11 Jul China and the dirty little secret of South African equities
As published by Business Day and other major news sources on 7 July, 2022 by Pieter Hundersmarck
Without the powerhouse, the JSE would have provided a dismal 3%-4% annually in rand in the last decade.
It’s been a torrid 2022 so far. Global markets are over 20% off their highs in January, inflation is surging and Central Banks are tightening. The specter of recession is looming.
South Africa’s JSE has experienced some respite from this, through higher resource prices and better terms of trade. But the relatively better performance of SA equities disguises a dirty little secret: the lion’s share of the JSE’s performance comes from exposure to one country, China, through resource stocks and Naspers. Without these two factors, South Africa’s equity performance over the past decade would have been almost 80 percentage points lower than the JSE All Share’s.
The five charts below tell the story.
First up are the returns the JSE All Share Index has delivered over 10 years versus the MSCI All Country World Index (ACWI). The chart shows that global stocks have trounced the JSE over 10 years, delivering 17.8% per annum vs the 11.6% per annum of the JSE, both in ZAR.
Next up, we need to decompose the returns of the JSE. We know that Mining and Resource shares (Sasol, BHP, Anglo, the plats and gold stocks) play a meaningful role in the Index. The chart below repeats the returns of the JSE index but this time compares it to the JSE excluding resource stocks. Once excluded, it would appear that investors are no worse off without resources in the index.
But this is misleading. The chart below shows the strong performance of resource counters over the past five years. Without resources, the JSE All share index would have gone backwards over the last 5 years of the previous decade by c. 25%.
But resource stocks aren’t the only China dependents of the JSE. Another large contributor to the JSE returns has been the performance of Naspers (Tencent). So how has the JSE index done without Naspers? The chart below shows that without Naspers, the returns of the JSE would have been more pedestrian.
The final piece of the performance puzzle is the performance of JSE Index without Resources and Naspers? The chart below tells the story.
It’s an entirely different picture. Without resources and Naspers, performance would have been almost 80 percentage points lower than the JSE All Share’s over the 10 years.
Deconstructing the JSE performance raises critical issues for investors and asset allocators. The first issue is that resources are important for the JSE and the currency, and resources are highly dependent on Chinese consumption. For now, even without the Ukrainian conflict, the tailwinds behind resources are strong. Chief amongst these tailwinds is years of underinvestment due to poorly thought-out policies around ESG, and a still growing global economy that demands commodities.
Higher commodity prices will be good for SA investors. Just look at the latest returns from one of SA’s top resources funds. Managed for years by the very capable Henk Groenewald and Duane Cable, and now by the equally capable Nic Stein and Nic Hops, the Coronation Resources Fund has returned an astonishing 19.4% p.a. since inception on March 31, 2002. Is that return sensitive to the end-point? Of course, it is. But all return calculations are.
But there is a bigger picture here. Who is the buyer of all the marginal barrel of oil, ton of coal and ounce of platinum? The answer is China, which accounts for over 40% of all the consumption of the world’s resources.
When all the positive returns of the local index have historically been driven by China growing its economy at over 6% for the past decade, coupled with incredibly accommodative global monetary policies, how do you think the JSE will perform when neither of these conditions hold?
This should be very worrying. It is already alarming that without China, the local market would have provided a dismal 3-4% per annum in rand over the last 10 years (not to mention dollars). It is even more alarming when we consider the next 10 years.
The second observation is the factual realisation of how concentrated the bets are on the JSE when excluding resources and Naspers. All told, 75% of the capitalisation of the JSE consists of commodity stocks and four companies: a large indebted beer company, an embattled tobacco company, a luxury goods company and a holding company that owns a Chinese internet asset. The number of companies listed on the JSE has shrunk by 43% over the past two decades according to Listcorp. Fishing in these waters is difficult and risky.
Over the past decade and more, SA investors have benefited inordinately from Chinese growth. Primarily through Naspers, but also through exposure to resource stocks. Without them, the returns of the JSE would have looked remarkably different.
Investors need to understand where their returns have come from, and where they are likely to come from in the future. The conclusion can only be one of tighter risk management. Resources are a volatile space, and always have been, especially in a country where the land expropriation bill has been on the table, where the State has persistently failed to provide clarity on the mining charters and taxation. Naspers, for all its many shortcomings, has been a boon to South African investors. However, investors have finally woken up to how fragile the investment case really was, and how fragile it will look over the next decade.
About Pieter Hundersmarck:
Pieter is a fund manager and member of Flagship’s global investments team.
Pieter has been investing internationally for over 13 years. Prior to Flagship, he worked at Coronation Fund Managers for 10 years in the Global and Global Emerging Markets teams, and also co-managed a global equities boutique at Old Mutual Investment Group. Pieter holds a BCom (Economics) from Stellenbosch University and an MSc Finance from Nyenrode Universiteit in the Netherlands.