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The valuation debate: Friend or foe when investing

The world of investing thrives on making informed decisions, navigating risk, and aiming for profitable outcomes. In this bustling market, valuation acts as a compass, guiding investors towards potentially undervalued gems or warning against overinflated bubbles. But is valuation truly essential? Does it deserve its place as a cornerstone of sound investment strategy, or is it merely a theoretical mirage offering a false sense of security?

Those who champion valuation see it as a beacon of rationality in an emotionally-charged market. By analysing financial statements, industry trends, and future prospects, investors can arrive at an intrinsic value for an asset, independent of market fluctuations. This intrinsic value becomes their benchmark, allowing them to identify opportunities when the market price dips below their assessment of fair value so that they avoid overpaying when the market price soars beyond. Valuation proponents argue that a disciplined approach based on fundamental analysis, anchored by valuation, leads to long-term success. They point to legendary value investors, like Warren Buffett, whose focus on undervalued companies with strong fundamentals has yielded remarkable returns over decades. By ignoring short-term market noise and focussing on intrinsic value, they argue that investors can weather market storms and achieve favourable growth.

That being said, not everyone is convinced of valuation’s infallibility. Critics argue that intrinsic value is a subjective concept, heavily influenced by assumptions and estimates. Forecasting future cash flows, which is a crucial element in many valuation models, can be fraught with uncertainty, making the intrinsic value itself inherently debatable. Furthermore, critics highlight the limitations of historical data and traditional valuation models in capturing the true potential of emerging industries and disruptive technologies. They argue that focussing solely on intrinsic value can lead investors to miss out on high-growth opportunities in rapidly evolving sectors. In such cases, they suggest focussing on qualitative factors, such as innovation, leadership, and market dominance, rather than relying solely on traditional valuation metrics.

The truth, as often happens to be the case, lies somewhere in between the two extremes. While relying solely on intrinsic value might be overly rigid, dismissing it entirely can lead to impulsive decisions driven by market hype. Perhaps the most sensible approach is to see valuation as an important step in the quest to identify great investments, not as a definitive answer. Investors should leverage valuation alongside other analysis methods, incorporating qualitative assessments, market trends, and risk analysis into their decision-making process. By triangulating their approach, they can gain a more comprehensive understanding of an investment’s potential and make informed choices that align with their risk tolerance and financial goals. The debate around valuation’s role in investing is unlikely to disappear anytime soon. However, by understanding the strengths and limitations of this tool, investors can navigate the market with greater confidence and make informed decisions that increase their chances of success. Remember, in the ever-evolving world of finance, the key is not to blindly follow any single doctrine but to adapt, learn, and make informed choices that align with your unique investment journey.

Consumer relief and a strained fiscus

Battered by low wage growth, high interest rates, and increasing debt levels, many South African consumers are in the worst financial shape that they have been in for years, maybe even decades. The result is a persistently weak economy. But, the worst might be over.

A faltering economy, driven mostly by a failing state, meant that salaries and wages in South Africa (SA) failed to keep up with inflation during 2022 and 2023, resulting in a decline in household buying power of about 5%. The danger of plummeting salaries, however, is not just that households stop spending sufficiently to grow the economy but that consumers will need to borrow money to make ends meet. In these tough times, consumers often turn to unsecured loans, which are not backed by any assets, which means banks charge higher interest rates to offset the risk. This usually does not end well for the borrower. The last time there was a boom in unsecured loans (between 2012 and 2014), many households ended up poorer than before because they could not keep up with the interest rates that they were being charged.

In the end, lower incomes and higher interest payments – not least because of the unsustainably high interest rates that the South African Reserve Bank has forced on us – have put South Africans in a very tight spot. Consequently, households have been unable to purchase the goods and services that they previously could afford, putting strain on various sectors of the economy. In fact, we have not seen the services sector perform this poorly, so consistently, for a very long time. The reason for this is that SA is a consumer-driven economy with more than 60% of its gross domestic product (GDP) attributed to private final consumption. As such, when households are under pressure, economic growth is under pressure. And if economic growth is under pressure, households are under pressure, and so the vicious cycle continues.

Fortunately, despite the uncertainty of the upcoming elections and the reaction of capital markets, the outlook for 2024 is much different. Inflation has been easing and even the outlook for food prices is positive. Interest-rate cuts may only be a few months away and could be reduced by at least 1%. Even unemployment figures have improved, albeit only slightly. Amidst cooling prices and the resilient nature of recovering enterprises, we are even expecting higher income growth this year. Overall, the purchasing power of households should improve, together with their standard of living, which declined during 2022 and 2023. That being said, consumers will probably only really feel the difference in 2025.

