VCS Agency - Lunar Capital

Patience

Market Overview

The current market is characterised by political uncertainty and multiple global economic issues. The main issues affecting the South African market are Rand volatility, emerging market woes and political and policy uncertainty.

The Rand has weakened significantly against the major currencies (-19.4% YTD against the USD) benefiting South African investors invested in developed offshore markets. The Nasdaq market has shown sharp increases year-to-date (+17.5%), with the JSE All Share Index marginally down year-to-date (-1.4%).

Key Indicators

	31 Aug ‘18	31 Jul ‘18	31 Dec ‘17
JSE ALSI	58 669	57 433	59 505
Nasdaq	8 110	7 672	6 903
USD/ZAR	14.75	13.14	12.35
LBWFA*	119.66	109.37	108.54

Portfolio Overview

The portfolio performed well in August, benefitting from the good results from FirstRand and Discovery locally and from Amazon and Nvidia offshore. Rand weakness also had a positive impact on the portfolio. Aspen also had a good run in August (but sharply down in September after unimpressive results).

Approximately 38% of the portfolio is offshore. 16% of the portfolio is in Cash; 30.6% is in the Technology sector; 18.7% in Financials; and 17.1% in Biotechnology.

We continually seek opportunities in our preferred investment themes to deploy our cash, but remain patient until the right opportunities present themselves.

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Thought for the Day: Patience

“The stock market is a device for transferring money from the impatient to the patient” Warren Buffett.

The South African stock market is certainly testing the patience of investors in the local market. A strategy of regular (monthly) investments in good quality investments generally pays off well over the long-term. There is a lot of noise on a daily basis that can really mess with an investor’s mind. Typically, when sentiments are low, stocks are cheap and vice versa. Unfortunately, stock prices can remain high or low for extended periods of time truly testing the patience of investors. Investors are tested further, when a correction does occur, as these can be quite sharp rises or falls in the stock market.

The patient investor who has a regular investment in good quality businesses, who ignores daily gyrations in the markets will generally do well over the long-term.

Transact Online

Clients invested in the Lunar BCI Worldwide Fund can obtain statements, tax certificates or transact online at: https://www.bci-transact.co.za/Webclient/Login

Investors considering an investment in the Lunar BCI Worldwide Flexible Fund can obtain more information at www.lunarcapital.co.za and obtain application forms at https://lunarcapital.co.za/forms/

Disclaimer

DISCLAIMER: This research report (“report”) is confidential, issued for the information of clients of Lunar Capital (Pty) Ltd (“Lunar”) and may not be issued to members of the, nor published in, public. The information, research and opinions contained herein have been formulated in good faith and where applicable have been derived from published sources generally reliable and believed to be fair, however the information, research and opinions, as the case may be, are not warranted to be complete or accurate. Lunar does not assume liability or responsibility for their form, sufficiency or accuracy. Any person making use of this report does so entirely at his or her own risk. Lunar does not assume liability for any losses arising from any errors or omissions in this report, irrespective of whether there has been any negligence, including gross negligence, by Lunar, its affiliates, officers or employees, and whether such losses are direct, indirect or consequential. This report is neither an offer nor a solicitation to buy or sell, and is not intended to call attention to, or to market, or promote the services of Lunar. Lunar does not have a proprietary interest, other than a possible casual or arbitrage interest, in any of the listed companies referred to herein and no director of Lunar, unless otherwise stated in this report, is a director of the companies referred to herein. Lunar Capital (Pty) Ltd, FSP 46567, Reg No. K2015013022. Collective Investment Schemes in securities (CIS) are generally medium to long term investments. The value of participatory interests may go down as well as up and past performance is not necessarily a guide to the future. CIS are traded at ruling prices and can engage in borrowing and scrip lending. A schedule of fees and charges and maximum commissions is available on request from the company/scheme. Commissions and incentives may be paid and if so, would be included in the overall costs. The Unit Trust portfolios are licensed under the Boutique Collective Investments Scheme. Boutique Collective Investments is a full member of the Association for Savings & Investments SA.

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What to do about the Rand?

