The Investor August 2024
ShareFinder’s prediction for Wall Street for the next 3 months (top) and the JSE (bottom):
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Time to stand together
By Richard Cluver
Dear South African Investor, I think we all share a common problem of a shrinking Rand, Capital Gains Taxes and Exchange Controls which have hamstrung us in recent years. But it does not have to be that way!
I think I have the solution if all of us are prepared band together to make it work and challenge those who are blocking our investment freedom!
I think I speak for most readers when I note that while our individual wealth might allow each of us to feel financially comfortable at home, just go on a visit to children who have emigrated to Australia, Britain or the USA and all of you I am sure know the squirm every time you use your credit card to buy things whose cost you do not need to even think about here at home.
In short, your investments are hamstrung and you would be unusual if you did not regularly lose sleep over the fact that your life’s savings could easily be snatched away from you by capricious politicians! We are, in other words, a toothless group with no political voice. Yet, authoritative studies suggest that we, the wealthy, collectively own 85 percent of South Africa’s wealth, pay the greatest amount of all the nation’s taxes and our investments account for most of the nation’s employment- creation.
In short, we are very important for the survival of this country, but nobody is listening to us!
Not sure if you are really wealthy? Then note that if you own assets of more than R2.08-million or if your monthly income is greater than R48 753 the statistics say you are one of South Africa’s Top One Percent.
But you are also an endangered species. According to the Henley Private Wealth Migration report, South Africa is expected to lose 600 top ‘One Percenters’ this year. And it is not that we have a lot of you. Henley figures suggest there are just 37 400 left in this country and that 18 700 have already left in the past decade.
In a nutshell, I accordingly believe it is time to use the power of our collective wealth to, for example, legally challenge the injustices of double-taxation inherent in the Dividend Tax, the stultifying effect of Capital Gains Taxation both upon the economy as a whole and upon our individual portfolios and, most importantly Exchange Controls which block us from investing our money where it is safest!
I believe we can mount these legal challenges without having to individually dig into our pockets and nevertheless simultaneously make our investment nest eggs grow faster and at significantly lesser than average market risk.
How to do this?
What I am proposing is something akin to a Trade Union for the Wealthy and to give it practical substance I propose to register a Unit Trust which will be guided by a newly-developed ShareFinder algorithm which replicates the selection techniques I have used to create the Prospects Portfolios which, as most readers know, have beaten all the world’s top-performing funds over many years.
In case you are not fully aware of those portfolio achievements, here is a synopsis:
Prospects New York: Compound annual average growth rate: 28.18% + DY 1.47% = 29.65% TR
Prospects London: Compound annual average growth rate: 25.4 + DY 3.2% = 28.6% TR
Prospects Sydney: Compound annual average growth rate: 28.6% +DY 3% = 31.6% TR
Prospects Johannesburg: Compound annual average growth rate: 13.1% + DY4.4% = 17.5% TR
Adding in the aggregate dividend yield of each of the four portfolios, the average gain has been 27.22 percent annually over the past five years. Compare that figure with the 18.9 percent five-year annualised return of the COG Partners’ US Select Quality Equity Fund which international fund arbiter Blackstone hails as the “Best in the World,” and I am sure you must agree that my “World-beating” claim is no exaggeration.
Without charging administration fees higher than the industry average of 1.5 percent…and a lot less if we can achieve critical mass of around R500-million – I believe we can generate sufficient funds to both handle the administration and the legal costs of going to war against unjust authority.
I visualise a trust governed by a management board chosen on merit from among your own ranks, elected by yourselves and managed by a long established and trusted independent administration company which is appropriately backed by comprehensive fidelity insurance and meets all the standard legal requirements. I have had some preliminary talks and am accordingly confident that, provided there is sufficient buy-in from yourselves, it would be comparatively easy to launch.
Thus, from the outset, and recognising that you can legally “lend” shares to a unit trust without incurring any taxation in order to participate and to bypass the capital gains problem, all I need to know is whether enough of you might be interested:
* Whether you think you possess useful skills you could offer and
* Most importantly, how much you could comfortably invest in a safe unit trust.
To get the ball rolling I am asking all interested readers to write to fund@sharefinderpro.com to enable me to create a confidential database of interested people and begin the dialogue. I will respond with greater details and keep all of you in the loop as we move forward.