Concerning the upcoming Budget Speech, a few things have caught our attention: President Cyril Ramaphosa is committed to extending a COVID-era monthly payment for low-income citizens until March 2025. These payments can eventually become the basic income grant that he hinted at a month ago, when he said that there is a “strong case” for it despite fiscal constraints. Despite the strain that a basic income grant will place on the fiscus, it might not be all bad news. For one, it will reduce the gap between those who have (jobs) and those who do not, as well as alleviate some of the socio-political tension in our economy. We expect the ruling party will use policies like these as an electioneering tool to win votes in the upcoming election. Many also expect Ramaphosa to sign the National Health Insurance into law. But even if he does, we believe that it will be vehemently opposed in court and will not see the light of day for many more years to come (at least not in its current format). Ramaphosa also intends to fully implement the previously announced pay increases for 1.3 million state employees. Consequently, the consolidated budget deficit should widen to 4.8% of GDP this year, and remain at 4.6% in 2025, a major overshoot of official estimates. We doubt that the markets were expecting anything different and should, therefore, not react too negatively. But we would still advise our clients to brace for impact.

Financial Consultant I Building Wealth

Invest in Yourself – Charting a Brighter Financial Future through a Financial Consultant 

The world of finance evolves daily, and navigating the complex web of information, products, services, and strategies can feel intimidating if you are not properly informed. When these decisions are crucial to your future, a financial consultant acts as a trusted compass, helping you chart a course towards financial security and your unique goals. But who are these financial professionals and how can they help you unlock your full financial potential?

Today, the financial experts at Efficient Wealth explore the role of a financial consultant and how they can assist you in achieving your financial hopes and dreams.

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Investment Management I Building Wealth

Interpreting the Maze: A Basic Outline of Investment Management

Investment management is a term that often invokes images of fast-paced trading floors and high-powered financiers, but it is so much more than simply buying and selling stocks. It is a complex journey of building and safeguarding wealth. Understanding its intricacies is important for every investor, regardless of their experience.

In this article, the professionals at Efficient Wealth briefly explain the complexities of investment management.

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Financial Services I Achieve Your Financial Goals

Harnessing the Power of Financial Services: Your Personalised Roadmap to Wealth and Wisdom

The world of finance can feel like a maze riddled with complex terms and financial jargon. However, mapping through this terrain becomes significantly smoother when you equip yourself with the right tools and knowledge. Conveniently, this is where financial services can assist you, serving as your compass and guide on the path to achieving your financial goals.

Today, the financial experts at Efficient Wealth explore how to leverage financial services efficiently to build your wealth and secure your financial future.

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Beyond Financial Planning: Unpacking the Power of Wealth Management

Gone are the days when wealth management was seen as managing investments only for the wealthy and famous. Today, it is a sophisticated orchestra, expertly blending financial tools with life goals, risk tolerance, and individual aspirations. It is a journey, not a destination, guiding rich and ordinary individuals and families alike towards long-term financial security and helping them fulfil their dreams.

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What the Tour de France and markets have in common

Dr. Francois Stofberg: Senior Economist at Efficient Wealth and the Managing Director of Efficient Private Clients, with specialist input from Renier van Zyl.

Long-term investing shares parallels with the Tour de France – a strategic journey where endurance prevails over short-term sprints. Much like cyclists navigating diverse terrains, investors navigate market fluctuations from quarter to quarter and year to year. Success demands patience, resilience, and a strategic approach, underscoring the significance of steadfast commitment in the financial race for wealth.

For those unfamiliar with the Tour de France, it is cycling’s premier event, covering 3 500 kilometres in France across three weeks. It was originally started in 1903 to boost the L’Auto newspaper’s circulation and then evolved into a global spectacle. Cyclists face various stages, from challenging mountain climbs to flat sprints. The yellow jersey, introduced in 1919, symbolises the overall leader. The Tour de France has woven a tapestry of legendary battles, captivating audiences with its blend of athleticism and endurance.