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Introduction

This blog discusses the reasons for the volatility in the Rand and what the ordinary person can do to protect herself from the impact of a weakening Rand.

Why has the Rand been so volatile?

The South African Rand has experienced much volatility over the last few years. There are many reasons for this.

Local political events like Nenegate and other cabinet reshuffles, the ANC NEC elections, pronouncements on policy changes like the Mining Charter or Land Expropriation Without Compensation; can impact how local and international investors view the risks or benefits of investing in the country. This could lead to additional investments flowing into or out of the country, resulting in either Rand strength or weakness.

Economic conditions can also influence whether the Rand strengthens or weakness. As South Africa is a net importing country and has a higher rate of inflation than most of the developed economies, the Rand should weaken over the long-term. This is what has been experienced. Low economic growth in the country; unemployment; the state of country, state-owned enterprises, and/or company finances can also impact the strength or weakness of the Rand.

Governance can also influence the strength or weakness of a currency. High levels of corruption, the rule of law, the efficacy of the judicial system, the strength of institutions such as the central bank and the tax collection agency; can all influence how the currency behaves. This is especially so when there is a marked deterioration or improvement in governance. In a highly mobile international investment environment, money can leave or enter a country very quickly, which can have a profound influence on exchange rates.

Sentiment can also play a role. We witnessed this after the election of Cyril Ramaphosa as ANC President and then the subsequent disillusionment of his ability to bring about quick changes. Similarly, sentiment can be influenced by international events. A recent example is the Turkish Lira crisis, where all emerging country currencies were impacted, and the Rand especially so.

These are just a few reasons why the currency can strengthen or weaken. Sadly, these are not in the control of individual or professional investors.

Why should you care?

Should you even care if the Rand weakens, given that you live in South Africa and that your expenses are largely in Rands?

Unfortunately for South Africans, most of the goods that we use are imported and are thus impacted by exchange rates. As the Rand weakens, imported goods become more expensive in Rands. South Africa also imports oil which is priced in US Dollars. So, a weakening of the Rand has an impact on fuel costs. This impacts not only your travelling costs, but also the cost of transporting goods. So, even locally produced goods that need to be transported get more expensive.

Clothing, motor vehicles, medicines, TV’s, cellphones, Social media platforms, some food items, fuel, fridges, toasters, stoves, computer hardware and software are all mostly imported. The prices of these goods and services become more expensive as the Rand weakens.

You should care if the Rand weakens because your cost of living will increase. You should also act to reduce the impact of this increase in your cost of living.

What can you do?

If you’re not in control of how the Rand behaves, what can you do? Do you idly watch the Rand weaken over time, albeit in a very torturous route?

There are a variety of ways that one can invest offshore. Exchange Control allows an individual upto R1m per annum to invest offshore and more if you are up-to-date with your taxes at SARS, subject to SARS approval. One can also invest in a local unit trust that has offshore exposure. Many funds, such as the Lunar BCI Worldwide Flexible Fund have some offshore exposure. You can invest in these funds without impacting your foreign exchange allowance.

Regular contributions (for example through a debit order) into these funds can provide a good way to be invested offshore, thus limiting the impact of a weakening Rand. If you contribute to a retirement fund, you could select the option that has upto 30% invested in offshore markets.

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Investing on offshore markets is thus not out of reach for the ordinary people. If you invest an amount on a regular basis (say, a monthly debit order), you benefit if the Rand is strong by getting more foreign assets, and as the Rand weakens, you benefit on the growth in Rand terms of the amount you have already invested.

By investing offshore, you provide a hedge (protection) against the Rand weakening and ultimately providing some protection against your cost of living increasing.

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Trade Wars

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What is a Trade War?

“A trade war is a side effect of protectionism that occurs when one country (Country A) raises tariffs on another country’s (Country B) imports in retaliation for Country B raising tariffs on Country A\’s imports. A tariff is a tax imposed on imported goods and services.” This is the definition of a Trade War as per Investopedia.

For example, if the USA imports TV’s from China and China imports maize from the USA; then a trade war between the two countries could involve the USA raising tariffs (customs duties) on TV’s imported from China; and China could raise tariffs on maize from the USA. This results in the landed cost of TV’s into the USA increasing and similarly for maize imported by China from the USA.

