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Time for Clear Heads

These difficulties aren’t limited to South Africa either. Global economic growth is still tepid and geopolitical tension is high.

“It’s very much at the top of everyone’s mind that there are very high levels of uncertainty both on the political and macro economic fronts,” says the manager of the PSG Equity Fund, Shaun le Roux. “As far as politics is concerned we have what’s going on inside the ANC, a very divisive US election, and Brexit and its consequences. On the macro economic side, there are big questions around the South African economy, which is going through a very tough patch and may be looking at a recession.”

Of these, the local political landscape is perhaps the most concerning. However Le Roux says that while the stakes are high and the outcomes unpredictable, investors shouldn’t make hasty decisions based on noise alone.

“What one needs to bear in mind is that when a story is dominating all the newspaper headlines the market knows about it and the market tends to be quite efficient at pricing in bad news,” he argues. “In this regard our analysis shows that something like a sovereign debt downgrade is pretty much priced in by the market already.”

Although there could still be a crisis caused by a successful attack on the integrity of treasury and the Reserve Bank, this is not PSG’s base case. Nevertheless it’s important to be diversified to be protected against even the worst possible scenario.

“The main pint that we try to make to clients is that when the world is this uncertain and the range of outcomes is this wide, we think you gain very little by trying to forecast exactly what is going to happen,” Le Roux says. “Brexit is the best example of how futile this can be. What we are rather focusing on is trying to make decisions that give our clients the best chance of achieving their objectives.”

This requires taking a long-term view and seeing opportunities beyond the market noise.

“When there are this much uncertainty and fear, we typically find that the market will give you some good opportunities,” says Le Roux. “But you need to be able to take a long-term view backed up by a long-term process. We are prepared to be patient, but we also can’t dismiss the risks out of hand. We just have to make sure that our clients are adequately protected.”

This means ensuring that they aren’t exposed to assets that could incur permanent capital losses. At the moment, Le Roux believes that there is a very real risk of this in certain assets.

“The anomaly is that even though there is all of this uncertainty and fear, at the same time there is a backstop to global financial markets in the form of ridiculously low developed market bond yields,” Le Roux says. “A consequence of this is that asset classes that are deemed to be related to bonds, specifically the highest quality equities are trading at very elevated valuation levels. We would argue that ownership of inflated assets poses the biggest risk to future performance for investors.”

At the same time, there are other parts of the market where the uncertainty has given rise to attractive asset prices.

“This includes domestically-focused business in South Africa such as banks, where the tough economic conditions and the recent spike in bond yields have had a dramatic impact on share prices,” Le Roux says. “In the last six to nine months we have been buyers of financial stocks and have also been adding South African bonds to our multi-asset portfolios.

“It’s important to note that we hadn’t been invested in South African bonds for a number of years before this,” he adds. “ It’s only in recent times that we think we can buy them at a margin of safety and at levels that lock in attractive real yields on a long-term view.”

Ultimately, he argues that the only safe way to negotiate times like these that are so uncertain is to focus on the fundamentals as much as possible.