The correlation between the Tour de France and financial markets is intriguing. The Tour has never been won by a cyclist who has claimed victory in every stage. During the difficult mountain stages when conditions are challenging, it is usually the climbers who prevail; in the case of markets, defensive funds usually outperform during challenging times. Conversely, flat stages favour speed, akin to high-frequency traders utilising leverage and derivatives. Similarly, financial markets witness varying dominant strategies, whether defensive, growth or quality, each quarter or year, reflecting the Tour’s changing winners from one stage to the next. But, ultimately, success lies in donning the metaphorical yellow jersey or, in our case, achieving financial prosperity. But how do investors win the yellow jersey in the race for wealth?

Renowned investor Howard Marks asserts that success in investing lies not in being consistently right all the time but in being more right than others most of the time. Terry Smith from Fundsmith emphasises that “in order to win or achieve financial success, one needs to be excellent at one discipline, not bad at the others, and to work with your team”, or, in this case, your Efficient financial advisor. In this way, we can assist clients in investing in the correct long-term strategy and not switching strategies during the wrong period, that is, in the wrong stage of the race because they might have temporarily fallen back in that particular period (stage). What we often see happen is that clients switch funds, or even asset classes, incurring fees and taxes at the wrong time, only to discover that their previous approach outperformed after the switch.

In recent decades, quality investing has established itself as the pre-eminent leader among various investment styles, consistently earning the coveted metaphorical yellow jersey. In short-term sprints, quality can underperform but, over the past 25 years, quality investing has consistently outperformed the MSCI World Index in every rolling ten-year period. Or, as Marks put it, being more right most of the time. At Efficient, we align ourselves with long-term, quality investors, prioritising businesses with proven track records over extended periods. These enterprises stand out through attributes such as price leadership, superior quality, robust brand strength, and adept managerial prowess, among other defining characteristics.

In the persistent pursuit of wealth, we implore investors to be resilient like Tour de France cyclists. Steadfast, long-term investors must own quality businesses, unaffected by short-term market fluctuations. Success demands patience, strategic commitment, and a disciplined approach that will steer investors through the different stages to financial triumph.

Best way to invest: Monthly or lump sum?

As the tax year comes to an end, investors assess their retirement annuities and tax-free savings accounts. They also ask: Why is there a variance in my monthly contribution returns? The short answer is that debit order investments benefit from down markets.

But what is the best way for you to invest? Last year, 2023, was a good year in the markets. A typical balanced or pension fund delivered a return of approximately 12%, much higher than the 5.1% inflation and 8% of cash. However, a monthly investment return does not always correspond to the return on the fund fact sheets. This can be because of:
• The initial low value of a monthly contribution; or
• The timing of monthly cash flows.

Initially, market returns have a low impact on a monthly investment as the fund value is low. The table below shows the impact of a 10% market return on a monthly contribution of R1 000 pm versus a lump sum of R12 000.

Note: Monthly contributions on the 1st of each month

The table shows that the monthly growth is more for the lump sum investment. However, the timing of the cash flows also have an impact on the return. Monthly investments tend to perform better than a lump sum investment when the market first declines and then recovers. During a negative market cycle, a monthly investment will accumulate more units when the prices decline. When markets recover, there are more units in the portfolio, resulting in a higher return than a lump sum investment. The table below shows the difference between a negative and positive market cycle.

Source: Morningstar, ASISA South Africa Multi-Asset High Equity

Monthly vs. lump sum? The answer is not as simple as choosing the one over the other: Remain focused on your long-term goals and invest consistently.

 

 

An ear to hear, and some sense to see

Dr. Francois Stofberg: Senior Economist at Efficient Wealth and the Managing Director of Efficient Private Clients.

During the last few years, it seems as though we have started each year in the same way: Warning investors about potential market volatility. This year, as local and global factors converge into a cooking pot of uncertainty, seems to be no different. In the end, however, our advice has been stellar and has rewarded investors who stayed the course.

What we tell investors who are willing to listen
Do not try and time the market – this does not work in the long term. Do not take unnecessary risks – it is one of the quickest ways to destroy wealth. This means that you should not run after returns, especially if you do not know about all of the associated risks. Currently, there is an unhealthy appetite for private-equity investments in South Africa (SA), and many of these managers have taken advantage of needy investors. Desperate investors are quick to forget about Sharemax, Ecsponent, and the like. Investing in cryptocurrencies can fall in the same category but we will speak more about this in future communications. Furthermore, do not be short-sighted and do not let short-term volatility upset you. Try to see past the noise and be objectively aware of your biases. Do not make rash, emotional decisions – make informed, strategic, long-term capital-allocation decisions with the input that we provide together with your financial advisor. In this way, you can not only protect your wealth but even create more in the long term.