All I need from you at this stage is to determine that there is sufficient financial backing to be able to achieve critical mass. If the interest is there, then I can take things to the next step!
Logically you might ask what has inspired this move. Well let’s start by noting that for over a half-century, beginning when my investment columns reached millions of South Africans courtesy of the leading newspapers of the old Argus newspaper group, I have helped readers decide which shares to buy, at what price and when. And you, my readers, have made millions. I know that because you have told me so and large numbers of you have shared portfolio details. So I know it is true!
Collectively you could have a net worth in the region of R350-billion making you as a group bigger than the combined value of the South African unit trust and exchange traded funds industry. You have very real muscle! So you can imagine I am quite proud to have helped you get there.
But lately, and with increasing frequency, readers have asked what will happen if I am no longer around? Furthermore, in recent years I have watched too many friends brighter and more capable than myself fading into dementia or simply giving way to age. Thus, recognizing that I cannot hope to keep on forever, I recently tasked the ShareFinder team to try and create a computer clone which could replicate my own share-buying techniques……and the good news is that they have succeeded magnificently.
Running on ‘autopilot’ and back-tested over the past 15 years it has delivered far better annual growth numbers than any of the long-term South African unit trusts. So we have the mechanisms in place which can provide you with a properly-managed portfolio with sufficient spread of shares to provide safety, a competent and trustworthy administration, and an algorithm which does not require human intervention to generate buy and sell decisions which can, in turn, happen without incurring tax liability. And in time we can apply the same techniques to overcome the barriers of exchange controls.
Initially I foresee a JSE-confined fund but, once that is bedded down, we would rapidly advance to include the greater security and growth-potential of a performance-weighted international fund which we have already theoretically tested and which is delivering amazing results.
For now, however, here is a graph of what our proposed ‘autopilot’ fund would have delivered from JSE shares over the past 15 years. Bearing in mind that this is still a work in progress with a number of critical decision-making points needing optimization, the overall gain from February 2010 until the present is compound annual average of 9.15 to which one needs to add a composite dividend yield of 4.4 percent to give a Total Return of 13.55 percent.
Compare that with South Africa’s most popular fund, the Satrix40, with a green trend line illustrating that it has delivered a compound annual average growth rate of just 7.9 percent over the same period and readers will appreciate that we have a powerful new tool to work with.
We can certainly do a lot better than the Satrix!
You can write to me in confidence for my eyes only at fund@sharefinderpro.com which is a closed user group created so that potential participants can discuss the project in private and plan our future!
A Sticky Last Mile
By John Mauldin
There was an historically large revision to US unemployment data this week, which was even worse than the headline when you dig into the actual numbers.
On top of that, there is some “behind the numbers” data on inflation, which is typically not talked about, that will have a big impact on the Fed decision, not to mention traders and mortgages. This all has implications for the economy and maybe even for the election. While it’s not quite Sophie’s Choice, it’s still not easy for the Fed.
This week we take a not-so-random walk through the data, trying to simplify what is actually a fairly complex subject. I think it is quite fun, but also important. Let’s dive in.
Unemployment Shock
The Bureau of Labour Statistics (only a wonk would choose that name) did their annual revision this month, revising the last year down by 818,000 jobs, or roughly 68,000 jobs a month. This is in addition to the already revised 300,000 jobs downward on a monthly basis, or over 90,000 jobs a month from the original estimate.
When somebody asked my friend David Bahnsen if he thought the higher-than-normal jobs revision was a conspiracy trying to make the economy look better than it is, he quipped: “If the conspiracy was to help the incumbent party in the election, having it get out 10 weeks BEFORE the election seems like a very bad conspiracy to me.”
A couple of thoughts. First, slightly more than 1,000,000 private sector jobs were lost in this revision. Government jobs went up almost 200,000. The private sector is where you can see the impact on the real economy, the one that produces actual GDP. There are some who might suggest that government jobs are a drag on the economy. Just saying…
Government jobs are not a function of demand, but of budget. If there is a budget for X number of employees, then the government agency will hire X number of employees. Given that there have been no budget cuts of any significance, in fact it has been the opposite, in the last three years, those who try to stare into the crystal ball of monthly employment data to predict the economy have a particularly difficult time.
