Published on July 15, 2009
Creating wealth in the great recession: Alec Hogg The Investment Focus is brought to you by Discovery and Moneyweb.
Andrew Carnegie’s Playbook “Navigating the Great Recession”
Where we are USA (GDP $14 330 bn) Japan (GDP $4 840bn) GDP: -6.1% (4Q: -6.3%) GDP: -15.2% (4Q : -14.4%) Govt. debt is 110% of GDP Govt. debt is 225% of GDP China (GDP $4 220bn) S Africa (GDP $300bn) GDP: +6.1% (4Q: +6.8%) GDP: -6.4% (4Q: -1.8%) Govt. debt is 23% of GDP Govt. debt is 27% of GDP
The Great Recession: how we got here Excessive leverage • “The most important lesson is the world needs a whole lot less leverage” Gross immorality • Consumer credit give to people who couldn’t handle it • Derivatives traders preyed on their customers Stupidity • People inside institutions themselves; regulators didn’t listen “Horribly failed” by accounting profession • The people who created the principles should be removed
Two wise men: Warren Buffett and Charlie Munger
Some of their 35 000 AGM attendees
Warren Buffett, media star
Quotable “The watchword throughout the country became the creed I saw on restaurant walls when I was young: ‘In God We Trust; all others pay cash.’” Warren Buffett, March 2009
Consequences of the financial crash Deep economic recession which “it’s going to last a very long time” Probably lead to increased regulation for financial services China, not US taxpayer is picking up the tab Lower US Dollar as politicians lower the value of ballooning debt Buffett: “You can bet on inflation.”
Quotable “The best protection against inflation is your own earning power. The second best protection is owning a wonderful business that does not need injections of capital. With these guidelines, I’d say invest in yourself.” Warren Buffett, May 2009
Bobbin Boy to Billionaire… 25 November 1835 to 11 August 1919 Shrewd stock investor and entrepreneur Founded Carnegie Steel and became US Steel Gave away 90% of his fortune • Buffett too
The richest people of all time 1 John D Rockefeller Standard Oil $318.3bn 2 Andrew Carnegie Carnegie Steel $298.3bn 3 Nicholas II Tsar of Russia $253.5bn 4 William Vanderbilt VDBilt Railroads $231.6bn 5 Asaf Jah VII Nizam of Hyderabad $210.8bn 6 Andrew Mellon Mellon Bank $188.8bn 7 Henry Ford Ford Motor Company $188.1bn 8 Marcus Licinius Crassus Emperor of Rome $169.8bn 9 Basil II Byzantine Emperor $169.4bn 10 Cornelius Vanderbilt VDBilt Railroads $167.2bn OTHERS: 15 Elizabeth I Queen of England $142.9bn 17 Sam Walton Walmart $128.0bn 22 Cleopatra Queen of Egypt $95.8bn 57 Bill Gates Microsoft $40.0bn 86 Warren Buffett Berkshire Hathaway $26.0bn
The Andrew Carnegie Playbook Only buy when others are panicked; Invest to build your business during times of crisis. “Berkshire Hathaway is now following the Andrew Carnegie Playbook.” Charlie Munger, May 2009
Some advice from Warren Buffett “Stay within your circle of competence – understand whether the competitive advantages are durable or not. And really understand that the market is there to serve you.” Warren Buffett
And when it comes to investing… “If you have an IQ of 150, to be a good investor, best you trade 30 points to someone else. But you DO need to have emotional stability, inner peace, the ability to think for yourself. If you have that quality, you will do very well at it.” Warren Buffett, May 2009
And while we’re on the subject of IQ… “If you think your IQ is 160 and it’s 150, you’re a disaster. Much better is someone with an IQ of 130 who operates within himself.” Charlie Munger, May 2009
