The first seven months of 2018 have been miserable for South African investors. The local stock market has given back some of the gains it made in the second half of last year, listed property has been sharply negative, and bond returns have been volatile.

The investment environment as a whole is also extremely difficult. Concerns about trade wars have impacted on emerging markets, the rand has suffered from investment outflows, and the South African economy continues to struggle to gain any momentum.

“It has been a really tough 2018 so far,” says Nadir Thokan, portfolio manager at 27Four Investment Managers. “Even on a three year view, there is no local asset class that has given you double digit annualised returns.”

Source: 27Four Investment Managers

Even international equities have only delivered a little over 10% for this period, most of which has been due to rand depreciation. Balanced funds have therefore delivered very moderate returns.

“Investors are not very encouraged by the outlook either,” says Thokan. “The first quarter GDP numbers for South Africa were shocking, business confidence is tapering off after Ramaphoria, the petrol price is hurting consumers, and the Reserve Bank has completely changed its tune after the last rate cut because inflation is on the rise over the medium term.”

This is leading many people to question what they should be doing with their money.

“People don’t feel very confident about their ability to unlock better returns going forward,” says Thokan. “Investors are exceptionally uneasy about this low return environment and how it seems to have become entrenched.”

Don’t be swayed by emotion

The greatest risk to many investors in this scenario, however, is themselves. People are tempted to forget their long term goals and make emotional decisions that, unfortunately, often end up being taken at the worst time.

“Investors are seeing that they would have been better off in cash over the last three years and asking why they should take risk in the equity market when things are not improving,” says Thokan. “But actually equities and risk assets are offering much more value now than they have at any point in the last three years.”

He points out that investors should consider a number of recent examples that illustrate how making investment decisions based on sentiment would have been completely the wrong thing to do.

When Nhlanhla Nene was dismissed as finance minister in December 2015, fears about South Africa’s future led many people to sell government bonds and disregard the asset class completely. However, the next year saw a significant rally in the bond market in which savvy investors made a lot of money.

“While people were getting emotional about the firing of the finance minister, the reality is that the real yield pick up for foreign investors was massive,” Thokan explains. “They were big buyers of local bonds.”

Subsequent to that, in mid-2017, South Africa’s sovereign credit was downgraded to sub-investment grade by S&P and Fitch. Again the emotional response was to sell government bonds, but once again these assets actually rallied in the months that followed.

Conversely, at the height of Ramaphoria this year, an emotional investor would have thought this was the time to get back into the bond market. However, that would once again have poor timing, as yields soon began to go up, and investors suffered capital losses.

“The point is that investor sentiment and investor emotion often lead you to make the wrong decision,” says Thokan. “What actually mattered on the bond market is the yield differential between the USA and South Africa. In other words, it is always more about the fundamental valuation rather than sentiment.”

Source: 27Four Investment Managers

A similar story has played out in the South African equity market in the last eight months. Shortly before the ANC conference at the end of last year, the narrative was that the local economy was in a recession, the environment was uncertain, and banks were therefore going to struggle to grow profits.

“But this was exactly when you wanted to own those businesses, because the price-to-earnings [PE] differential between banks and the JSE was wide,” says Thokan. “Yes, there were challenges, but this was more than reflected in the prices you were paying. Banks were trading on PEs of around nine, while the overall market was at 18.”

From December to March, these counters re-rated significantly, with FirstRand up close to 40% and Standard Bank climbing more than 35%. At that point, Ramaphoria was starting to take hold, and, emotionally, this was when investors would have thought it was the right time to buy these stocks.

“That, again, would have proved exactly the wrong trade,” says Thokan. “From the end of March to today, banks are down 25% to 30%.”

The key was again the fundamentals. Because the share prices on these counters had already climbed so far, their valuations were now much higher and the margin of safety much lower.

Source: 27Four Investment Managers

This is the lesson that investors should consider now. Returns have been unquestionably poor for some time, but what really matters is where the fundamentals are right now.

“The JSE is trading on its cheapest multiple on a forward basis for a long time,” Thokan says. “Companies are generating earnings growth and are trading on decent dividend yields. That means that you are being offered a decent cushion. While investors are frustrated about how long they have been in this low return environment, this is exactly when you want to be in equities because they are offering fundamental value.”