In a conversation with Barry Habib today, he noted that one of the two most important data points the Fed will be looking at prior to its September meeting will be the August unemployment numbers coming out the week before. Given that we have just had a fabulous demonstration of how unreliable the monthly employment numbers are, how much confidence should we have in the Fed using that number to set the rate of the most important price in the world—the Fed rate? Of course, they know it’s a flawed number, but they must make a decision anyway.
I’ve told this story before, but it bears repeating. It is almost exactly like some general in the spring of 1944 going to future Nobel laureate Kenneth Arrow and asking him to predict the weather over Normandy on June 6, 1944 (D-Day). After he told the general it was impossible, the general answered, “We know that, but we have to have a number for planning purposes.”
Historically, the revision was large but certainly not the largest. There have been larger revisions to the upside. My friend Philippa Dunne at TLR Analytics sent us this fascinating chart:
Source: TLR Analytics
Philippa noted:
“As you can see on the graph above, the 2024 benchmark, -0.5%, is the fifth largest over the last 32 years, among 2009’s -0.7%, 1994’s +0.7%, 2006’s +0.6%, and 1995’s +0.5%. It’s reassuring they aren’t all in the same direction. The annual benchmark is an integral part of the BLS process, and a major reason the establishment series is so important.
“Between 1993 and 2000, revisions averaged 0.3% in absolute terms, narrowing to 0.2% between 2001 and 2019, including 0.2% between 2001 and 2008, and 0.1% between 2010 and 2019. Since 2020, the average moved back up to 0.3%, not so surprising given the displacements of the pandemic.”
There’s actually a very good reason that the numbers are so flawed, both up and down. It all has to do with the Birth/Death ratio. It is not a conspiracy to make the economy look bad or worse than it is, although some of my friends and various analysts contend that it is. The Birth/Death model is absolutely necessary. This is an establishment survey, which means they survey established businesses. By definition they won’t have new businesses in their survey rolls, and it’s no surprise that businesses that no longer exist don’t answer the phone (or email).
This number is what most modellers politely call a “fudge factor.” It is the number you use when you don’t know the real number, but you know it must exist. Without this number the revisions would be massively higher and the unemployment numbers would be almost completely useless as opposed to only somewhat useful now, at least in the short term.
The Birth/Death ratio is based on past performance. They essentially look at what has historically been the real number with the benefit of hindsight, and more or less assume that it will look the same in the future. Never mind the caveat that past performance is not indicative of future results.
There is simply no other way to do it, without actual forecasting, which we all know is impossible. And in general, most of the time it’s not too bad. But because it is a backward-looking number, it is going to miss the inflection points. By that I mean when the market is recovering from a recession or a downturn, the model will miss the actual improvement in the employment numbers. The miss is similar on the downside.
I was surprised to learn from this table that the unemployment number has been revised upward 16 times and downward 15 times, with the occasional no revision, and often the revisions are de minimis. We only really notice it when the misses are big, but those misses tell us something: The economy is changing so pay attention.
So even though the August employment number, which comes out the 1st Friday of September, will likely be a flawed number that will later be revised, it can be put in context of the trend and therefore useful.
The Fed has clearly telegraphed a 25-basis-point cut in September. A sizeable number of traders think the Fed will cut 50 basis points. I assume they are essentially thinking that the September unemployment number is going to come in soft enough to alarm the Fed to cut more than they are currently indicating. We will see that number in two weeks, so stay tuned.
What Inflation?
CPI inflation in July was 2.9%. The latest PCE inflation data was 2.5%. As we all know, the Fed prefers the PCE. We will touch on why in a few paragraphs. But since their target is 2%, we’re obviously getting closer. And maybe closer than you think. I will use the CPI data to illustrate this point because it is more recent, but the PCE data would be similar.
Ed Easterling of Crestmont Research sent me a note, and then we had a long chat. You get a shortened version. Let’s start with this table:
First impressions: Since March of this year, the direction has generally been a gentle slope down. With the month-over-month numbers? Wildly volatile. You can see the last 12 months by looking at the far-right column, which is the 2023 month over month, and then the middle column of the 2024 numbers. The difference has gone from a negative 2.39% in November of last year to a high of 7% and 8% in February and March of this year. There are lots of factors involved: energy, core goods, etc. So how do we make sense of this?