What are the implications of a Trade War?

We can immediately ascertain that trade wars result in higher costs for consumers in both countries. In the example above, Americans will have to pay more for TV’s and similarly the Chinese would pay more for maize. Typically, in a trade war, multiple goods and services are impacted, so the price of many items of goods and services will increase.

The effects of this are:

People buy less of those goods because they have become more expensive;
People try to find cheaper substitutes;
People can’t do without those goods (e.g. staple food) so they spend less on other goods;
Local industries could benefit, however. So, for example the TV manufacturing industry could be revived because the higher costs of Chinese built TV’s are now more expensive than locally (USA) built TV’s. This could lead to job creation locally.
Illicit trading could take place, e.g. smuggling (think about the tobacco industry in South Africa).
Also, countries and industries that are not directly involved in the Trade War could also be negatively. The world’s supply chains are highly interconnected and integrated. The impact of a global economic slowdown would affect almost every market.
If the Trade War involves more countries, alliances can be developed between countries to create more bargaining power and/or to create trading blocs.The dynamics could play out in several and complex ways.

Why would anyone want to start a Trade War?

Again, according to Investopedia, “Trade wars can commence if one country perceives another country\’s trading practices to be unfair or when domestic lobby groups (e.g. trade unions; industry bodies) pressure politicians to make imported goods less attractive to consumers.”

A Trade War could be started for political purposes; e.g. to force regime change or even to force concessions such as lower tariffs or forcing local skills beneficiation.

Common forms of unfair trading practices are:

Local subsidies for certain industries to protect jobs or develop local know-how,or even to establish certain levels of security for food, energy, etc. The European union subsidises their farmers quite significantly, for example.
Dumping, i.e. the practice of selling goods at very low costs (maybe even below cost price) into a market to make local companies uncompetitive and unprofitable. This eventually forces the local companies to go out of businessto benefit the exporting country’s industry.
Creating logistical barriers, e.g. complex and bureaucratic processes to approveand release goods that are imported.
Making it difficult for foreign companies to establish businesses in-country.

Trade wars, whilst largely considered to be detrimental for all, can provide some relief for local industries (and by implication local jobs). In an ideal world, everyone would be able to trade freely with each other. And as trade grows, so does productivity, which ideally benefits everyone by giving consumers better products and services at cheaper prices.

Sadly, we don’t live a fair world and different interest groups will always play a role in how we deal with each other. Free trade is thus a utopia, but in my opinion something that every country and industry should strive towards.

What should we do?

The World Trade Organisation (WTO) was established in 1995 to moderate trade disputes and to create a forum for multi-lateral trade negotiations. South Africa is a signatory of this and this would be the right place to deal with disputes.

But at a strategic level as a country, we should be looking to be very competitive in a few industries (e.g. tourism, agriculture, mining, information technology services, financial services; etc.). We should be doing this to create more jobs, especially those that are relevant and least at risk of being disrupted in the near future. In other words, we should create more resilience in our economy, so that we are in a stronger position to negotiate when there are disputes.

As investors, we should be concerned by the current trade war that is being initiated by the USA. A full-on trade war can have significant impact on global growth. We should be cautious of those industries that could directly be impacted by these trade wars (mining?). We have not heard of what actions South Africa would take – these could also be both negative or positive for local companies, even if just temporarily.

We continue to monitor how this Trade War may pan out, if it becomes an all-out war or if it is just merely quibbles to gain certain concessions. In the meanwhile, we will also assess what this may mean to our current investments and what decisions we would need to take to mitigate risks or to take advantage of opportunities that present themselves.

Whilst an all-out Trade War could impact global growth, good investing opportunities may also become available.

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Share focus: NVIDIA

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Nvidia manufactures high-end Graphical Processing Units (GPU’s) , i.e. computer processing chips. They work closely with software vendors that develop solutions on the Nvidia processors to build solutions for end-customers. Many AI (Artificial Intelligence), AV (Automated Vehicles); Cloud Computing Datacentres, and Gaming Applications utilise Nvidia processors. These are significant growth markets and the company has performed incredibly well over the past few years. It has strong relationships with software vendors. It recently built the fastest supercomputer in partnership with IBM.

