FIFI PETERS: The year 2022 has been a bruising one for equity markets, both locally and offshore. For a perspective on how tough the year has been and where the opportunities in the market still lie, I’m joined by Clyde Rossouw, the co-head of quality at Ninety One.
Clyde, thanks so much for your time. Let’s start with a quick global perspective, given that you manage Ninety One’s Global Franchise Fund, which in itself invests in global equities. What do you make of how the year has panned out so far?
CLYDE ROSSOUW: Yes Fifi, you are right. It has been a tough year for investors. There’s been no place to hide within the broader markets. Equities are down across the board, global stocks are down,[inaudible] stocks are down – and depending on what currency you measure it in, there’s either been little or a lot of money to be lost.
So I think the key point that’s been driving all of this is not necessarily about the underlying fundamentals for profits and for earnings growth, which [are] still relatively robust. I think the bigger issue is the fact that people have been worrying about inflation, they’ve been worrying about interest rates, and higher rates typically lead to lower multiples. In other words, people are prepared to pay less money for the same unit of cash flow that they would’ve previously, a year ago. So you’ve had a derating of stocks and that’s been the principal driver behind the stock market weakness.
I think it’s important for investors to remember that good businesses will still be able to grow, even in the current environment.
Therefore one must be careful about making very big predictions around stock levels, and rather make sure that you focus on individual businesses in your investment decision-making.
FIFI PETERS: And what are good businesses in this environment?
CLYDE ROSSOUW: Look, we like to focus on companies that we think can navigate the macro environment better than others. So in simple terms, if you sort of think about that, these are typically businesses that have very strong competitive advantages, these are typically companies that have dominant market shares.
They’re able to grow even in tough market environments. They typically have relatively low sensitivity to broader markets, financial markets and to the economic circumstances. They don’t require a lot of capital to be invested to grow. And typically the cash they generate comes back to us as shareholders, either in the form of dividends or share buybacks.
So for us that’s the kind of business we’d be looking for.
FIFI PETERS: And how are you feeling about respective sectors, starting off with technology? A big benefactor of the Covid-19 boom that we saw in stock markets has not quite been the benefactor of the reversal that we have seen so far this year. Do you see any opportunity in technology presently?
CLYDE ROSSOUW: You are right. The circumstances driving technology performance in 2020 were very different to what’s been driving the markets this year. The big difference is the fact that you don’t have what I would call the liquidity capital rewriting into support. In 2020 all the central banks cut interest rates; they put a lot of money into the financial system. This year round it’s actually a reversal. Money is going out of the financial system, rates are going up. So very different fortunes.
I think, again, within technology it’s important to differentiate between companies that are losing money but have the promise of a better future somewhere down the line. Investors are not prepared to fund those companies anymore. So [with] the likes of Twitter with marginal profitability, a lot of stocks out there that have those kind of characteristics, the market doesn’t have the same patience this year as it had then.
Let me give you one example of a business we do like. Our largest holding is Visa.
It’s a technology business. Despite all the innovation taking place in cryptocurrencies with Bitcoin, Ethereum, and lots of news flow on that this week, the Visa card network can still process 1 700 transactions per second, whereas Bitcoin can only do seven …
That’s a business with a dominant market share, a 50% share of credit cards across the world. The network is growing. It’s a business which is inflation-resistant because they take a percentage of the value of transactions that take place. As long as people swipe their credit card somewhere at a merchant, whether it’s inflation or whether it’s real, it doesn’t matter, [Visa] will still take a percentage of that. Over time they generate good margins and they have nothing to do other than give the money, the excess cash, back to us the shareholders.
So that’s a business within the technology space we do like. It generates cash today, and it has a very, very good robust growth pipeline over time.
FIFI PETERS: All right. So I imagine that Visa is one of the companies that are in the fund presently. But what other themes and holdings do you have outside of technology?
CLYDE ROSSOUW: That’s a good question because, if you look at South Africa, South Africa is sort of under-endowed with structural growth stories at the moment. At least when you look at the international environment, there are a lot of sectors that [are benefiting from a] tailwind.
I’ve spoken obviously about Visa, which is a leader in the payment space. If you look at Prestige Beauty, for example, we own a big position. [There is] Estée Lauder, which makes premium skincare, makeup and cosmetics.
The need for investing in better looks going forward is not diminishing. In fact, people are spending more money on their face and on their skin than ever before. So that’s a structural driver we like.
We’ve invested in a semiconductor equipment manufacturer called ASML. They essentially provide a monopoly in the tools that will power the creation of the next generation of semiconductors around the world, a very niche business with 100% market share.
And then there are businesses that also benefit from climate change. So we’ve got a software services business called Autodesk that actually leads innovation with computer design in creating blueprints for buildings which are far more energy efficient.
So there are lot of businesses out there that have very attractive characteristics that one can still invest in with the good structural tailwinds.
FIFI PETERS: All right. Finally, going back to where we started, just reflecting on the falls that we have seen in most stock markets this year, do you think it’s done right now, and are you optimistic for the future?
CLYDE ROSSOUW: I think the important point here is to really think about what the next level of surprises is going to be on [the] interest rate, because we all know that this week is going to be a big week for interest rates. The Fed meets, many other central banks meet, and there’s a lot of upward pressure on short-term interest rates. Obviously the difference there is that long-term interest rates seem to find a level.
We watch US 10-year rates quite closely; they are sitting at 3.5%. Mortgage rates are at 6%. So we don’t think stocks or shares have to necessarily become cheaper from the current level.
If we do see in the second half of this year – we are expecting inflation to moderate; we see energy lower, oil lower, we start to see signs that we’ve been reaching the peak in food inflation – [and] as inflation moderates it will take the pressure off the interest-rate regime, and therefore valuation multiples no longer need to compress.
So that’s what I’d be looking for. It’s obviously early days. We are in that bottom-up period. And then in the meantime we think the important thing for investors to remember is to look for companies that actually, as I said, produce corporate profits today, where there’s less risk around the earnings profile.
Fortunately we can find businesses that have – even in the event that the shares are a little bit cheaper at the end of this year – obviously derated quite a lot already this year, [so] you’re not going to lose money because the earnings growth will offset any derating that’ll occur within the marketing environment.
So again, that’s what we would encourage investors to continue to think about.
FIFI PETERS: All right. Clive, thanks so much for that perspective. We’ll leave it there. Clyde Rossouw is the co-head of quality at Ninety One.
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