Episode Transcript
The Finance Ghost: Welcome to episode 294 of Magic Markets. This week, we will be taking a look at Q3. That's because we are already in October, if you can believe it, which means that Q3 is now in the rear-view mirror. Moe and I will be looking at what's happened offshore and locally during the quarter.
Moe, why don't we jump straight into it? I think Q3 looked relatively calm at a headline level, but if you start to dig down, then perhaps not so calm, as usual. So, give us the headline story here for Q3?
Mohammed Nalla: Indeed, Ghost. I always enjoy these quarterly wrap shows because a lot happens during a quarter and that gets masked by the headline numbers, if you look at that. Q3 was really a prime example of this because a lot of the headline index returns conceal a lot of the action that happened beneath the surface.
Looking at specific names: Microsoft, Meta, Nvidia and Apple each gained more than 10% in the quarter and this is really what helped the headline indices to hold up. But by September, looking at market breadth, nearly 80% of the S&P 500 shares were actually falling. And if you compare that to the equally weighted index, that was down around 5% for the month. So, the index looked resilient at a headline level (the S&P 500), but the broader market really struggled.
So, it wasn’t a risk-on market, as evidenced by the headline number, and it does have these very significant sectoral divergences.
On a total return basis, if we look at some of those sectors, energy was the standout. It gained more than 17% as oil moved above $100.
But other sectors, like technology – that gained just over 7%. Healthcare – 6.5%. I think that's kind of been the dark horse, if you ask me. It's one I've been speaking about for a long time and that's come through very strongly over the course of the last 12 months with Q3 just adding to that.
We also had communication services that rose close to around 5%, but those were the only four of the 11 sectors in total to finish the quarter in positive territory, with declines in the other seven sectors. That's what I'm talking about when I say that the market breadth wasn't impressive.
Materials lost around 2%. Financials, down 2.6%. Consumer staples (which should be defensive) fell 3.3%. And then industrials lost nearly 5%. Consumer discretionary declined, also over 5%.
And the rate-sensitive sectors were really the hardest hit. I mean, if you look at real estate, it lost almost 9%. Utilities (which, again, are supposed to be defensive), down by more than 12%.
Now, what drove some of this divergence? Energy, we know that's the obvious one, benefitting from the oil shock. But tech and communication services, those really continued to ride the AI theme.
Healthcare was a bit more defensive. It was a source of strength. I mentioned that.
But the higher bond yields, that's what's been punishing utilities and real estate while weakness in both discretionary and staple shares pointed to this overall concern about the pressure that fuel prices, interest rates and inflation are going to be placing (and are in fact placing right now) on households, which links very nicely to the show that we did last week.
The Finance Ghost: Moe, it's interesting there that you highlight the consumer stocks because I'll be talking about those later as well. They also haven't had a great time in South Africa. Healthcare has been putting out some better earnings on the JSE as well, so that's an interesting one for you to call out too.
Moving outside the US now, where were the major winners and losers if you go beyond those borders?
Mohammed Nalla: Yeah, that's an important question because outside the US, performance was really mixed.
Asia though, that's where you saw a lot of action and a lot more volatility. Japan's Nikkei fell around 5%. South Korea, that's the headline grabber. That dropped nearly 19%.
Now, we previously spoke about the concentration risk of specific names like SK Hynix and Samsung not only on the Korean market, but also on the MSCI Emerging Markets Index. So, the market’s really unwinding part of its enormous AI and memory chip rally, and that hit Korea and the MSCI Emerging Markets Index quite hard.
China, that was quite interesting. A bit of a split there. You had the Shanghai Composite, which was down 6%, but Hong Kong's Hang Seng gained nearly 8%. This really tells you that it's no simple global risk-on, risk-off trade that we saw in Q3. It was all about selectivity, which was important not just on country selection, but also, more importantly, even on sector selection, as we outlined in the section when we covered the US.