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Lunar BCI Worldwide Flexible Fund Two-Year Review

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Two Years On

On 1 June 2018, we celebrated two years since the launch of the Lunar BCI Worldwide Flexible Fund.

We are proud of our performance of 8.27% (after costs and fees and including distributions) for the two years to 31 May 2018. This performance ranks the Lunar BCI Worldwide Flexible fund as 6^th out of 55 Worldwide Flexible Funds in the South African market over the two-year period and well ahead of the average fund performance of 0.04%.

The main drivers of our performance were:

We held a number of quality businesses through most of the period (Discovery, FirstRand, Amazom, FaceBook, Nvidia, Aspen, Amgen, PSG, Shoprite) and these have done well over the period, with a few exceptions;
We held higher levels of cash through most of the period (approximately 20% of the portfolio) awaiting better entry levels in the market;
Negatively, we were impacted by the poor performance of Small cap shares and the contagion from Steinhoff (we held no Steinhoff shares, but PSG was impacted). Rand volatility also impacted the portfolio negatively during the period.
Our best performers since inception are:
- South Africa in ZAR: FirstRand (51.15%), Shoprite (34.79%); Discovery (29.55%), Equites (12.96%).
- Offshore in USD: Amazon (103.82%), NVDIA (90.29%), Facebook (48.79%)

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We would have liked to have performed better than we did but are satisfied that most of our major investments have performed well. Our positioning was somewhat risk averse during the period. Where an investment did not pan out the way we envisaged, we analysed the reason/s for it and used that to improve our investment process. We are confident of our Investment Process.

“The stock market is a device of transferring money from the impatient to the patient.” Warren Buffett.

We have been patient and will be until we think it is time to be more aggressive.

Our Portfolio

Our portfolio composition is as follows:

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We recently reduced our stake in Discovery as our view was that it was trading at elevated values. We do however believe that it is a quality business and it is still part of our Top 10 holdings. We also sold our holdings in AliBaba at a good profit. We were concerned about the high number of acquisitions that AliBaba was undertaking.

Recent acquisitions include Glencore and Naspers. We like the mix of commodities mining and commodities trading in Glencore. It is also well placed to take advantage of the demand for cobalt and copper which are core components required for electric car and cell phone battery technologies. As for Naspers, it is trading at a deep discount to net asset value and its holdings in Tencent is an entry into the growing Chinese technology sector. The recent drop in Naspers share price provided us with an opportunity to invest.

Our portfolio is geared to taking advantage of demographic trends such as:

The growing middle class in emerging markets;
Ageing populations, especially in developed markets;
Technological changes creating opportunities for disruption and innovation;
The changing preferences of millennials;
Rapid urbanisation, especially in megacities; and
Climate change and the shift to cleaner energy sources.

We continue to assess these demographic trends, and how to position our portfolio given the opportunities that present themselves. We aim to invest only in those companies that provide growth at the right price and those that provide the potential rewards for the risk that we take. We wish to obtain above average and real returns at a portfolio level for our investors.

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Thank you to our clients, staff, directors, and business partners for your support, guidance and friendship. Whilst there are always significant risks in the financial markets, there will also be opportunities from which to profit. It is left to us to identify these risks and opportunities through our investment philosophy and methodology. Our aim is to provide a platform for growing the wealth of our families and communities.

We look forward to our third year as a fund, continuing to provide investment insights, and managing the fund for the benefit of all our stakeholders.[/fusion_text][/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

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Hubris

Archive / By VCS Agency

Hubris

Investors are faced with a multitude of risks in any investment decision that they take. With the recent results from Famous Brands, Mediclinic, Taste Holdings and also not so recently Woolies and Old Mutual; one can’t help wondering if executive hubris^* is not one of the bigger risks that investors face.

