Creating wealth in the great recession:

Alec Hogg

The Investment Focus is brought to you by Discovery and Moneyweb.

Andrew Carnegie’s Playbook

“Navigating theGreat Recession”“Navigating the

Great Recession”

Where we are

USA (GDP $14 330 bn)USA (GDP $14 330 bn)

GDP: -6.1% (4Q: -6.3%)

Govt. debt is 110% of GDP

USA (GDP $14 330 bn)USA (GDP $14 330 bn)

GDP: -6.1% (4Q: -6.3%)

Govt. debt is 110% of GDP

Japan (GDP $4 840bn)Japan (GDP $4 840bn)

GDP: -15.2% (4Q : -14.4%)

Govt. debt is 225% of GDP

Japan (GDP $4 840bn)Japan (GDP $4 840bn)

GDP: -15.2% (4Q : -14.4%)

Govt. debt is 225% of GDP

China (GDP $4 220bn)China (GDP $4 220bn)

GDP: +6.1% (4Q: +6.8%)

Govt. debt is 23% of GDP

China (GDP $4 220bn)China (GDP $4 220bn)

GDP: +6.1% (4Q: +6.8%)

Govt. debt is 23% of GDP

S Africa (GDP $300bn)S Africa (GDP $300bn)

GDP: -6.4% (4Q: -1.8%)

Govt. debt is 27% of GDP

S Africa (GDP $300bn)S Africa (GDP $300bn)

GDP: -6.4% (4Q: -1.8%)

Govt. debt is 27% of GDP

The Great Recession: how we got here

Excessive leverage• “The most important lesson is the world needs a whole lot less

leverage”

Gross immorality• Consumer credit give to people who couldn’t handle it

• Derivatives traders preyed on their customers

Stupidity• People inside institutions themselves; regulators didn’t listen

“Horribly failed” by accounting profession• The people who created the principles should be removed

Two wise men:Warren Buffett and Charlie Munger

Some of their 35 000 AGM attendees

Warren Buffett, media star

Quotable

““The watchword throughout the The watchword throughout the country became the creed I saw on country became the creed I saw on

restaurant walls when I was young: restaurant walls when I was young:

‘‘In God We Trust; all others pay cash.’”In God We Trust; all others pay cash.’”

Warren Buffett,March 2009

Consequences of the financial crash

Deep economic recession which “it’s going to last a very long time”

Probably lead to increased regulation for financial services

China, not US taxpayer is picking up the tab

Lower US Dollar as politicians lower the value of ballooning debt

Buffett: Buffett: “You can bet on inflation.”“You can bet on inflation.”

Quotable

““The best protection against inflation The best protection against inflation is your own earning power. The second is your own earning power. The second best protection is owning a wonderful best protection is owning a wonderful business that does not need injections business that does not need injections of capital. With these guidelines, I’d of capital. With these guidelines, I’d

say invest in yourself.”say invest in yourself.”

Warren Buffett,May 2009

Bobbin Boy to Billionaire…

Shrewd stock investor and entrepreneur

Founded Carnegie Steel and became US Steel

Gave away 90% of his fortune• Buffett too

25 November 1835 to

11 August 1919

The richest people of all time

1 John D Rockefeller Standard Oil $318.3bn

2 Andrew Carnegie Carnegie Steel $298.3bn

3 Nicholas II Tsar of Russia $253.5bn

4 William Vanderbilt VDBilt Railroads $231.6bn

5 Asaf Jah VII Nizam of Hyderabad $210.8bn

6 Andrew Mellon Mellon Bank $188.8bn

7 Henry Ford Ford Motor Company $188.1bn

8 Marcus Licinius Crassus Emperor of Rome $169.8bn

9 Basil II Byzantine Emperor $169.4bn

10 Cornelius Vanderbilt VDBilt Railroads $167.2bn

OTHERS:

15 Elizabeth I Queen of England $142.9bn

17 Sam Walton Walmart $128.0bn

22 Cleopatra Queen of Egypt $95.8bn

57 Bill Gates Microsoft $40.0bn

86 Warren Buffett Berkshire Hathaway $26.0bn

The Andrew Carnegie Playbook

““Berkshire Hathaway is now following the Berkshire Hathaway is now following the Andrew Carnegie Playbook.”Andrew Carnegie Playbook.”