The Finance Ghost: Of course, it's not just about equities, right? There's a big bond market out there. And I think, particularly given the geopolitical climate we’ve found ourselves in, there's been a lot of focus on yields pushing up and what that means for the bond market.
So, let's just spend a couple of minutes there, Moe, if you don't mind, before we head into what you think some of the takeaways might be for Q4?
Mohammed Nalla: Yeah, I'm glad you asked that because we've been speaking a lot about bonds. We've done a couple of shows on that. And I would say the biggest macro story of Q3 was actually bonds.
I mean, you had the US 10-year Treasury yield, which rose around 87 basis points during the quarter. It ended around 5.3%. Their 30-year ended above 5.6%, so those are really major moves.
Bond investors are currently being asked to absorb persistent fiscal deficits. That's that term premium argument that comes through. There’s heavy government issuance and they've been skewing from the longer end of the curve to the shorter end, so there are some yield curve dynamics at play there. You've also got resilient economic growth and renewed inflation pressure from energy, so that's really what's been driving some of the bond market.
But there's this interesting contradiction that I want to unpack here. The AI investment boom is supporting earnings. It's keeping part of the equity market quite strong. But building out data centres, energy infrastructure and semiconductor capacity requires enormous amounts of capital. That can strengthen growth and it can increase electricity and commodity demand, but it's also keeping bond yields higher.
So, the same AI theme that's supporting equity valuations is also the theme that's pushing up the discount rate that you have to use to value those equities. And that's a bit of a tension and a contradiction in the markets at the moment.
You mentioned it's wider than just equities and bonds, so let's touch on commodities very quickly because that reinforced the inflation story. Brent crude moved from around $73 to more than $100 a barrel. This was one of the strongest quarterly performances since the pandemic.
Oil therefore shifted from being a major disinflationary tailwind to an inflationary problem. This is what's squeezing consumers. It's increasing business costs and it's made central banks' jobs a lot harder.
Touching on gold, that still gained around 3% for the quarter. It wasn't very exciting, but it did fall sharply in September as the bond yields and the dollar strengthened. Remember, gold is sensitive to what's happening in real rates and those have actually increased globally.
Copper rose around 7% and that's supported by the infrastructure, electrification and AI-demand theme. So, that's all worth watching because copper strength alongside a major oil rally is not a particularly comfortable signal for inflation, reinforcing the bonds and the equity story that we discussed.
The Finance Ghost: It's kind of a sign of the times, right? [laughing] That when you say that gold gained 3% for the quarter, but – and I quote – “that wasn't very exciting” – 3% for the quarter in the oldest asset around! It's actually remarkable, the world we now live in. I understand where it's coming from. It's because our framing at the moment is these really high percentage moves. It's how high inflation is. It's pretty wild out there.
Maybe in that context then, as we head into Q4, what would you say some of the big takeaways are for investors from what we've now seen in Q3 and what are your views there?
Mohammed Nalla: I say it's not exciting because of what's happened in the bond market, right? And that ties into my outlook right now. The big question for Q4 is whether equity earnings can continue to grow and offset the higher yields and the higher input costs.
If we see bond yields stabilise and profit growth broaden beyond the AI complex, equities can keep grinding higher. But if the 5% Treasury yields and the $100 oil persist, then the higher discount rates, the pressure on consumers, those all become a lot harder for equity markets to ignore. So, a lot of risk in that particular space of the market.
The key question that I think long-term investors will need to ask is whether a 5% yield on the 10-year is a juicy enough return to start an allocation to bonds again. They've certainly been out of favour. I think the market is split on this one, but that's the question that's occupying a lot more of my time recently and I think that's going to frame the next quarter for us, specifically.
Ghost, I've done a lot on the global stuff, but we want to know what's happening down in South Africa. Give us the lay of the land. What did the JSE do over Q3?