Offshore Expansion

In the name of offshore expansion, too many South African companies have lost significant shareholder value:

Woolies was forced to write off R6.7bn after their disastrous acquisition of the David Jones business in Australia;
Old Mutual finally through in the towel in their London listing and foreign acquisition spree that began in the mid-1990’s. They significantly overpaid for foreign acquisitions. Just compare Old Mutual and Sanlam since they demutualised: shareholders who re-invested their dividends would have received a 553% gain if they invested in Old Mutual versus a 2,822% gain if they invested in Sanlam^**. Old Mutual went on an aggressive international expansion, somewhat neglecting its home market; whereas Sanlam stayed at home built its base and cautiously expanded into niche overseas markets;
Famous Brands, once a darling of investors is now struggling with its acquisition of UK’s Gourmet Burger Kitchen and closing some of the brands that it acquired offshore;
Taste Holdings, similarly is in a dire financial position as result largely for over-paying to bring big-name franchise brands like Starbucks into South Africa.

It is not only South African companies venturing offshore that get it wrong:

Massmart has struggled since it was acquired by the giant Walmart group. So much for bringing international best practice and significant buying power to a previously well-performing business.

The list can go on and on. Too often expansion plans don’t pan out how management paint the picture. Some records also show that most acquisitions don’t meet the original return criteria. One has to question why management do those deals in the first place. Does management overrate their own importance, or do they want to have their names emblazoned on iconic deals, or are they driven by perverse incentive schemes? Executive hubris?

Beware the trophy head office

Hubris takes another form in fancy new head offices. I’m certain there is a study somewhere that shows companies beginning to underperform after they move into fancy new head offices.

In the name of productivity, attracting top human capital, or branding; substantial amounts of money is spent building or leasing new offices, but it is never clear that the required return on investment is actually achieved.

It must be a great kick and boost to self-importance to drive into the fanciest offices in town.

Should we paint all with the same brush?

We know however that not all acquisitions or expansions are bad and that it does make economic sense at times to upgrade to newer, more efficient business premises. We argue that investors should be sceptical of acquisitions, international forays and trophy business premises. Too often, these in fact tell you more about executive hubris than about business strategy.

A good indicator of money well invested is Return on Capital Invested (ROIC) and ultimately also Return on Equity (ROE). Businesses that are able to allocate capital efficiently significantly outperform those that follow some grand footprint or flag planting strategy over time. We gave the example of Sanlam versus Old Mutual earlier. Another great example is FirstRand versus Standard Bank. FirstRand has been much better at capital allocation than Standard Bank and this is reflected in their comparative share price performance over the long-term.

Both Sanlam and FirstRand have also acquired businesses, expanded offshore and moved into new buildings. Arguably, they have been more selective and disciplined about the investments that they made and how much they paid for them. Their shareholders have benefitted substantially more than those invested in their competitors, and who may have not been as selective and disciplined in their investment decisions.

Beware executive hubris!

^* hubris = excessive pride or self-confidence; arrogance; feeling of superiority

^** Source: Business Day 18 March 2018; https://www.businesslive.co.za/bd/companies/2018-03-16-returning-old-mutual-will-find-sanlam-ahead/

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Seeking Growth Markets

Archive / By VCS Agency

At Lunar Capital, we are continuously on the look-out for long-term investments that can benefit investors in our fund (and ourselves as we are also significantly invested in the fund that we manage).

Ideally, we would allocate a portion of our fund to a large growth market (country, industry or other) that we think offers good growth potential and is trading at reasonable levels.

One of the markets that we regularly look at is the Indian market.

India

India is the second most populous country in the world. At current population growth rates, it could overtake China by around 2024 as the most populous country in the world.

Here are some statistics about India:

Population = 1.34 billion 2^nd Most Populous Country

Population Growth Rate = 1.2%pa

Gross Domestic Product = USD 2,611 Billion 6^th Largest economy in the World

GDP Per Capita = USD 1,983 Ranked 139^thin the World

GDP Growth 2017 = 7.1%

India is a large economy, growing at a very fast rate, but by-and-large the majority of the population is still poor by global standards.

