Darwinism in the corporate world, Dynasty Asset Management

Equities this week were mostly indifferent to the widely expected interest rate hikes from the Fed and European Central Bank (ECB). Markets also took heart from the International Monetary Fund (IMF) slightly upgrading its growth forecast for the global economy and stating that the risk of a crash landing has significantly receded.

As we noted in our Newsflash last week, focus is increasingly turning to corporate earnings in this more stable macroeconomic context where the rate hiking cycle is approaching its peak. With economists and investors more optimistic that the global economy is heading for a soft landing, the emphasis is shifting from a broad rerating of market pricings towards evaluating companies on their individual strengths and merits.

This week, for example, we saw Meta and Alphabet get a lift off the back of strong forecasts and results that surprised slightly on the upside. Microsoft, meanwhile, dipped – mostly because the market was disappointed with the growth of its cloud business. This marks a sea change from an environment where stocks mostly fell and then recovered in unison in response to inflation and interest rate news.

Following the strong rerating of major indices from last year’s lows, we’re not expecting markets to climb as fast or as hard as they did in the first half of 2023. The recovery of the first six months came from a rising tide that lifted all boats, although some more than others. The next six months will be increasingly about which specific companies will either raise or beat their earnings estimates.

Our investment philosophy applies a blend of passive and active components. While the inclusion of broad passive instruments remains the optimal way to capture general market growth, we seek to identify and include more concentrated, actively managed funds to capture individual companies in specific sectors that are likely to outperform over the long-term, but also mitigate against downside risk.

We believe that these companies have embedded “Darwinism” – the ability to innovate and evolve through the continual investment in their brands and new technologies. They’re the companies that are best built to adapt to any environment – able to survive through difficult conditions and conditioned to thrive in favourable circumstances.

“The most powerful (natural) species are those that adapt to environmental change without losing their fundamental identity which gives them their competitive advantage. ”

– Charles Darwin, Naturalist

Global News

In an expected move, the Fed lifted interest rates 25bps to a target range of 5.25% to 5.5%, the highest level in 22 years. Chairman Jerome Powell indicated that this did not mean that the Fed would only raise rates at every other meeting (despite a pause at the previous one) as prevailing data will be considered.
The European Central Bank’s interest rate hike of 25bps takes the rate to the highest level ever and is the ninth consecutive increase. It also kept the door open to further tightening, although it needs to balance fighting stubborn inflation with the real risk of a recession. The deposit rate is now 3.75%.
The latest GDP data is adding to predictions that a recession in the US will be averted. The economy grew at 2.4% in the second quarter. Ahead of the data release, economists at the Fed had joined the group of private-sector forecasters who were rethinking their calls for a recession this year.
It’s not just the US that may miss a recession. Despite lingering inflation and a sluggish recovery in China, the global economy is showing signs of resilience this year, the IMF said. This implies that a global recession could be averted. This optimism in its latest World Economic Outlook could show that efforts to contain inflation without causing serious economic damage are working. Global GDP will expand 3% in 2023, it said, up from its April prediction of 2.8%.
Across Europe and in Manhattan, high-rise financial districts have been hit hard and it’s about to get worse as tenants vacate buildings due to the turmoil sweeping office markets around the world. Vacancy rates are soaring and valuations plunging. Banks and other prime tenants are looking to make going to the office more desirable as part of a post-pandemic reset, opting for smaller sites in locations closer to shops and restaurants. This structural pressure on commercial property is one of the reasons why we have been and remain deliberately absent from the listed property sector.
Meta Platforms has exceeded expectations for second-quarter sales and has given a rosy outlook for the current period, showing that the social networking giant is winning over advertisers to its new Reels short-video feature. Meta continues to invest in Artificial Intelligence and Virtual Reality.
Elon Musk has decided that Twitter’s product name would be changed to “X”, and that the bird logo will vanish as well as all the associated words, including “tweet”. This move wiped out anywhere between $4 billion and $20 billion in value, according to analysts and brand agencies.
As at Thursday’s close the S&P was flat for the week.

Local News

Ahead of the Agoa summit to be held locally in November, government has warned that US legislators hostile to Pretoria could use this Forum to highlight the country’s relationship with Russia and China to potentially exclude it from the preferential access to US markets. Meanwhile, South Africa has asked the US to consider an early extension to Agoa, which it argues would provide certainty for investors and encourage them to commit additional investment on the continent. While South Africa continues to seemingly be ideologically aligned to Russia, it is trying to placate the US due to the vital incentives it receives through the preferential trade agreements.
In a move that is being seen as a media blackout, Daily Maverick’s press accreditation for the Russia-Africa summit was revoked. This blackout, part of a trend whenever media asks difficult questions, is despite government entities and political parties claiming to be transparent when it comes to media asking difficult questions. Government has not stepped up to defend media, despite freedom of speech being enshrined in the Constitution.
Ahead of next year’s vital elections, Stephen Grootes has pointed out that our independent institutions will come under more pressure than ever. Perhaps the strongest pressure will be felt by the Electoral Commission, with the first indication of trouble coming in the George by-elections last week as the polls were allowed to proceed despite allegations of voters being illegally registered.
In what may be South Africa’s saving grace, momentum is increasing as 115 CEOs of top companies have now joined the previously reported move to support a business-led initiative to assist government in getting the economy back on track, and fix the country’s energy, logistics, and security problems. Companies and CEOs behind the pledge reach across all sectors of the economy. Together, they represent listed entities exceeding a value of R11 trillion, employing more than 1.2 million people.
In the face of continuing rolling blackouts, government is working on about 25 projects over the next ten years in existing substations that could potentially unlock about 13 gigawatts of energy. Loadshedding could well end by March 2025, according to Eskom chairman Mpho Makwana. In addition, government has launched an “energy one-stop shop” to speed up the process for companies when they apply for approval for new electricity generation projects.
The IMF has lifted its forecast for South Africa’s 2023 growth rate to 0.3% from the 0.1% it expected in April thanks to resilience in the services sector in the first quarter. However, it still expects economic gains to be well down compared with 2022 because of power shortages and it has cut its 2024 forecast slightly, to 1.7%, which remains woefully short of the rate required to improve service delivery and the standard of living for citizens.
The JSE gained this week as investors celebrated the international news noted above regarding the US and global GDP growth, despite the rate hikes in the US and Europe, which had been expected. The positive sentiment also helped boost the rand, which closed its discount to our estimate of fair value by trading in a volatile range of R17.42/$ to R18.02/$ and was at R17.70/$ at the time of writing.
In good news for consumers and business alike, PPI dropped to 4.8% in June, from 7.3% in May 2023. This inflation predictive indicator is now at its lowest point since March 2021, when it was recorded at 5.2%, and is far off from the peak hit in July 2022 when it reached 18%.
The continued departure of listed companies from the JSE is making it harder for asset managers and investors to diversify their portfolios, placing their financial security at risk, Coronation has warned. This, it said, is a consequence of very cheap valuations, which is likely to continue. On Thursday, Liberty Group paved the way for the possible delisting of Liberty Two Degrees, with a buyout offer to minority shareholders for the property group. The JSE has shed almost R10 billion in value in a little more than five years.
Kumba is losing R1 billion a month because of disruptions with Transnet Freight Rail’s iron ore export line. The lost sales reported in its interim results are in addition to the R10 billion in lost earnings reported for the 2022 year. However, government, Transnet and the industry are coming together to tackle the challenges to rail performance as well as stop theft, which could result in a turnaround in corporate profits that are being lost to these external capacity constraints.
As at the time of writing, the rand was 1.3% stronger and the ALSI was 1.9% higher for the week.