Annus Horribilis X 2, or 3? Market disruption in 2007 and 2008 • Crisis borne of modern finance • Old-fashioned economic crisis 2009: Poor economic fundamentals support outlook for stock market weakness Recovery in developing countries not seen until 2010 Yet developing countries have lent economic stability • Domestic demand from sustained development • Stringent regulatory regimes • Government investment
Slave to the USA? Decoupling holds ~ 60% of the rise in world GDP between 2000 - 2008 happened in developing countries • 2000: developing countries = 37% of global GDP • 2008: developing countries = 45% of global GDP Economic and business cycles between 2000-2008 • Economic cycles of America and Europe converged • Business cycles of India and China converged Proving that • Developing countries grow or shrink autonomously, not just under the influence of the rich countries Study by IMF, University of Virginia, Cornell University, quoted in The Economist, 20 June 2009, page 58
Developing Countries drive global growth Between 2000-2008, developing countries generated 60% of global GDP growth Source: IMF, The Economist
A little perspective: 2007-9 v. 1998-9 Every 10 years or so, global economies & markets plunge SA not doing so badly compared to AEC impact • Better information • Localised problem • DC regulatory controls • SA saw significant gains post-crisis Precedents exist for understanding current conditions No doubt it will be a rough recovery, but recover it will
GDP from one major crisis to another W L V Z S Alphabet soup of recovery profiles Forecast Forecast Forecast Source: Bloomberg
Onto the Next … Good things do end, to start again • China and India are expected to drive recovery • USA to follow; EUR likely later Domestic demand is key to recovery • Governments of developing countries are pouring money into it Rising exports to China, India will not wholly compensate for drop in exports to USA, EU South Africa is mostly driven by domestic demand • Only ~30% of GDP comes from exports • Relatively protected
The Good Global market sentiment is positive – ‘worst is over’ • Markets run on: fundamentals & what everyone hopes will happen • Sometimes the two agree Investment stimulus in USA, China • Positive impact on sentiment • Results yet to be seen but expected to be good • Funding the stimuli means higher taxes South Africa • Unit Trust investment in Equity is ~20% now
The Bad Slower contraction; Japanese-style stagflation is possible • Will we see a repeat of Japan and ZIRP? • Yes: effective rates are negative, like Japan; unemployment rising • No: more flexible and immediate responses to turmoil 2009 global stock market rally likely to fizzle short-term • Rising oil prices put the brakes on growth • Outlook for higher taxes reduces consumer spending South Africa • Begins its old-fashioned economic recession • Strong rand is double-edged sword • Unit Trust investment in Money Market is ~37% now
Volatility is still higher than in 2007 Source: Bloomberg
What do we do now?
Longer term returns – All asset classes Economic Group 2 years 3 years 5 years 10 years All Share -9.0% 4.2% 20.3% 15.4% Resources -11.4% 0.6% 21.3% 20.9% Financials -13.2% 0.1% 15.1% 9.3% Industrials -4.5% 10.7% 21.7% 13.2% Property Unit Trusts -1.1% 11.5% 20.4% 22.8% All Bond 7.7% 7.7% 9.3% 13.2% Headline CPI (last 9.4% 8.6% 6.4% 6.7% available figures) Source: Investec
