Just as the Magnificent Seven tech stocks are dominating America’s stock market performance, South Africa’s Terrific Ten, mainly precious metal companies, are doing so back home. Times like these are challenging for active managers because 84% of South African equity performance comes from a handful of markets, while the rest of the market delivers far less impressive single-digit returns.
When stock tips are plentiful and come from every corner, particularly about those whose prices have risen substantially in recent years, investors may experience FOMO (fear of missing out) and be tempted to dive in. However, conventional wisdom says it’s time to be cautious.
So, what is the answer to the question of whether investors should bring their offshore money back to South Africa to get in on the resource stock rally? Much of this stems from the ALSI Top 40’s 52% year-to-date return (in US dollars). As a firm that has been managing client portfolios through many market cycles, this has been a challenging period for active management.
A tale of concentration
The numbers are striking. Gold Fields is up 204% this year. AngloGold Ashanti has surged 190%. Together, our other precious metals miners and Naspers/Prosus have contributed 84% of the JSE All Share Index’s returns. Strip out these, and the market is up only 6% for the year, which wouldn’t ordinarily make headlines.
The US market is experiencing a mirror image of this phenomenon, with its Magnificent Seven tech stocks dominating because of their multi-billion-dollar investments in artificial intelligence, while South Africa’s Terrific Ten profit handsomely, mainly from mining precious metals.
The active manager’s predicament
The question on every active manager’s mind at a time when stock markets are as heavily concentrated as they are now, is how to manage money responsibly when investors are overwhelmingly interested in a handful of stocks. The average retail investor looks at Gold Fields’ performance and says, “Let’s buy more of that”, which is antithetical to everything we know about successful investing. You’re supposed to buy low and sell high, not chase yesterday’s winners.
A well-established investment philosophy that prioritises diversification helps to mitigate the risk of falling into these traps, but it does not eliminate the challenge completely. We believe allocating 50% of a portfolio to South African gold miners, regardless of their past or potential performance, would be overly speculative and not aligned with a risk-conscious, diversified investment philosophy.
The South African paradox
One also needs to remember that stock markets are not economies. The same is true in South Africa. Our GDP growth remains below 1%, and the outlook remains tepid, yet the precious metal-driven stock market rally suggests we are in a golden age. This is not cognitive dissonance; it is simply that revenue for many of the top-performing stocks is not tied to the fortunes of the domestic economy because their wares are sold abroad.
One positive impact on the domestic economy is the improvement in our terms of trade, driven by higher gold export prices and a weaker dollar, which benefits the fiscus through a more resilient current account. Taxes on mining-company profits will also bolster government finances, which aids debt metrics.
The Transnet factor
Although there has been much improvement of late, underinvestment in transport infrastructure over the past decade has left the volume of commodities leaving our borders lower than it could have been. This was true in 2021/22, too, when platinum prices skyrocketed and we could not move all of it either because trains were broken or ports were clogged. We could not capitalise on South Africa’s natural advantages.
In this regard, the recent licensing of private operators by Transnet offers hope, but even with these improvements, it is unlikely that we will reach the tonnage levels we achieved in 2019 any time soon – let alone historical highs. However, albeit slow, it is progress.
Managing concentration risk
Investors tempted by FOMO should take heed: forecasting the future with perfect accuracy is almost impossible. Even professional investors have only broad ideas about possible outcomes. No one has perfect insight into what will happen next. This is why it is essential to be exposed to select risk and return drivers. This approach reduces the risk of a material permanent loss of capital.
The critical point to us is this: we do want to participate in these rallies but are averse to jumping in after a 200% run in a stock and risk buying at the top. We constantly ask ourselves, if you’re underweight in these positions, do you add more now, or is what you have enough to deliver on our intended outcome?
Looking beyond the rally
While everyone is focused on gold and platinum, we believe investors should be thinking about the “picks and shovels”, quite literally, in our case. Which industrial businesses benefit from this commodity boom? What about the tax revenue flowing to the fiscus? These second-order effects might offer more attractive opportunities than chasing mining stocks at these levels.
The five-year figures provide a clearer view of how various asset classes and regions have performed. During this period (to the end of September), the SA All Bond Index returned 71%, the SA All Share Index (ALSI) 132%, and the S&P 500 114%, according to Nedbank Research. On a compound annual growth basis, the ALSI, which delivered 18.5% over the period, outperformed the S&P 500, which generated 16.3%, by more than two percentage points a year. When considering these longer-term performance numbers, you realise that a relatively concentrated emerging market like ours can at times outperform materially, but timing and patience matter.
The bottom line
Ignore South African equities at your peril, but don’t mistake a narrow rally for broad economic health. As investment managers, our job is not to capture every spectacular gain but to ensure our clients’ wealth survives and thrives across multiple market cycles. Sometimes that means watching from the sidelines as others get lucky on concentrated bets.
Jan-Daan van Wyk is an associate director at Stonehage Fleming Investment Management South Africa.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article does not constitute investment or financial planning advice that is appropriate for every individual’s needs and circumstances.