Most foreigners and business people who visit India are intrigued by the country. It has a highly developed service sector, and a workforce that is skilled and relatively cheap. It is ranked as one of the Top 10 foreign direct investment countries in the world.

Services make up approximately 54% of the Indian market, with Industry making up 29% and Agriculture 17%.

Indian Stock Market

The Bombay Stock Exchange (BSE) has a market capitalisation of approximately $2,120 billion and is the 11^th largest stock market in the world. It has over 5,700 companies listed on the exchange. It is currently trading at a Price Earnings Ratio of approximately 23.

With the large number of companies listed on the BSE, it is very difficult for an outsider to successfully pick the right stocks to invest in. India also has its fair share of corruption. Government and corporate scandals are a regular feature of the market.

The current price earnings ratio on the BSE also appears expensive by historical and global standards.

Factors contributing to growth

There has been significant infrastructure spending in India, from new and improved airports and roads to power plants and hospitals. Government has also committed to obtaining 40% of energy requirements through renewables by 2030.

India also has a growing middle-class, that is skilled, ambitious and entrepreneurial. This will likely continue to propel consumer spending.

Indians are also obliged to register their identities through the Adhaar programme. This records all citizens digitally using biometric data. The benefits to financial institutions and other businesses and agencies who require proof of identity are enormous with the Adhaar initiative.

India has also become a tech start-up hub (3^rd or 4^th largest in the world) and some very successful start-ups like Flipkart, Ola and Snapdeal have been established in India.

Impediments to growth

All is not rosy however:

There is a huge infrastructure backlog. This issue is magnified given the size of the population and cities;
Pollution levels is some cities like Delhi are at dangerous levels;
Poverty is still a large feature of the country;
Corruption still exists in both the public and private sectors;
India has a grindingly slow judicial system;
There is always a risk of social and/or religious uprisings, especially given that 2019 will be an election year;
Too few contribute to the tax base, especially compared to the size of the economy; but this has been steadily increasing.

These are some of the hurdles that the country faces to potential prosperity.

How to get exposure to the Indian market?

The Indian market should however be on investor’s radar screens. The demographic changes in this market will likely be a tailwind behind this economy. Whilst corruption is rife, this appears to be reducing. The economy is also becoming more open. Government appears to be tackling the major issues, but success rates will vary.

Stock-picking in a market like India would be very difficult for outsiders. Arguably, a good strategy would be to invest via a low-cost index tracker option. Unfortunately, this is not available directly in South Africa. South African investors would need to use their foreign exchange allowance and invest directly through the Indian market or via one of the developed market exchanges (e.g. Nasdaq).

Another alternative would be through some local unit trusts that have direct or indirect exposure to the Indian market.

A regular (say monthly) investment subscription rather than a large lump sum investment is also probably a good strategy for the individual investor.

Lunar Capital Strategy

We know that many South Africans are keen to have exposure to the Indian stock market. Our approach is to try and minimise the risks to our investors, whether it is understanding the dynamics of a particular company or determining whether a particular investment is priced appropriately or not.

To date, Lunar Capital has not invested in the Indian stock market, but we do follow the market and, in all likelihood, would invest in this market at some time in the future, either directly in certain stocks or via a low-cost exchange traded fund.

At this stage, we continue to monitor the Indian market. If and when the correct opportunity presents itself, we will allocate an appropriate quantum of funds to the Indian market.

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Share Focus: EPE Capital Partners (EPE)

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Ethos Capital (EPE) invests directly and indirectly in a diversified portfolio of unlisted investments, which are managed by Ethos Private Equity, the largest private equity firm in sub-Saharan Africa.

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Inflation and its impact on stock prices

Archive / By VCS Agency

What is Inflation?

Inflation is when the prices of goods or services rises sustainably. This is when we as consumers pay more for our goods and services. To put it differently, it means that our money is worth less. We get fewer goods or services for the same amount of Rands or Dollars. In South Africa and many other countries, we use the Consumer Price Index (CPI) to measure inflation.