I think it helps to look at the actual index the CPI is based on. This is a cut and paste from the BLS website. They have this index back to 1913 (when the Fed was created). Just for the record, they recalibrated the index to 1982. So, in 1913 the index would have been 9.8. Today it is 314, or more than 32 times higher. My back of the napkin calculation says the dollar buys about three cents of what it did 111 years ago. Fascinating to see how slowly it rose and then took off over time. But let’s move on.
The “M” numbers are the months. The numbers which have an “S” preceding them are the average for the first half of the year (SO1) and then the second half (SO2). Inflation has been roughly 4.5% total since January of 2023, from 299 to 314. (Economists use numbers to the right of the decimal point to demonstrate they have a sense of humor.
Notice the last three months. The index has been flat as a pancake. This is not the first time of course, but over the last five months annualized inflation would be under 2%. That shows we are moving down from the last few years.
We get the next CPI release on September 11, the week before the Fed meeting. If inflation is 2% month over month in August, the annualized yearly will be 2.6%. If it is 3%, then it will still be 2.7%. That data will be important.
But what is it likely to say? We got a clue from this data from David Bahnsen, who writes a short memo on inflation a few times a month.
“As I have been pointing out for months, core goods prices are in outright deflation. Housing is highly distorted (see second chart below). And the core PCE level is now at the Fed target of 2%.”
Core goods include energy and food. Energy, to my mild surprise, has been trending down with no contribution to inflation for the past few months there. Ditto for most food prices.
Plus, Owners’ Equivalent Rent (OER), which is used to substitute for housing costs, is clearly overstating inflation in the CPI.
I *think* this is for new rentals, but even renewals are under 3%, not the over 5% in the CPI. OER is coming down month by month merely due to the lag in the way they calculate it. Home prices are up (a lot) but are also under pressure. Thought question (which no one knows the answer to): what would rentals and home prices be without the effect of (pick a number, but a large one) 10 million+ “non-conforming” immigrants over the last 3–4 years?
My friend Bill Hamlin, a very senior oil trader, sent me this chart. Only insiders pay attention to deep data like this, which shows the amount of oil in tankers (called floating storage) over the past five years. You can see it is close to five-year lows. There is no room for using the SPR. Production is up, but geopolitical risks are high. Energy prices could rise influencing inflation. But barring that, inflation will be low in August and likely in September as well.
Again, CPI shows a higher inflation rate than PCE. Recently that has been a differential of ~0.5%. If CPI comes in at 2.6%, then PCE could be 2.2% or less…? There is certainly room for a 25-basis-point cut. A weak or even merely soft unemployment number for August could actually spur them to a 50-basis-point cut.
Note that five out of the last six rate cutting cycles began with a 50-point cut, generally during a recession or crisis. The markets have been wrong about rate cuts for several years, but they might actually be right this time. We could see 150 bps or more over the next six meetings.
Since we are not in a crisis or recession, I don’t expect a 50-basis-point cut absent a dismal unemployment number in September. However, the manufacturing sector is clearly in, at a minimum, a small recession. There are a host of reasons that lower interest rates would benefit the economy, and I think if the market were actually setting rates rather than 12 people sitting around a table, rates would already be lower.
I sincerely hope that we get nowhere close to the zero bound ever again. I think we should consider 2% to be the boundary. If something can’t be done for a 2% fed funds rate, then what makes one think that 1% or less would make that much difference? That doesn’t benefit real businesses, even though it would certainly make some sectors of the financial industry and private equity happy. And we shouldn’t be doing anything for them in that regard.
I’m So Confused
We are in an interesting time. Earnings revisions this past quarter have been generally positive, and this has been reflected in the market, which doesn’t seem to want to roll over. And likely won’t until a recession. That’s a good thing. Unemployment is clearly softening, but GDP is still well above 2%, which is better than the average of the first 20 years of this century. Inflation is also softening, but gold is at an all-time high.
