Higher risk of global credit stress due to restrictive interest rates by central banks is weighing on global growth and operating margins, which will lead to a global earnings recession, with a US recession also on the cards. And given that SA equity earnings cycles move in sync with global earnings growth, local earnings are likely to follow suit – disappointing, although not crashing.
This was the view shared by Old Mutual Investment Group at its latest investment update this week, where its presenter’s outlined that while the SA earnings decline is being exacerbated by weak domestic factors and commodities, they are unlikely to fall as hard as global earnings given that SA is more defensively positioned and diverse.
The anticipated decline in global earnings has heightened fears among both local and global investors. Siboniso Nxumalo, Chief Investment Officer of Old Mutual Investment Group, highlighted that historical data reveals a strong correlation between recessions and market drawdowns, with the S&P index witnessing over 20% drawdowns during seven of the last eight recessions. Notably, the majority of these drawdowns occurred during the actual recession, rather than the preceding 12 months.
“Should a US recession ensue we could see global earnings declining by 20% over the next 12 months, presenting a strong case for a global market slowdown,” said Nxumalo. “South Africa, in particular, is likely to be affected due to its increased sensitivity to global equity earnings since 2009.”
Portfolio Manager Jason Swartz emphasised the South African equity market’s diverse earnings drivers, highlighting Resources sector weighting of 28%, Rand sensitives of 29%, as well as SA Financials at 21% and SA Defensives at 15%.
“We therefore don’t foresee SA earnings falling as far as 20% given its diversified market makeup, rather falling somewhere between 0 and 5%.”
Swartz warned, however, that we need to be cognisant that we are currently experiencing a contraction in the business cycle, which typically yields poor returns as pricing power weakens and earnings begin to collapse.
He added that there are a litany of challenges facing the local economy, as seen through the higher sovereign risk premium demanded by investors, particularly when compared to other emerging markets.
“We know that loadshedding is a key contributor here, continuing to concern investors as it erodes growth. But while we certainly aren’t out of the woods yet, the trough is in sight as more capacity comes back onto the grid in 2024 alleviating some of the persistent challenges at Eskom,” he adds. “That said, caution remains necessary.”
Nxumalo added that despite the expectation that SA earnings are going to fall short, historically, the JSE has demonstrated an upward trend. “We are now living through a growth shock world, but we’ve seen this before, just in different forms,” says Nxumalo. “The upward trend of the JSE over time, despite the many crises impacting it, is due to this diversified global exposure in the domestic market given the large portion of global exposure in the JSE, which is not representative of the SA economy.”
Given that the rand is at crisis levels, Nxumalo warned investors when considering the seemingly straightforward option of taking their money offshore. “Being cautious doesn’t necessarily mean taking your assets offshore, as offshore assets are expensive, and the risk is taking them out when the rand is very cheap,” he said. “In addition, the US as an investment destination, doesn’t appear to be attractively valued, given the anticipated slowdown recession.
“The devil is in the detail,” he said.
“However, in the face of rising risks around the energy crisis, short-term foreign policy certainty and long-term growth uncertainty, we have reduced our SA equity exposure and would argue that we have improved the defensiveness of the shares in the portfolio.
This doesn’t mean that there aren’t any notable opportunities that investors can capitalise on, he points out.
"South African banks present an attractive investment opportunity,” advised Nxumalo, "with certain banks offering not only great dividend yields but also great value, as the ratio of portfolio provisions to performing loans remains adequately maintained”. This indicates that the local banking sector has diligently set aside provisions to cover potential loan losses to mitigate risks associated with non-performing loans.
Nxumalo added that allocating capital to bonds, cash, and gold will add further defensiveness to investment portfolios currently.
While this strategy and portfolio repositioning can be successful, caution is advised as the growth dominoes begin to fall, Nxumalo stressed in his concluding remarks.