Inflation can be caused by several factors. Here are some of the causes of inflation:

When the economy is doing well and people have more money, they may be willing to spend more on goods and services. This higher demand leads to increased prices.
When commodity prices such as oil goes up, it increases not only the cost of fuel that we use for travelling, but also the cost of transporting goods and services. This translates into higher costs, thus leading to inflation.
Exchange rates also play a role in inflation. If the South African Rand weakens against other major currencies, then this too causes rising inflation, because the cost of imported goods is more expensive in Rand terms.

Moderate levels of inflation generally imply a good economy, i.e. one that is growing healthily. High levels of inflation imply an overheated economy which will likely result in an economic crash. Very low levels of inflation imply a subdued economy.

It is the role of central bankers like the South African Reserve Bank (SARB) to try and manage inflation. They typically do this through monetary policy, i.e. by raising or lowering the interest rates that they charge to commercial banks. If they wish to reduce inflation, they raise interest rates. This leads to consumers having less money to spend on goods and services, as they have higher interest payments on the debt that they owe to banks and other lenders. In this way, the central bank tries to manage the economy so that it does not overheat. Vice versa, when they want to give the economy a push.

Inflation versus Returns

Inflation is a stealth threat to any returns. If your returns are below the rate of inflation, then you are in fact earning a negative return, i.e. you are losing money in real terms. So, when looking for where to invest in, one should always be mindful of the impact of inflation on one’s investment.

Where an investment pays a fixed rate like a bond, then the impact of inflation on returns is easily understood. As inflation rises, the value of the bond drops and vice versa.

The impact for companies, however is not so simple.

Inflation versus Stock Price Returns

There are several conflicting factors at play here:

As inflation increases, the returns on your investments should be lower in real terms, so arguably the share price should reduce.
However, inflation also implies that companies can charge higher prices for their goods or services. In this way they will earn higher revenues. So, this should negate the impact of lower real returns discussed the above.
Factoring in higher inflation rates into valuation models should also have a negative impact on share valuations, which could lead to lower prices.
Markets also operate in complex ways – from exuberance to pessimism, from forward looking to backward looking. So, at any point in time these factors may overshadow whatever inflation may or may not be doing.

It is thus not entirely obvious how inflation impacts stock prices. However, what one should look out for is any significant shifts in inflation. When South Africa broke the back of double digit inflation in the 1990’s, share prices and price earnings multiples increased commensurately. It is thus advisable to look out for any significant and sustainable shifts in inflation.

What are we looking at in terms of Inflation?

In the two markets in which Lunar Capital mostly operates; South Africa and the USA, we could possibly see some interesting developments from an inflation perspective:

In South Africa, the last CPI figures indicated a year-on-year increase of 4% per annum. According to Investec, inflation should increase to between 4.7% to 5.3%, given the VAT and fuel price increases. This is still below the 6% that is imprinted in most people’s minds as to where inflation is. In our opinion, this will have a moderately positive impact on stock prices (price earnings multiples) of companies that have a strong market position.
In the USA, inflation and interest rates are on the rise. In our view, this would likely put the brakes on any significant stock market rallies in the near-term. If anything, there may well be a further correction in the market.

S&P 500 Annual Averages per Decade

The following table shows average annual results for each decade:

	Price Change	Dividend Dist. Rate	Total Return	Inflation	Real Price Change	Real Total Return
1950\’s	13.2 %	5.4 %	19.3 %	2.2 %	10.7 %	16.7 %
1960\’s	4.4 %	3.3 %	7.8 %	2.5 %	1.8 %	5.2 %
1970\’s	1.6 %	4.3 %	5.8 %	7.4 %	-5.4 %	-1.4 %
1980\’s	12.6 %	4.6 %	17.3 %	5.1 %	7.1 %	11.6 %
1990\’s	15.3 %	2.7 %	18.1 %	2.9 %	12.0 %	14.7 %
2000\’s	-2.7 %	1.8 %	-1.0 %	2.5 %	-5.1 %	-3.4 %
1950-2009	7.2 %	3.6 %	11.0 %	3.8 %	3.3 %	7.0 %

Source: http://www.simplestockinvesting.com/SP500-historical-real-total-returns.htm

The table above shows that investing in the equities markets has been a good hedge against inflation in the long-term. Interestingly though, this is not true for two out of six decades in the table shown above. The negative return in the 2000’s reflects the impact of the global financial crisis of 2008-2009; and the negative return of the 1970’s reflects high inflation in the USA. However, over the 6 decades, real returns have been excellent (7.0%).

