Don’t confuse the economy with the stock market

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SIMON BROWN: I’m chatting with Ross Biggs, head of equity at M&G Investments. Ross, I appreciate the time. There’s an American phrase which is ‘Wall Street is not Main Street’. In other words, don’t confuse the economy with the stock market. It’s equally applicable to South Africa, I have no doubt.

ROSS BIGGS: Yes. Thank you very much, Simon. I think probably one of the biggest fallacies in the market is thinking that the economy is going to predict what stock market returns are going to do. So if we look back in history [over] the South African market, for instance, even if you could have predicted what the South African economy might have done over the next year, those GDP outcomes or economic returns bore very little comparison to the sort of stock market returns that you would’ve received.

I think one of the main reasons that you need to consider is that the South African index or the index of any particular country often doesn’t truly or fully reflect the underlying economy. If we look at South Africa, for instance, look at some of the companies in the JSE Top 40 and look at the revenues that those companies earn, only a quarter of the revenues from those companies come from South Africa. Three-quarters of revenues from companies listed on the South Africa stock market actually come from outside South Africa. Asia’s a big weighting, as are the US and Europe. It’s not just a South African phenomenon; it’s a global phenomenon as well. If you look at the FTSE 100, that index is not reflective of the UK. It’s dominated by global oil companies and global commodity companies, for instance.

SIMON BROWN: I take your point. As you said, in Asia, what, 30%. I suppose that’s probably largely Tencent, Europe at 22%, America at 16%, according to research. And to your point, sometimes if we look at this year and at how the economy is doing, our market is green – not by a heck of a lot, but when you look at load shedding, no growth and high interest rates, it clearly shows you that that stock markets are independent of the country they happen to be geographically located in.

ROSS BIGGS: Exactly, Simon. And I think the one underlying reason is that the stock market is often not reflective of the underlying economy. And then the other big reason is the valuation embedded in the stock market. As poor as the economic outlook might look for South Africa or for the United Kingdom, for instance, valuations look very, very attractive in some of these markets. Often that’s the biggest driver of stock market returns, not the sort of underlying GDP growth in an economy.

SIMON BROWN: Does this almost then support the argument for bottom-up research? In other words, go and look at a stock and, sure, where it operates, rather than saying, ‘The US has better GDP than Europe, therefore I should be in the US’. It’s actually about really going and digging into individual stocks – classic stock picking.

ROSS BIGGS: I think that’s right. And I think in the current environment good-quality companies are going to start to stand apart from the lower-quality companies. I think that’s [where] you’ve got to spend a lot of time, particularly at the moment, where businesses are [dealing] with or [have] a lot of significant issues.

If you’re running a business today not only do you need to deal with your normal operating environment, but you’ve got issues with Eskom, you’ve got issues with Transnet. So you’ve got to really do your work to see what sort of operational stress, financial stress companies might come under in the current environment. I think companies with low debt, strong business models and the ability to push through price increases are going to do relatively much better than the lower quality and poorer quality companies in the market. But I think you do need to also have an assessment of where we are in the cycle, and a sort of high-level sense of what’s happening in the markets.

SIMON BROWN: I take your point on that, and I also take your point that tough times are often great at sorting that wheat from the chaff and showing you which are going to be the better ones, as you say, with lower debt, the ability to raise prices, and quality management.

ROSS BIGGS: Yes, absolutely. I think that’s going to make companies over the next couple of years stand out in terms of operational performance. If you look at the South African market, retailers are probably going to have a tough time – property companies, companies where their clients are under pressure, their business is under pressure. And then if you add debt into that mix it can be very, very difficult. And so yes, I think the quality will stand out in the current environment.

SIMON BROWN: A quick last point on debt. You mentioned it there, particularly in a rising rate environment. If we look into Europe and the US where we all had free debt for a decade, that’s changing things quite markedly.

ROSS BIGGS: Yes. And I think what’s also very, very difficult in the current interest rate cycle is the pace at which interest rates have increased. So if you look at the US, rates have gone up at the fastest pace in decades. Rates have gone up 5%. In South Africa we are now in this rate cycle, with 475 basis-point rate increases. So the pace at which rates have gone up is also going to make business particularly difficult if you’ve got debt. It’s in the space of less than a year that rates have moved up so aggressively, and that impairs your ability to do things and try to manage your debt position. There has been a very quick increase in the rates.

SIMON BROWN: That’s a great point. It’s not just the quantum of how much they’ve gone up. It’s that speed that they’ve gone up.

Ross Biggs, head of equity at M&G Investments, I appreciate the time.

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