It has been a number of months since I have produced a client letter, the last two being in March and April. Quite frankly there has been little to add to what had been said at the beginning of the Coronavirus lockdown. I believe that on balance my views have held true, namely that markets will recover and that the weakness provided a great buying opportunity. I also expressed the view that these events will exacerbate the challenges of the South African economy and further expose the reality of our dire situation. My repetitive call to engage in offshore investing as much as possible has proven to protect portfolio values in Rand terms and since the beginning of 2019 the returns have been phenomenal (in both hard currency and Rand) – this particularly because of my bias to the USA and Eastern markets, with an emphasis on China.
So far I seem to have elevated myself to savant, but in truth there are some elements I underestimated, with the most important being that I felt that the global pandemic would pass and we would return to normality. Whilst not trying to predict the timing of the recovery, I did not think that the viral wave would be with us as long as it has or that there would be a resurgence. I still think that the death rates are rather low relative to total populations, but none the less the world is still unable to put a lid on its spread. The announcement of the role out of vaccines has been of great relief, but the efficacy is yet to be proved on a global scale. Despite “Covid fatigue” (the relaxing of attitudes to the virus), the pandemic is likely to change our way of life. It is my hope that heightened awareness of simple hygiene and some measure of social distancing will remain with us, as will consideration for how our actions affect others.
From a business / investment point of view it has already caused an acceleration of changes in the way we go about our lives. Old school shoppers have been forced to consider online purchases and have discovered the convenience thereof. The same goes for online entertainment and general interaction via social media. Many businesses have discovered the economic benefit of having staff work from home. As a gregarious species, we are not about to all become reclusive, but we are likely to avail ourselves to a greater extent of simpler and smarter ways of going about our lives. Companies that are alert to the new way will be those that not only survive, but thrive.
Much has been said about the apparent disconnect between investment markets and the underlying plight of the many who have lost jobs or a large part of their income. There is no doubt that unemployment levels have increased globally and that this loss of consumers will weigh on economies. However, there are factors that are countering these negative effects. I have already spoken of the online (technology) industry that has enjoyed increased business. It is these type of companies that make up a large part of market weightings (particularly in the USA) and have been behind the market surge. Similar to 2008, central banks have been lowering interest rates, which lends itself to lower discount rates being applied to valuations. They have also, together with government, provided liquidity and financial stimulus packages, once again propping up markets. Whilst these measures can have an inflationary impact, I feel there is limited ability to pass on price increases to a consumer base under strain. As such, and similar to 2008, I expect these stimulatory measures to have a lasting effect.
Going forward I maintain my mantra – invest offshore. From both a structural and political point of view, I find no reason to expect that local returns will match that available offshore. There will be niche opportunities locally, but in general offshore will, in my view, provide superior returns. I continue to advocate the USA as an investment destination as well as the East, with specific emphasis on China. Despite recent political challenges within the USA, the underlying institutions will prevail and I expect their economic dominance to continue. China’s global influence is rising rapidly and the growth of their own consumer base will advance them to a super power with economic influence matching and even surpassing the USA. As a somewhat contrarian play, I also believe in the potential of India, due to its sheer size and youthful demographic. However, I would temper exposure until a more stable political environment emerges (a difficult ask for a country as diverse as this). Other emerging Asian economies also hold attraction for their prodigious work ethic and productivity.
What has changed, is my view on fixed property. I had always regarded exposure to this asset class as being important for its stability and defensive qualities. Rental income had been such a reliable form of income. However, performance has been subdued for some time now. The structural change in the way we shop (online) and the way we work (from home) leads me to feel that occupancy levels will fall and rental income will be under pressure. I therefore recommend exiting this asset class or at least adopting a much reduced weighting. There are however niche property portfolios that would be worth holding, but not the more general office/retail portfolios.
Something else I under-estimated is the limited or even lack of protection so-called conservative funds hold. These would be funds holding only fixed income securities or a strong bias to this asset class. The panic of the lockdown saw loss of value in longer dated interest instruments as concerns over credit risk rose (this was exacerbated in SA as Moody’s downgrade came at the same time). At the short end returns have dropped as interest rates have been cut. There will always be a place for cash holdings to meet specific needs, but to my mind conservative portfolios come at great expense in terms of opportunity costs. Of preference would be defensive equity holdings with a good dividend history (some at levels better than cash).
As I have already said, offshore equity returns have been quite phenomenal since the beginning of 2019. Whilst I do not think this pace will be maintained for the year ahead, I am confident of the continuation of an upward trajectory. This is predicated on the efficacy of Coronavirus vaccines and a somewhat more congenial world order under a Biden presidency. It is difficult for me to recommend chasing after US stocks that have already run so hard, but I do not foresee any surprises on the downside and therefore advocate a hold. The defensive equities I spoke of above that will benefit not only from a recovering consumer base, but also a growing one (especially in the East), is something currently worth considering for a portfolio. China (and perhaps the East as a whole) is also worth including, for both its ascendancy in the world order and the benefits that I think will flow from improved trade under Biden. The USA’s relationship with China will not be a comfortable one, but I do think it will be less confrontational.
Please note that whilst our offices will be closed from 18th December to the 11th January, we are still available telephonically and on email.
After what has been a crazy year, the Harvest Team thanks you for your continued support. We wish you peace over Christmas and prosperity in 2021. Most of all, we wish you good health.