mining – off-set somewhat by lower manufacturing. The world economy, led by the US, has been recovering steadily, and with it the prices of the commodities that South Africa produces. The effects of the downgrades will be felt in the second quarter, and will certainly reduce the positive impact of rising mining production. The maize crop will also help, by reducing inflation and making food more readily accessible and cheaper. The [glossary_exclude]Statistics[/glossary_exclude] SA report on power consumption reveals that over the past ten years, power consumption has declined in South Africa by about 5,5%. This is due in large part to the 2008 power outages and [glossary_exclude]load[/glossary_exclude]-shedding. It is also due the fact that electricity prices have risen by 400% over the same period. Many consumers and businesses have installed their own power generation from renewables. It is also a reflection of the poor state of the economy since the sub-prime crisis and the collapse of commodity prices. South Africa’s Special Economic Zones (SEZ) have become an important vehicle for growth in this country. They have attracted both local and foreign investors. One of the best examples of this is the R11 billion investment by the Beijing Automotive Industrial Company and the IDC. This investment at the COEGA SEZ in the Eastern Cape aims for 50 000 vehicles for local and export consumption by 2022 and 100 000 by 2027. It will create thousands of jobs and stimulate many secondary industries in the area. The same is true of the smaller investments in the production of minibus taxis in Springs. This has been producing mini-bus taxis since 2012 and will increase its production to 2400 taxis per annum, some of which will be exported to other African countries. This policy of genuine job creation and encouragement of foreign investment is in sharp contrast to the current government rhetoric about “radical economic transformation”. State Owned Enterprises (SOE) have become a major problem in South Africa. At the February budget, the government had put up a total of R466bn in guarantees for various SOE’s. Nearly half of that was for Eskom (R214bn) for the completion of its new coal-fired power stations (Medupi and Kusile). The next largest commitment is Sanral at R34bn, then SAA at R16,7bn. The SAA loss for the 2016/17 year is expected to be R4,8bn. Eskom will draw down further on its facility (a total of R350bn) as it brings those power stations up to full production. These commitments are obviously a drain on the treasury and take funds away from other possible uses. There are about 200 SOE’s in South Africa and some of them run at a profit. Most, however, require government [glossary_exclude]support[/glossary_exclude]. The national broadcaster, for example, will certainly be requiring additional funding soon. The shortfall in tax collections has had to be funded by a new higher level of taxation and the accompanying increase in Dividend Withholding Tax (DWT) to 20%. The money has to come from somewhere… Vehicle sales are always reckoned to be a good indicator of economic growth, because consumers can usually put off buying a new car if times are tough. New vehicle sales in South Africa have been depressed for some time. But the export market for new cars and vehicle components has been booming – indicating that the rest of the world is growing. In 2016 South Africa managed to export almost 345 000 vehicles, a new record, and it is expected that even more will be exported this year. Taken with vehicle components, however, we still run at a trade loss of R32bn – meaning we import R32bn more than we export, but this number is done from R62bn in 2015. It is expected that we will be in a net overall surplus by 2018. So the motor industry, stimulated by the government’s Automotive Production and Development Program (APDP) is becoming a success story, even as local vehicle sales are depressed. Notably, sales of vehicles and components to the rest of Africa halved in 2016 – indicating clearly the effect of the impact of commodity prices on Africa. The maize crop this year turned out to be the largest in South Africa’s history at 15,6 million tons. This is more than double last year’s crop and has seen the maize price tumble from over R5000 a ton to just above R1700. The effect of this is multifarious. Food prices have come down beginning with maize meal and other direct maize products and moving on to the price of chicken (which is basically re-processed maize). Millions of subsistence farmers in South Africa can feed their families this year from their crop which leaves more money for other uses. South Africa will also be able to export millions of tons of maize and generate a solid foreign currency inflow.Commodities
Gold:
In 1970, South Africa produced 1000 tons of gold – completely dominating world production which was at that time about 1300 tons. Last year, South Africa produced just 5% of total world gold production. This shows how the South African economy has diversified away from gold and declined to become the world’s 7th largest producer. The problem is that most of South Africa’s gold is at very deep levels and is becoming more and more [glossary_exclude]expensive[/glossary_exclude] to extract. This fact, combined with union action, mine safety stoppages, declining prices and legislative uncertainty, has all but destroyed the gold industry. There is the possibility that a new technology that does not require workers to go underground to mine gold could revolutionise the SA gold industry because it remains a fact that about 40% of the world’s known underground reserves of gold are here in this country.Platinum:
Platinum mines Lonmin and Impala pay royalties to various communities because they are mining their land. These royalties are paid into a trust which is supposed to be used to benefit the community. However, in the case of Bapo Ba Mogale community and the community by Impala’s Marula mine the money paid over to communities has not reached them. In the case of Bapo Ba Mogale, more than R600m is missing and it the subject of an investigation by the Public Protector. Clearly, this misappropriation was partly responsible for the Marikana situation. Lonmin has retrenched 6000 workers and is looking to [glossary_exclude]close[/glossary_exclude] the two shafts in the area because they are unprofitable. The demand by the community that Impala employ 1500 members of the community clearly indicates that they do not understand the economics of mining. While mining production is generally improving, the reality is that approximately 60% of platinum mines are unprofitable at current platinum prices. Platinum production from South Africa is expected to drop this year as mining houses shut down unprofitable production. Sibanye has between 200 000 to 300 000 ounces of production that is unprofitable at current prices. Neal Froneman, CEO of Sibanye, has indicated that he will [glossary_exclude]close[/glossary_exclude] down whatever production cannot be made profitable. This will inevitably [glossary_exclude]lead[/glossary_exclude] to further job cuts in the mining sector. The world supply of platinum is expected to be about 5,9 million ounces of which SA will contribute about 4,2 million ounces or about 71%. Demand for auto catalysts will be flat at 3,4 million ounces. These figures indicate that things will probably be tough for Sibanye in its newly-acquired platinum mines for some time.General
The 50% jump in malaria cases in South Africa this year is attributable to the warmer, wetter conditions that have prevailed. Most cases occur in Limpopo province. Obviously, the climate is also a function of global warming which has seen record warmer temperatures throughout the world in the past ten years. Some experts expect that Gauteng will be a malaria area by 2025. This could have a significant impact on the South African economy. Warren Buffett, in his company Berkshire Hathaway, has accumulated a cash pile which is [glossary_exclude]close[/glossary_exclude] to $100bn. That is about equivalent to one year of South Africa’s GDP to put it into perspective. He is now 86 years old and began investing with $100 that he made doing a newspaper round when he was ten years old. He is undoubtedly the greatest investor who has ever lived. There is now speculation that Berkshire might be looking to make a massive record-breaking acquisition. The largest acquisition they have made to date was the $34bn purchase of the Burlington Northern Sante Fe railroad. The municipalities in South Africa have been as much of a problem for the government as the parastatals. Many of them have been constantly mired in financial mismanagement, corruption and nepotism. Eskom has been trying to get certain municipalities to pay their arrears for electricity by threatening to cut off their supply. This has had the knock-on effect of threatening businesses in the municipal areas which have paid the municipality for their electricity but which now face being cut off from critical electricity supply. Astral has achieved an out-of-court [glossary_exclude]settlement[/glossary_exclude] with Eskom to pay them directly and side-step the municipality. This secures Astral’s electricity supply, but it establishes a precedent for business to go directly to Eskom instead of going through their municipalities. Many municipalities rely heavily on the cash flow from electricity billing. The accusation leveled at the banks of foreign currency collusion and market fixing now appears to be almost completely without foundation. One bank (Citibank) Paid a R70m admission of guilt and ABSA and Barclays have agreed to co-operate in exchange for leniency. But the [glossary_exclude]Commission[/glossary_exclude]’s affidavit contains no hard evidence of collusion or market fixing. Without hard evidence, this attack is looking more and more like part of the general attack on the banks initiated by the ANC. At the time that the accusations were first made, they had a significant impact on international perceptions. Investors never seem to grasp the concept of discounting. Major economic events, like the downgrade are usually widely anticipated with professional overseas investors adjusting their positions well in advance of the actual event. Thus it is surprising that when it actually happened the downgrade caused quite a few South African investors to move into off-shore funds. They obviously thought that the downgrade would result in a massive and continuing fall in the rand. The reality is that the rand has fallen, but very little. Foreigners have poured about R30bn into the SA economy since the beginning of this year and the outflows have been relatively minor. The benchmark ten-year government bond is only about 15 basis points higher than it was before the downgrade. Some of the strength is because of the recently renewed interest in emerging markets. So as a private investor you need to watch the trend carefully and always try to see the event, positive or negative in context. The knee-jerk move off-shore may well prove to be ill-advised. The electric motor vehicle is coming into production more quickly than most people realise. Sales of electric vehicles