Commodities: value on weak US$? Commodities (US$) Commodity June ‘09 3 months 6 months 12 months YTD Precious Metals Gold Spot (US$/oz) -5.34% 0.8% 5.3% 0.2% 5.3% Palladium PM-fix (US$/oz) 5.51% 15.8% 36.1% -46.7% 36.1% Platinum Spot (US$/oz) -1.26% 4.3% 27.0% -43.1% 27.0% Silver Spot (US$/oz) -13.54% 4.9% 19.7% -21.9% 19.7% Industrial Metals Copper Cash LME (US$/ton) 6.95% 26.6% 76.0% -41.8% 76.0% Nickel Cash LME (US$/ton) 16.27% 70.2% 48.1% -26.1% 48.1% Steel Hot-rolled Coil price FOB -5.00% -3.1% -9.5% -53.9% -9.5% (US$/ton) China Ex Vanadium Spot Price 98% CIF ($/lb 0.00% -17.0% -38.5% -76.1% -38.5% v205) Zinc Cash LME (US$/ton) 3.05% 19.6% 38.8% -17.1% 38.8% Energy Brent Crude IPE $/Barrel) 8.63% 50.3% 86.6% -50.3% 86.6% Source: Investec
Stocks: Long-term perspective Developing Country stock index performance since the last major crisis Local currency, local index levels Source: Bloomberg
Stocks: South Africa outperforms Country/ Region Index June 2009 3 months 6 months 12 months YTD World MSCI World Free -0.4% 21.0% 6.8% -29.0% 6.8% EM MSCI Emerging markets -1.3% 34.8% 36.2% -27.8% 36.2% Pacific MSCI Pacific 2.1% 25.7% 9.7% -24.3% 9.7% Europe Dow Jones Euro Stoxx 50 -2.69% 25.7% 1.9% -33.8% 1.9% Developing Countries Brazil Bovespa -2.8% 47.7% 63.1% -35.8% 63.1% China MSCI China 4.1% 35.8% 37.6% -8.1% 37.6% India MSCI India -2.2% 59.8% 57.4% -5.0% 57.4% Russia MSCI Russia -14.3% 37.8% 45.9% -61.1% 45.9% South Africa MSCI South Africa 1.2% 31.3% 26.1% -11.9% 26.1% Developed Markets France Cac 40 -4.7% 22.1% 1.8% -34.2% 1.8% Germany Dax 30 -3.6% 24.4% 0.9% -33.3% 0.9% Hong Kong Hang Seng 1.6% 37.7% 30.4% -13.1% 30.4% Japan Nikkei 225 (not TR) 3.5% 25.7% 5.6% -18.8% 5.6% UK FTSE 100 -1.4% 26.0% 12.7% -34.6% 12.7% USA Dow Jones Industrial 30 -0.4% 12.0% -2.0% -23.0% -2.0% Source: Investec
Bonds: safe & suffer by comparison Bond and Money Market (local currency returns) Name June 2009 3 months 6 months 12 months Year-to-date All Bond -0.23% 0.3% -4.9% 19.3% -4.9% GOVI -0.23% 0.3% -4.6% 18.6% -4.6% OTHI -0.24% 0.4% -6.0% 22.1% -6.0% Bonds 1-3 0.11% 1.4% 3.7% 16.8% 3.7% Years Bonds 3-7 -0.28% 0.6% -1.8% 20.7% -1.8% Years Bonds 7-12 -0.03% -0.1% -6.0% 19.9% -6.0% Years Bonds 12+ -0.52% 0.1% -10.7% 24.1% -10.7% Years Barclays BESA Govt Inflation- 0.10% 3.4% 5.9% 7.7% 5.9% Linked Bonds Source: Investec
Take Warren Buffet’s advice BUY WHAT YOU KNOW Global Economic background • China, India to drive economic recovery • Investment momentum into those markets is strong • USA due to recover next year; EU late 2010 Africa is the new Far East – 10-year horizon • Undiscovered in terms of large investor flows • Chinese and Indian investors have forged strong ties • African leaders are tired of being pushed around, are giving as good as they get South Africa, largest & most advanced economy, to lead
Africa asserts itself on world stage • Kikwete admonishes IMF/World Bank/UN at WEF (Business Day, frontlineafrica.com, FT) • African Leaders Want Bigger Role in IMF, Push for Aid (Bloomberg) • Africa seeks a voice in global financial management (Africa Renewal) • G20 Summit: Did Africa get what it wanted? (The Independent, UK) • Ethiopian PM and IMF to represent Africa’s voice at G20 summit (afrik.com) • Tsvangirai raised money overseas Africa asserts itself and the value it represents to the world via resources. SA poised for leadership.
African growth will be substantial African economies are termed ‘frontier economies’ by major investment banks Profit potential over the next 10 years is large, based on fundamentals and what people hope will happen BUY WHAT YOU KNOW China/India to lead economic growth – but do you know those companies? What are costs to invest? SA companies are • Capitalising on domestic demand • Moving into Africa to capitalise on rand, continental progress
Where to from here?
