Emerging markets such as Africa traditionally represent big reward — and big risk. Recently, at the first hint that the Fed might taper its bond-buying program, emerging markets experienced a stomach-churning increase in volatility that affected currencies, stocks and bonds. We take a look at the most liquid market on the continent — South Africa — and the investment bank Investec (INVP.L).
In terms of the Fed’s tapering, markets have wisely assumed that any reduction in bond buying (meaning reduced liquidity sloshing around the financial system looking for a home) will immediately impact emerging markets – one of the primary beneficiaries of Fed Chairman Ben Bernanke’s loose monetary policies.
Take a step back, though, and remind yourself of the longer term opportunities in emerging markets and consider whether now seems to be an interesting time to contemplate investment. As the BRIC (Brazil, Russia, India, China) countries are now synonymous with emerging markets, I thought we’d look beyond – to the one emerging continent that doesn’t have BRIC representation – Africa. To give some sense of the growth and opportunity there, the IMF (May 10, 2013) forecasts that sub-Saharan Africa will experience GDP growth of 5.5% in 2013/2014, making it the second- fastest growing region in the world after emerging Asia.
We looked at opportunities within Africa’s largest economy– South Africa. South African financial services seem to be an area of opportunity – with most of the larger stocks scoring well on StarMine’s Intrinsic Valuation model.
Chart 1
Source: StarMine Professional
Gauging momentum and sentiment
The general problem with value stocks is timing – it isn’t hard to identify a stock that looks inexpensive. The challenge is not buying that stock until there’s some kind of catalyst for a re-rating by the market. StarMine’s Val-Mo model is designed to help in that process, as it identifies stocks that appear inexpensive both on a dividend discount model and relative value basis. It also takes into account shorter-term momentum – analyzing whether sell side sentiment (and revision) is becoming more or less positive and whether the share price moving in the right direction – the latter being a proxy for buy side sentiment.
Investec is the South African large cap with the highest Val-Mo score (99). It also has the lowest Price/Intrinsic Valuation score for the country’s market (not just the financials) combined with positive analyst revisions sentiment and price momentum.
Chart 2
Source: Eikon
Rugby sponsor
Investec is an Anglo-South African investment bank and asset manager primarily operating in the U.K., South Africa and Australia – markets, one can assume, where the commodity-heavy SA corporate sector operates due to deep capital markets for commodities firms. While not a household name in the U.K. or Australia, readers with a passion for rugby may recognize Investec’s name and distinctive zebra logo through sponsorship of both Super Rugby and the Rugby Championship.
Investec also scores well on the Smart Holdings model, which takes a different look at a stock’s attractiveness. Smart Holdings examines the current holdings of several thousand buy side firms globally, but doesn’t recommend their current holdings. Rather, it examines what their holdings imply for their investment style – are firms focused on ROE? Leverage? Long-term growth? Value?
By knowing which investment factors and styles are predominant in panelled board rooms around the world, one can forecast which other equities are likely to start coming up on the agenda. In Investec’s case, its trailing price/book ratio, EV/EBITDA and this year’s revenue growth are where it scores highly (whereas it looks unattractive on trailing 5-year EPS, ROA and interest coverage. The current factors and Investec scores are in chart 3.
Chart 3
Source: Eikon
Checking funds flow
If one is going to look at emerging markets and specifically Africa, then the elephant in the room (pun intended) has to be funds flow, as the marginal buyer of equities in most of those markets are international investors – whether short term hedge funds or the (increasingly fickle) retail ETF purchaser. In Chart 4 from Lipper showing net flows in the emerging markets ETF category of weekly reporters, we can see how quickly ETF investors have returned to their love affair with emerging markets. (The left axis of the chart is the dollar amount for overall investments in emerging market ETFs.)
Chart 4
Source: Lipper
Liquidity issues
So how shall we weigh all of this up?
For now, ETF investors continue to put their money to work in emerging markets ETFs. As we saw from the recent second quarter swoon, however, it’s difficult to tell what percentage of this flow is long term and how much is hot money that will evaporate once the Yellen Fed begins tapering.
If you think I’m over emphasizing the role of investor flows – consider that the entire Johannesburg exchange is capitalized at US$480 billion, only slightly larger than Apple at $470 billion. Or to put it another way, the overall U.S. market is about 45 times larger than South Africa. As a result, the flows of funds into and out of that market will have a disproportionate effect. Where these are long term flows, that’s unlikely to be an issue but for investors who are trading in and out of different markets – make sure you have a chair when the music stops.
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