and hybrids are rising rapidly in Europe. CEO of Glencore, Ivan Glasenberg, has suggested that over the next decades metals like copper, lithium and cobalt will be in high demand as the world switches over to the new technology. The move away from the internal combustion engine will also have a major impact on the oil industry over time and Saudi Arabia may find itself sitting on a lake of oil that nobody wants. Battery technology is moving forward rapidly with the advent of smart phones with a five- to seven-day battery life (such as the new Xiaomi phone for R2 000). This could also revolutionise electric cars. The decision by General Motors to leave South Africa and to sell its plant at Struandale (Port Elisabeth) to Isuzu should come as no surprise. They were only producing and selling about 35 000 vehicles per annum – which meant that they could not take advantage of the government’s Automotive Production and Development Program (APDP). Isuzu is keen to build up their sales of Isuzu bakkies to compete with Toyota and Ford in Africa. The plant has the capacity to produce 100 000 vehicles per annum. GM will be retrenching 1800 staff. This move is not really related to the downgrade which South Africa has recently endured, although it certainly did not help.Companies
BANKS (J835)
The JSE Banking index is on a dividend yield of 4,88% which is historically high. Normally, the banking index trades on a [glossary_exclude]dividend[/glossary_exclude] yield below 4%. Barclays Africa [glossary_exclude]Group[/glossary_exclude], especially is on a [glossary_exclude]dividend[/glossary_exclude] yield of 5,66% which represents good value for this share. Obviously, banking shares are discounting the possibility of a currency downgrade, prompted by the imminent Moody’s decision, but they are discounting a level of bad debts which does not currently exist and which is not likely, even if there is a downgrade. In our view, you may have to wait a [glossary_exclude]long[/glossary_exclude] time before you see one of the “big four” banks on a [glossary_exclude]dividend[/glossary_exclude] yield above 5% again. One of the most interesting aspects of the banks is how Capitec is growing and whether this growth is being achieved at the expense of the “big four” (Nedbank, Standard, ABSA and FNB). Capitec claims that it added 1,3 million new customers in the year to February 2017 – but where did those customers come from? ABSA claims to have kept its client numbers stable, FNB says it grew customer numbers by 5%, and Nedbank by 4,8%. Standard doesn’[glossary_exclude]t[/glossary_exclude] publish customer numbers. Perhaps, Capitec is accessing a new market of the previously unbanked. CEO of Capitec says that about 75% of their new clients were taken from other banks.DIAMOND CORP (DMC)
The intransigence of AMCU in its efforts to extract the highest possible wages from Diamond Corp (listed both in London and on the JSE) is now at least partly responsible for the [glossary_exclude]failure[/glossary_exclude] of the business and the loss of all the jobs at the mine. This is an example of how [glossary_exclude]union[/glossary_exclude] action actually results in a significantly worse result for its members. All have now lost their jobs – an outcome which cannot be in their best interests. AMCU perhaps needs to consider more carefully what is in their members’ best interests.SIBANYE (SGL)
Sibanye, run by Neal Froneman produced results for the first quarter of 2017 and they were a bit disappointing. The share price has come off from a high of 3540c on 13th April to its current level around 2800c. Part of the problem was the stronger rand during the quarter – before the downgrade. Sibanye, like all mining operations, is a function of the strength of the rand. If the rand falls they get more rands for their output. Since these results, however, the rand has fallen quite considerably and the current quarter will almost see a weaker average rand value against the US dollar. This may make Sibanye a good buy at current levels, especially if you think that the dollar price of gold could go up. Another major factor in the Sibanye share price is the rights issue to raise just over $1bn. This money will go towards the Stillwater purchase price of $2,2bn. The rights issue has been pitched at a deep 60% discount to the share price, with existing shareholders being offered 11 shares for every 9 they already hold at a price of R11.28 each.NASPERS (NPN)
Naspers owns 34% of Tencent, the Chinese messaging and on-line content company which is the dominant player in social media in China. Tencent out-performed analysts’ profit and turnover estimates for the March quarter which has pushed the Naspers share to new record highs. The share is on a Price:Earnings ratio of over 97. This means that if it continues to earn profits at the current [glossary_exclude]rate[/glossary_exclude] it will take 97 years for those profits to recover the current share price. Some of this extraordinarily high valuation is due to the rand-hedge component of Tencent, but most of it is due to the amazing growth and dominance of Tencent in the Chinese market. Tencent is making headway by developing its own content in the form of games (like Honour of Kings) and movies, including the Kong: Skull Island and the soon-to-be-released Wonder Woman. The company’s market capitalisation is now over $300bn – which makes Naspers’ share worth $100bn (over R1,3 trillion). This year Naspers shares have risen from R2034 to R2770. Our feeling remains that this share is heavily over-priced and should retreat from these high levels in time.