Tough time for savers Interest rates have fallen • Repo rate down from 12% in November 2008 to 7.5% (down 37%) • Futures markets forecast further 0.5% to 1.0% decline • 3 month money market rate currently 7.0% pa • After tax yield 4.2% (lower than inflation) Global rates significantly lower • US 3 month 0.5% pa • UK 3 month 1.0% pa Preference shares are down with lower prime rate – but still appealing relative to short term rates Corporate debt market more attractive but riskier – although spreads have fallen Equity markets appear to have bottomed – but the outlook for growth and earnings remains uncertain – companies conserving cash, reducing dividends But downside risk in equities lower than upside
JSE ALSI Index up 22.5% since March low
Snapshot of South African economy Economy in recession – first in 2 decades Heavily dependent on buoyancy of global economy – exports plus imports make up 74% of economic activity Manufacturing (18% of GDP) and mining (7%) contracting sharply Consumers (61% of GDP) paying down debt – no appetite to spend although lower interest rates, food prices and petrol helping Housing market in decline but share market stabilising Government infrastructure programmes valuable – but with savings rates low, financing dependent on foreign investors
There are some rays of light… Sensible fiscal and monetary policies have anchored the economy (up to now) Government debt levels remain low – recently raised $1.5bn at reduced spread Banks operating normally – prudentially managed National Credit Act and Forex controls protected economy from worst of the global crisis Corporates in good shape – satisfactory results under difficult trading conditions Still opportunity for growth domestically as well as in emerging Africa Lower rates and easing prices put more money in consumers’ wallets 2010 World Cup and other sporting events providing short-term kickers
JSE Sector breakdown of top 180 companies Property 2.40% Industrial 12.20% Financials 13.30% Foreign income 31.40% Resources 40.70%
JSE Market cap of top 10 listed companies Market Capitalisation % of Total Market Company Rbn Capitalisation British American Tobacco 449 11.5 BHP Billiton 385 9.9 Anglo American 297 7.6 SAB Miller 269 6.9 MTN 219 5.6 Sasol 173 4.5 Standard Bank 138 3.5 Angloplats 127 3.3 Impala Plats 108 2.8 Anglogold 101 2.6 58.2%
Equity markets recovering - green shoots appearing Signs of stabilisation in world economy – “getting worse more slowly” • China restocking – commodities prices picking up • US existing and new homes sales steadying - mainly at low end of market • Credit increasing – spreads tightening • US banks repaying government rescue money • Certain business confidence indicators bottoming Equity markets recent performance suggests most of the bad news has been absorbed Over past 10 years real return on US stocks -47% versus plus 71% on bonds - no risk taking will end capitalistic system Hurdle rate – shares should beat bonds/money market
Bears still having their say Commodity prices expected to fall after China completes restocking – “treat China’s stimulus package with caution” US treasury yields rising on inflation fears – “can’t have stimulus without inflation” • Rising yields hurting mortgage refinancing • Obstacle to economic recovery • Oil creeping up – adding further doubt to recovery Views that the US stimulus package, although sizeable, isn’t large enough to sustain growth Still questions about the drivers of US growth • Global economy down • Consumers still under pressure - rebuilding their balance sheets and fearing job losses • Corporate recapitalising and cleaning up their business portfolios Corporate profits in a decline • Down in last 7 quarters – still falling
Quotes from recent result presentations “Global economic conditions and consumer demand “Difficult conditions are expected to remain until at least weakened during the year and there remains little the second half of 2009.” visibility as to the timing of any recovery.” Astrapak SAB Miller “There are currently very few encouraging signs in the “Although interest rates are expected to decline further, global picture. We cannot predict when an overall Tiger Brands is expected to experience difficult trading improvement in trading will come.” conditions for the remainder of the year.” Richemont Tiger Brands “Retail trading conditions are expected to remain “The overall trading environment in the second half is challenging in the coming months.” expected to remain difficult.” Nu Clicks Barloworld “Reduced economic activity and the likelihood of “The company is well aligned with infrastructure, declining inflation will result in lower turnover growth.” mining and power generation markets and will continue Spar to benefit from anticipated government and parastatal spend on infrastructure spend.” “The indebtedness of the consumer remains a concern.” Steffanutti JD Group