Our approach to investing is to acquire great businesses at good prices and to hold them for as long as possible. The macro-economic environment is additional input into our decision making, but we rely much more on individual business analysis in our decision making. Ultimately, we aim to have real (i.e. above inflation) growth in the investments we make over the long-term.

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The Land Question?

Archive / By VCS Agency

In my opinion, the Land Question in South Africa raises a broader issue. It is the question of retribution for the crimes of colonialism and Apartheid. The Black Economic Empowerment policies attempted to address these issues but these have fallen short of meaningful empowerment of the previously disenfranchised. It has also had unintended consequences – fronting, favouring those close to the ruling elite, a laager mentality amongst many whites, etc. Add high levels of poverty and inequality, little access for many people to be able to earn a meaningful living; and this creates a ripe environment for a major social backlash. This backlash can take many different forms, from widespread civil unrest to xenophobic attacks, tribalism, racism, land seizures, etc.

What can government, citizens, activists, businesses, organised labour and the person in the street do to address this issue for an outcome that is likely not going to be satisfactory for most?

The ANC December Congress passed a resolution to adopt a policy of land expropriation without compensation. The Economic Freedom Fighters (EFF) is ensuring that this issue stays at the forefront of the national agenda. Rightfully so. It is unfortunate that since the dawn of democracy in the country, not much has been done by the elite (political and economic) to address this issue in a more wide-reaching and meaningful way. Having access to power and the ability to influence decisions, allowed these elites and their cronies to benefit greatly. It is not in their interest to rock the boat too much.

Now however, it is too difficult to sweep this issue under the carpet or pay mere lip service to how it will be addressed.

Irrespective of what the outcome/s will be and how it is addressed, it can be guaranteed that there will not be a satisfactory outcome for all. In fact, many may get little satisfaction. So, it is imperative that this issue is dealt with the utmost care and with an execution strategy that ensures that in fact as a whole we are better off as a country.

Perhaps, the starting point would be to develop a set of principles that cover the following key questions, amongst others:

Is it about Land reform or more broadly about economic reform?
Do we deal with the broader issue of reparation for the evils of Apartheid and colonialism or only about restoring rights where there is clear evidence ofdispossession and forced removal?
Under what conditions will expropriation without compensation take place?
What should be done about other policies (BEE for example) that haveattempted to redress past issues? Should these continue, be scrapped or changed
to get better outcomes?
How will potential beneficiaries be assisted to lay claims and how can they beset up to get the best for themselves and the country?
How will we deal with potential capital flight and its cousin, lack of newinvestments?

These are complex issues to solve, so setting up a set of principles upfront with the right set of stakeholders will be an essential and critical first step. It should also guide how trade-off decisions will be made.

Our clients at Lunar Capital ask us what the impact on one’s investments is, in this scenario?

At this stage, it is very difficult to predict exactly what will happen and who would be the winners and losers. It depends on what kinds of redress will be sought, and how it could be affected. To what extent will government first redistribute the land/properties in its own portfolio? Are there some cut-and-dried cases that could be resolved quickly, and what are these? If properties that are expropriated without compensation are bonded by banks, will the banks have to carry costs of the default? If not the banks, then whom?

We would be cautious of companies that own large tracts of land in rural, peri-urban and possibly even urban environments. Largely for now, we would not panic. The state has many options to address the issue of land reform before it needs to use the “expropriation without compensation” tool. We are also of the view that the current administration will deal with this issue sensibly, but it will likely face lots of criticism from both the left and right. The country has sufficient intellectual capacity to execute on this properly. It is up to government to ensure that it resources this task team appropriately.

A very good outcome can come from this for the long-term benefit of the country if dealt with from a point of principle and executed with an intention of properly empowering those who have been marginalised in the past and continue to be impeded by a lack of access to earn a decent living. This will be good for the country and for long-term investors.

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