Naspers January 2017 to June 2017 - Chart by ShareFriend Pro
EQUITIES (EQU)
Property shares are not normally attractive to private investors because of their relatively slow growth. Sometimes, however, a smaller REIT can be worth looking at. Such a share is Equities, newly listed in 2014, which has seen its share price rise from R10 to R17. It owns properties in South Africa and the UK, primarily in logistics ([glossary_exclude]distribution[/glossary_exclude] and warehousing etc.). It has almost a 100% occupation of its properties and has recently produced results for the year ended February 2017. It raised nearly R1bn in new cash in November last year which it has been using to acquire further properties. This is a sedate, but very secure investment in our view.LIFE HEALTHCARE (LHC)
The healthcare sector is generally regarded as a defensive sector because consumers have to pay for healthcare, even in a recessionary climate. Life Healthcare has seen its share price fall from a high of R47 (in September 2014) to current levels around R28.50. This is despite the fact that it has steadily grown earnings per share over that period. One of the reasons for this is its expansion into the UK market where it has acquired Alliance Medical for R14,3bn. This acquisition has negatively impacted profits for the interim period to March 2017, but the acquisition will almost certainly improve profits going forward. It also adds a considerable rand-[glossary_exclude]hedge[/glossary_exclude] component to Life. Investors looking for a very stable and growing investment could do worse than to consider this share. The UK has a high and growing incidence of cancer – which Alliance Medical is well-positioned to exploit. Investors should wait for the share price to break up through the downward trendline before buying – and this could take some time.
Life Healthcare Group June 2010 to June 2017 - Chart by ShareFriend Pro
STADIA (TO BE LISTED)
This is a spin-off from Curro of its tertiary division which is expecting to be separately listed on the JSE. As yet another PSG-backed listing, this is likely to attract strong interest, especially from those institutional investors who missed out on Curro. Curro’s share price has gone from around R8 when it was listed in 2011 to its current price of around R42 – and that is despite six rights issues used to fund massive expansion. Curro increased pupil numbers 14% in 2016. Of course, a company focused on tertiary education cannot expect to have as large a market as one in primary education – if only because relatively few students qualify for [glossary_exclude]entry[/glossary_exclude] into such institutions. But the steady decline of UNISA as a distance learning organisation presents a [glossary_exclude]clear[/glossary_exclude] opportunity in this area – and who better to [glossary_exclude]fill[/glossary_exclude] that [glossary_exclude]gap[/glossary_exclude] than a PSG-backed new listing like Stadia. This is certainly a listing that will be closely followed and receive massive institutional [glossary_exclude]support[/glossary_exclude].EOH (EOH)
In September of 2001 you could have bought EOH shares for 70c and 14 years later in 2015 they were trading for R178. This massive growth was substantially due to their CEO and founder, Asher Bohbot. Now he has taken the decision to step down and the market is very worried that his successor will not be able to produce the same kind of performance. Actually, for the past two years, the share has been trading in a sideways pattern between about R178 and R123. The announcement of Bohbot’s resignation took the share down 7% in a day and it is now available for R127. If it breaks below the previous cycle low of R123 it may go into a tail-spin – but it has been an excellent share, maybe the best on the JSE, and it appears cheap at current levels.
EOH October 2012 to June 2017 - Chart by ShareFriend Pro
DISCHEM (DCP)
Dischem’s maiden results to February 2017 were impressive, showing a solid increase in market share over the period. The plan to expand the number of stores is well under way with 11 new stores opening and plans to reach 200 stores by 2022. We believe that this share is a good [glossary_exclude]long[/glossary_exclude]-term investment, ideal for the private investor. Like all retail operations, it is susceptible to local political-economic developments and to major moves on Wall Street, but it has shown good resilience to shocks, like the ratings downgrade. The share is fairly fully priced at current levels, but it shows every sign of becoming an institutional “darling”.