The Finance Ghost: Yeah, thanks Moe. So, I must just caveat this by saying it's not quite a perfect Q3 view that I've brought to the podcast because we're recording this on the 5th of October, so it's a couple of days off. Bear in mind we just had a weekend. I just used the last few months’ three-month trading data because it's the easiest to pull off the systems. It might change the answers by a percent here or there, but it won't make much difference directionally.
So, if you look over the past three months, looking back from today, the FTSE/JSE All Share Index (JALSH) was down by around 2.8% – so, not a great time in the South African market. The FTSE/JSE Industrial 25 Index (INDI) was down 10%. Now, that's very much the ‘polony index’ as I think I've mentioned before on Magic Markets. It seems to be where they're just not sure where to put everything, so they just throw it in the INDI.
Your two biggest stakes there are Naspers and MTN, which really 1) could not be more different, and 2) are not exactly ‘industrial’ in the way you might think about the term when I say that word. So, both those counters have been under pressure over the past three months, and they've dragged the INDI down with them.
If we look at the FTSE/JSE Financial 15 Index (FINI), that's down around 5.5%. That's mainly your banks and your insurance groups. Some concerns around broader consumer credit health have been filtering through here. Because technically, an environment of higher rates and maybe some inflation is actually not necessarily terrible for banks, because they lend against assets and they earn a yield on them. So, I think that's a credit story coming through there.
Where higher interest rates will not help you is in property. The FTSE/JSE South Africa Listed Property Index (SAPY) was down around 4% over that period. So, some concerns there around long-duration assets, how to value them and also what it means for the borrowing costs of some of these companies.
Just to finish up on the indices that landed in the red, the FTSE/JSE Mid Cap Index and FTSE/JSE Small Cap Index were each down around 3%. Now, what's interesting is you're not really seeing this big pressure come through in the small caps, right?
So, in a relative risk-off environment, you'll often see the smaller companies get whacked harder. But that hasn't really happened here. And I think it's because they're already so browbeaten in terms of the valuations that they trade at. When you're a decent company trading on a 5x, 6x or a 6.5x P/E, how much lower can you really go realistically before those yields just start to look a little bit bonkers? So, I think that's part of what's happening there.
The winner over this period? The FTSE/JSE Capped Resources 10 Index (RESI). Up around 9%. So, energy stocks, mining specifically in South Africa. That's where you want it to be over the past three months.
Mohammed Nalla: Yeah, Ghost. No surprises on that Resources story. It's such a pity that South Africa's got to bundle them all into one index. In the US, for example, you get a sectoral split – you get energy; you get materials. But again, a pretty nuanced quarter there.
Can you dig deeper for us into what some of the major winners were on a stock-by-stock basis?
The Finance Ghost: Yeah, absolutely. And just a comment on that, though. We have the indices that go further down, of course, but they're not always tradable, so I tried to pick indices here that you can get an ETF for. I think if you try to become too cute on the JSE with digging down, then you run out of liquidity very quickly, sadly.
If we look at some of the winners, we have some mining companies near the top of the list – which won't be a surprise, based on the index performance. Sasol, up around 44%. Refining spreads and the oil price itself have been supportive there (we did a show on that recently, so go and check it out).
There’s been some love for coal as well in this quarter. Thungela, up around 37%.
Sappi – get this, it's up nearly 30% over three months, but it's still lost half its value year to date, which is incredible. It shows you just how rough things had actually gotten there. It is a highly speculative stock, but it has bounced pretty strongly off the 52-week low.
How's this for a 52-week range? I know I'm mixing my drinks here – we're talking about quarters and I'm giving you a 52-week range – but I just want to show you that single-stock volatility. 52-week low: R8.64. 52-week high: R26.30. That is spectacular.
The 52-week high is three times higher than Sappi's 52-week low. That company is fighting for survival in a market that I think has become a structural nightmare. The digitisation of everything has somewhat killed off demand for products like graphic paper, so it's tough for them out there. It really is.