I can’t remember a time when it was so hard to look out over the next six months and make a prediction. I have been wrong on a few occasions, but at least I felt comfortable making a prediction about the direction of the economy. That is just not the case today. There are too many conflicting signals. For once in my lifetime, the Fed might actually be ahead of the curve if they start the interest rate cut cycle. The American consumer hasn’t come close to throwing in the towel.
In the very long term, I am an optimist, but I still believe we will have a crisis near the end of this decade because of the debt cycle and the deep divide in this country, which will make the crisis even worse and extraordinarily difficult to solve. Over the next six months to a year? Hard to say.
If all that sounds confusing, I guess that’s because I am confused. I think it’s time to go fishing, sit in a boat, and meditate. Maybe when I come back some clarity will manifest itself.
Note: I wrote the bulk of this letter Thursday night. Here is my reaction to Powell’s Jackson Hole speech.
The money line was, “The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
Powell clearly highlighted his concerns about employment. As I said above, that data will be critical to choosing between 25 and 50. Everything else discussed above is still pertinent, as I thought it would be. It was a very much as expected speech.
Taking advantage of risk-aversion
By BRIAN KANTOR
Dealing with Covid in 2020 was a frightening episode. The JSE All Share Index lost 20% of its value by March that year and the S&P 500, suffered a very similar drawdown, of 20% in USD.
Yet something predictable then followed. Between January 2020 and July 2024 share markets have given very good returns and they have outperformed bonds and cash by large margins. R100 invested in the JSE immediately pre Covid with dividends reinvested, would now be worth R173. Had the R100 been invested in the S&P 500 it would now be worth significantly more R236. The same R100 if invested in the Bond Index or in a money market fund with interest reinvested would have grown to only R144 and R130 respectively.
A predictable outcome–given the large outperformance by a representative share portfolio on the JSE since 2000, or for that matter also since 1980 or 1960. The R100 invested in the JSE Index in 2000 would have grown to R2152 that is by 21 times at an annual average rate of return of 13.12% p.a. The R100 in money market would have grown by 6.3 times and the Bond Index by 10.6 times over the same period.
Incidentally the JSE has kept up with the S&P also measured in rands over these 24 years. The JSE outperformed significantly until 2010 and has underperformed since.
The JSE has therefore recovered very well from significant periodic drawdowns since 2000, 40% down in 2002, 51% in 2008, 24% after Covid and 15% with Fed tightening in 2022.
Equities are expected to give superior returns because they are more risky to hold than cash or bonds. The higher returns expected of equities compensate for the different risk of losses investors believe they are exposed to holding shares. Higher expected returns mean lower entry prices for investors, all else remaining the same. And these expected extra returns have been delivered to date by most Stock Exchanges.
Share prices move each day about an average of close to zero. They demonstrate a random walk with hopefully upward drift to give the expected positive returns over the long run. The more difficulty investors have in interpreting the news about a company or an economy, the wider are the daily swings in prices in both directions. This volatility gives rise to an objective measure of risk. It will be reflected in the cost of an option to insure against volatility. Investors can buy or sell a volatility index, the VIX, based on the underlying volatility of the S&P 500. When S&P volatility (risk) rises share prices fall. And vice versa they do so to improve or reduce prospective returns, in a statistically significant way as has again been the case this year.
Yet were share market returns measured over longer periods, the risk of an in period loss falls significantly. The average returns when investing on the JSE or S&P market are very similar when returns are measured over one, five or ten year holding periods. Since 2020 returns for holding the S&P Index have averaged about 14% over one year and 11.1% p.a. and 11.2% p.a. when calculated over consecutive five year and ten-year periods respectively.
However, the Standard Deviation (SD) of returns about the average has been much higher for one-year returns (13.87) than for five or ten year returns with SD’s of 2.93 and 1.96. The same relationship holds when the analysis is taken back to 2000. Risks (the SD or volatility of returns) have fallen sharply when the investment period is extended beyond one year. Absolute losses when returns are measured over five- or ten-year periods occur rarely. It took a Financial Crisis to do so.
The extra expected returns for extra equity risk applies to the averagely risk-averse investor with limited wealth. When you are investing for you children and grandchildren and their children, and are wealthy enough not to have to worry about being forced to cash in your shares, you can invest without much risk -and you can expect to pick up the money left on the table by the more risk averse. Further support for time in the market – not timing the market.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