Dischem Pharmacies November 2016 to June 2017 - Chart by ShareFriend Pro
GROUP 5 (GRF)
In 2007, [glossary_exclude]Group[/glossary_exclude] 5 reached a share price of R66 on the back of a booming South African economy. Since then it has fallen on hard times. This began with the fall-out from the sub-prime crisis in 2008 and was followed with the scandal of price-fixing and other anti-competitive practices and the subsequent fine. [glossary_exclude]Group[/glossary_exclude] 5 recently agreed to pay R255m towards the government’s “voluntary” effort to re-constitute the construction industry along empowerment lines. The interesting thing is that the Chairwoman of [glossary_exclude]Group[/glossary_exclude] 5 is Philisiwe Mthethwa – wife of Arts and Culture Minister, Nathi Mthethwa and sister of recently appointed Deputy Minister of Finance Sfiso Buthelezi. Clearly she is favourably associated with the Zuma camp. Notably, [glossary_exclude]Group[/glossary_exclude] 5 produced a loss of R338m in the year to December 2016 from a profit of R200m in 2015. There has also been a rash of senior resignations from the firm which have prompted Alan Gray (holding 25% of the company) to call for the board to be re-constituted. It is also interesting that the Public Investment Corporation (PIC) of which Buthelezi is also the chairman holds just less than 16% of [glossary_exclude]Group[/glossary_exclude] 5’s shares.AFRIMAT (AFT)
Afrimat is involved in [glossary_exclude]open-pit[/glossary_exclude] mining and supplying building materials for the road-building and other construction industries. Given that the construction industry in South Africa is generally depressed, Afrimat’s results for the year to end-February were exceptional. Headline earnings per share (HEPS) were up 25,4%, and this means that they have managed a 25% compound growth in earnings for the past nine years. There are very few shares on the JSE that can make such a claim. Clearly this is a very well-managed company which keeps a tight control over costs. Technically, the share price has been moving sideways for the past six months, but we believe it is due for an up-side breakout soon.
Afrimat June 2015 to June 2017 - Chart by ShareFriend Pro
LONG 4 LIFE (L4L)
The success or otherwise of listed companies usually comes down to the people who are running them. In the case of [glossary_exclude]Long[/glossary_exclude] 4 Life, you have two of the most talented and experienced executives in South Africa combining their talents to produce a new winner. Brian Joffee has built up Bidvest over many years and is renowned for his ability to make good acquisitions. Kevin Hedderwick, over 20 years, took Famous Brands from a small family business to the fast foods giant that it is today. When you buy a share like this you can only look at the two men who will run it, but we believe that this will be a real winner over time.TRANSACTION CAPITAL (TCP)
Transaction Capital is a company that exploits two aspects of the new South Africa. The first is the explosion of mini-bus taxis on the South African roads and the second is specialising in the difficult end of the debt collection industry. As the only company in the business of financing taxis, Transaction Capital has been able to expand its debtors book to 7,8bn while other lending institutions have to cut back theirs. This area of lending is clearly high risk, but TCP have mastered the art of making it profitable. The second [glossary_exclude]leg[/glossary_exclude] of their business consists of buying up companies’ bad debt books for as little as 10c in the rand and then managing to collect as much as 25c in the rand from the debtors. This is a massively lucrative business. The semi-recessionary conditions in the economy have resulted in a sharp increase in consumer bad debt. In its interim period to March 2017, TCP was able to buy a further 13 debtors books for collection. Nobody else wants to enter these two very high risk businesses and so by learning to manage them effectively and profitably TCP is growing rapidly. We believe that this is a share which could do very well in the future.
Transaction Capital March 2014 to June 2017 - Chart by ShareFriend Pro
MR PRICE (MRP)
Mr Price has had a terrible year with headline earnings per share (HEPS) down 10,4%. The increased competition in the clothing sector from both local and overseas brands has combined with sharply lower consumer spending to cut into profits. But, Mr. Price is a very well-run operation and is well positioned to benefit directly from any improvement in the economic environment. As the South Africa economy recovers, this will be one of the shares that will benefit first. At the moment the share has found a base and support just below R130 per share. At this level it is going for nearly half the price it went for in April 2015. In our view this share is relatively cheap right now, but it is an institutional favourite, so don’[glossary_exclude]t[/glossary_exclude] expect it to remain at these levels for [glossary_exclude]long[/glossary_exclude].