Equities Recent results have given us a glimpse of how companies are operating in the current Badly hit: • Platinum, base metal producers (ferrochrome) tumultuous environment • Companies servicing mining and motor industries • Credit retailers – furniture, white and brown goods, motor vehicles • Residential housing market – related construction companies • Gaming industry – top end of the hospitality industry • Financial services – especially non-retail banks In the black • Banks • Life insurers • Cash retailers – food, clothing, building • Low end hospitality • Construction – civils, cement • Tobacco and liquor • Cell phones • Resources - iron ore, coal, gold • Health, pharmaceuticals
Africa – open for business Shedding image that only growth industry is crime No longer associated with war, famine and tyrants Still poverty stricken but development booming Financial markets opening – FDI flows greater than aid Democracy on the increase Still relies mainly on commodities – oil, forests, mines Growth over last four years over 6%; 2009 forecast at 2% China spending billions of dollars helping build infrastructure China trade increasing rapidly
Current 24 favourite stocks Resources • BHP Billiton, Sasol, Exxaro Offshore • British American Tobacco, SAB Miller, Richemont Africa • MTN, Naspers N, Shoprite, Aspen, Tongaat Financials • Standard Bank, Metlife, Discovery, JSE Consumer • Pick and Pay, Mr Price, Truworths, Tiger Brands, Nampak Hospitality • City Lodge Infrastructure • PPC, Basil Read, Raubex
Lessons learned from the current crisis The US retains its power to command the global economy and create disorder • Humbled and reputation of its iconic institutions damaged but the nation still leads the world US and China will probably lead the turnaround with their huge stimulus packages • Fortifying China’s standing as a major power • India in the wings • Europe slipping away The credit crisis demonstrates that the dollar remains the leading reserve currency • Despite fears that high debt levels may compromise dollar’s status • Dollar recently endorsed by Japanese, Russian and Chinese finance ministers Downturn highlighted the vulnerability of economies heavily reliant on exports – minerals and manufactured good (eg China, Germany, Japan) Heady days of easy credit have passed – risk premiums will rise Self regulatory risk management techniques proved inadequate – need for greater vigilance in financial markets
Global equity markets
International interest rates
Situation in the world anything but normal Good news Aggressive government stimulus policies and financial rescue packages beginning to lift confidence Spreads between government and other more risky bonds declining – inter- bank rates also easing suggesting an increase in money flow Risk appetite improving – share prices up sharply since March lows – all the bad news appears to be in the market
Situation in the world anything but normal Bad news Householders still overextended and feeling pressure from bust in housing market and stock markets and fear of unemployment – will inhibit spending while they rebuild savings Huge fiscal deficits could push lenders to demand higher returns to compensate risk Companies deleveraging – focusing on core businesses – avoiding expansion projects or mergers Banks may have turned corner but could still face more asset write-downs Countries will soon need to rebuild their balance sheets – higher taxes Government involvement in economies could raise spectre of protectionism
Challenges ahead Remedial actions by authorities have removed risks of a major bank failure Investment industry faces a huge regulatory overhaul that could lead to tougher controls Government relationship with banks will probably reduce liquidity levels in financial markets Capitalistic system at the mercy of government and regulators - hamper entrepreneurial ventures and hinder m&a/private equity funding Need to rebalance global economy – encourage borrowing countries to export and saving countries to spend - Rising call for protectionism – urge to keep jobs and capital at home – break globalisation Risk premium on equities could possibly increase - investors will seek higher return measures
Failed the stress test Share options • Introduced to reward management • Align the interests of management with the stakeholders • “Don’t give me options – issue me puts!” Share buy-backs • Aggressive programmes destroyed wealth • Rethink the benefits of management’s wisdom Valuation techniques • Analysts metrics over optimistic • Did not succeed in providing support IFRS • Mark-to-market fed write-downs exacerbated crisis Scrip lending • Allowed sellers to mark down shares dramatically fuelling downturn Risk managers • Sophisticated techniques failed to pick up weaknesses in pooled products
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