Some things we are keeping a close eye on
Locally, we have an important election around the corner, the result of which is still anyone’s guess. Two scenarios seem likely: If the ruling party lose enough votes to force them into a coalition with the Economic Freedom Fighters (EFF) in key provinces like Gauteng, South African markets will most likely have a very bumpy ride. If the ruling party, however, goes into a coalition with some smaller parties, instead of the EFF, we might see favourable capital markets all around. Bonds, equities, and even the rand might outperform a depreciating dollar. Our state finances have also come under severe pressure, which will make for an interesting Budget Speech in February. Overall, something radical will be needed in government to shift the policy focus in SA away from rent-protectionist, social-upliftment policies towards wealth-creative policies. This is the only solution for poverty and unemployment in our country. The solution is definitely not to lean more left.

Globally, we are all aware of the social-political tensions, which a poll recently put as the highest risk factor for 2024. OPEC+ seems determined to keep oil prices elevated, which should keep fuel prices elevated in SA. China is still struggling to open the floodgates of growth, which will probably delay the shift in sentiment towards emerging markets for a little longer. It seems as if inflation has been reasonably taken care of in the developed world. The concern now is over the health of economies in the developed world. The question is no longer if the United States (US) will decrease interest rates but if they will be allowed to do so of their own choosing, or if a struggling economy will force them to do so. We are hopeful that the US will not delay in reducing interest rates because that will probably signal to our own South African Reserve Bank that they can start cutting too. We might see a 1% cut in interest rates this year, which means that each R1 million of household debt will cost about R800 less each month. More money to spend will be welcome news to struggling households in SA.

The tide is turning, especially for the hopeful remnant

Dr. Francois Stofberg: Senior Economist at Efficient Wealth and the Managing Director of Efficient Private Clients.

It has been a tough year for South Africans. In fact, we have been having tough years for as long as we can remember. Inflation has slowly been increasing since the 4% levels that we saw pre-COVID. In 2022, inflation reached nearly 7% and will most likely be around 6% in 2023. Higher inflation means that buying power deteriorates faster, making South Africans feel poorer. Interest rates, which are also higher than they should be, are doing their share to make us feel miserable. Unemployment has slowly been increasing recently but it seems to be stabilising around 32%. Gross domestic product (GDP) per capita (per person), adjusted for inflation, has slowly been decreasing over the last decade, which literally means that South Africans have become poorer. And it does not end there: If you are fortunate enough to be investing for retirement, your total liquid assets have probably not grown by more than 6% to 8% each year for the last five years (and much less over the last ten years); especially not if you adjust for fees and taxes. Once you also adjust for inflation, it means that your assets have been losing value too.

Most South Africans will blame government for their predicament, and rightfully so. The ruling party has been one of the greatest destroyers of wealth (like capital) and livelihoods in South Africa’s (SA’s) history. Corruption, cadre deployment, poor economic policies (like black economic empowerment), and weak employment policies that favour employees over employers are only some of the factors that have contributed to SA’s current and ongoing conundrum.

However, it is not as easy as simply blaming the ruling party. Since the global financial crisis in 2008/2009, rich countries have been artificially boosting their economies and markets with monetary and fiscal policy in a way that has led to a structural change in business cycles, sentiment, and valuations. So, while our government was failing us, the rest of the world was turning against emerging countries and their assets.

It is, however, worthwhile to note that, amidst the mounting obstacles, many individuals have created substantial wealth through legitimate pursuits in SA. These individuals, many of whom are our clients, always look internally, not externally: They observe, learn, and improve themselves and those around them. They do not blame but create. In this way, their skills are always in demand and they end up creating substantial amounts of wealth. We refer to these individuals as ‘the hopeful remnant’.

That being said, the tide is slowly shifting back to emerging economies. Rich countries are no longer able to keep their economies artificially strong and must now unwind their support. Also, while intervention in rich countries was keeping their economies alive, their economic fundamentals deteriorated. Debt-to-GDP ratios in these countries are set to exceed 120% of GDP, more than double the rate in emerging countries. Companies in emerging markets have remained resilient amidst insurmountable odds, whilst many in rich countries have been kept alive by intervention.

A shift in the tide of sentiment is something that we can look forward to in SA, especially the hopeful remnant. However, because of the manoeuvres of rich countries, the business cycle has been extended, meaning that we might have to wait a few more years. This might give us enough time to go through the pain of our local politics. Now, more than ever, it is important to remain patient and follow sound financial principles. Remember to always speak to your financial advisor and investment experts!