The weirdest positive move has to go to Stadio, up around 25% – not because of their earnings (which were good), but rather because of index inclusion and forced buying. That just shows you. Liquidity is a serious consideration in some of these SA stocks, once they fall into the index and those passive flows come in. You start to scratch down on the JSE, and the passive flows can become very big in the context of the liquidity in some of these stocks.
Mohammed Nalla: Indeed. I was watching that Stadio story with so much entertainment. I mean, we saw it really lurching higher. The risks, also, when stocks fall out of an index as well – given that tight liquidity, you've got to be very wary on both sides.
Ghost, to wrap up. You've touched on the winners. What about some of the bigger losers? Which stocks were the hardest hit?
The Finance Ghost: Yeah, so you mentioned consumer discretionary earlier and consumer stocks have got to be the biggest story here on the JSE as well. It barely matters which ones you look at. Woolworths, down 28%. Truworths, The Foschini Group and Italtile, all down around 24%. No one ever talks about Italtile, but they should because it's interesting.
Go further up the value chain in consumer and you'll find names like AVI, down 17%. Tiger Brands, down 15%. These are blue-chip companies that have been thrown around like ragdolls in the past quarter. Even the very best retailers are in trouble, like Pepkor – down 19%. Lewis, down 15%.
Now it's not that their business is not necessarily doing well. In some cases, growth has slowed. At Lewis, I think the credit look-through there will be a concern (as well as at Pepkor, actually). But there is a baby-with-the-bathwater argument going on here where the market has really just sold off everything. You have to ask yourself if all of these consumer stocks deserve the pain they've taken.
I have a long position in Pepkor that I'm still itching to add to, but I just keep resisting that temptation because I haven't seen any signs of a change in momentum in these consumer stocks. So, this is a good opportunity to look for the quality names when they've all been thrown out.
As a reference point though (and this is where I think the market is concerned), Capitec’s latest results included a significant increase in their credit loss ratio in both the personal banking and business banking books. The former linked mainly to macroeconomic assumptions, and inflation and higher rates are clear pressure points here.
And, in case you're wondering about the latter, one of the reasons was just the growth in the book essentially. It does tend to happen sometimes. As these loans are put out and a book is relatively new, you can see the credit loss ratio move higher. So, there is a credit point here that I think is filtering through into consumer.
Then, WeBuyCars. Another horrible quarter, down more than 20%. The market is not buying management's story about their ability to combat heightened depreciation in the used values of these legacy car brands that they have on the floor. So, we'll have to see what happens there. That stock is showing no signs of a bottom.
It's one of the ones I also have a position in. Again, itching to buy more, but just being cautious and waiting to see. I'm quite careful with buying something that has obvious negative momentum.
What I have been buying is the FINI 15 ETF, actually, just because I felt a bit underweight on some of my banking exposure. But that's very personal to me. I think we have very strong financial institutions and, long term, they have a good place in this world given South Africa's positioning in the Global South and what's going on in Africa. It's very much a long-term play (like most of what I do).
And yeah, it just shows you. Consumer was the big loser this quarter and it was broad based. And ugly, Moe. Very, very ugly.
Mohammed Nalla: Yeah, Ghost. I mean, I love the fact that the South African story talks to the global story. A lot of interplay between those two with the kinds of moves you've seen in the retail sector there.
I'm actually sorely tempted to come and have a look to deploy some capital at some of the names because South African valuations are not as demanding as you're seeing up in the US. But I will exercise a lot of caution around that. I think caution is really the flavour of the day as we head into Q4.
Unfortunately, that's all we have time for this week. Let us know what you thought of the show. Hit us up on social media.
It’s @MagicMarketsPod, @FinanceGhost and @MohammedNalla, all on X, or go find us on LinkedIn. Pop us a note on there.
Until next week – same time, same place. Thanks, and cheers.
The Finance Ghost: Ciao.