Charlie Munger,May 2009

Only buy when others are panicked;

Invest to build your business during times of crisis.

Some advice from Warren Buffett

““Stay within your circle of competence Stay within your circle of competence – understand whether the competitive – understand whether the competitive advantages are durable or not. And advantages are durable or not. And really understand that the market is really understand that the market is

there to serve you.”there to serve you.”

Warren Buffett

And when it comes to investing…

““If you have an IQ of 150, to be a good If you have an IQ of 150, to be a good investor, best you trade 30 points to investor, best you trade 30 points to

someone else. But you DO need to have someone else. But you DO need to have emotional stability, inner peace, the emotional stability, inner peace, the

ability to think for yourself. If you have ability to think for yourself. If you have that quality, you will do very well at it.”that quality, you will do very well at it.”

Warren Buffett,May 2009

And while we’re on the subject of IQ…

““If you think your IQ is 160 and it’s If you think your IQ is 160 and it’s 150, you’re a disaster. Much better is 150, you’re a disaster. Much better is

someone with an IQ of 130 who someone with an IQ of 130 who operates within himself.”operates within himself.”

Charlie Munger,May 2009

Annus Horribilis X 2, or 3?

Market disruption in 2007 and 2008• Crisis borne of modern finance • Old-fashioned economic crisis

2009: Poor economic fundamentals support outlook for stock market weakness

Recovery in developing countries not seen until 2010

Yet developing countries have lent economic stability• Domestic demand from sustained development• Stringent regulatory regimes• Government investment

Slave to the USA? Decoupling holds

~ 60% of the rise in world GDP between 2000 - 2008 happened in developing countries• 2000: developing countries = 37% of global GDP• 2008: developing countries = 45% of global GDP

Economic and business cycles between 2000-2008• Economic cycles of America and Europe converged• Business cycles of India and China converged

Proving that• Developing countries grow or shrink autonomously, not just

under the influence of the rich countries

Study by IMF, University of Virginia, Cornell University, quoted in The Economist, 20 June 2009, page 58

Developing Countries drive global growth

Between 2000-2008, developing countries generated 60% of global GDP growth

Source: IMF, The Economist

A little perspective: 2007-9 v. 1998-9

Every 10 years or so, global economies & markets plunge

SA not doing so badly compared to AEC impact• Better information• Localised problem• DC regulatory controls• SA saw significant gains post-crisis

Precedents exist for understanding current conditions

No doubt it will be a rough recovery, but recover it will

Forecast

Forecast

Forecast

GDP from one major crisis to another

W L V Z S Alphabet soup of recovery profiles

Source: Bloomberg

Onto the Next …

Good things do end, to start again• China and India are expected to drive recovery• USA to follow; EUR likely later

Domestic demand is key to recovery • Governments of developing countries are pouring money into it

Rising exports to China, India will not wholly compensate for drop in exports to USA, EU

South Africa is mostly driven by domestic demand• Only ~30% of GDP comes from exports• Relatively protected

The Good

Global market sentiment is positive – ‘worst is over’• Markets run on: fundamentals & what everyone hopes will happen• Sometimes the two agree

Investment stimulus in USA, China• Positive impact on sentiment• Results yet to be seen but expected to be good• Funding the stimuli means higher taxes

South Africa• Unit Trust investment in Equity is ~20% now

The Bad

Slower contraction; Japanese-style stagflation is possible• Will we see a repeat of Japan and ZIRP?• Yes: effective rates are negative, like Japan; unemployment rising • No: more flexible and immediate responses to turmoil

2009 global stock market rally likely to fizzle short-term• Rising oil prices put the brakes on growth• Outlook for higher taxes reduces consumer spending

South Africa • Begins its old-fashioned economic recession• Strong rand is double-edged sword• Unit Trust investment in Money Market is ~37% now

Volatility is still higher than in 2007

Source: Bloomberg

What do we do now?

Longer term returns – All asset classes

Economic Group 2 years 3 years 5 years 10 years         

All Share -9.0% 4.2% 20.3% 15.4%Resources -11.4% 0.6% 21.3% 20.9%Financials -13.2% 0.1% 15.1% 9.3%Industrials -4.5% 10.7% 21.7% 13.2%

Property Unit Trusts -1.1% 11.5% 20.4% 22.8%

All Bond 7.7% 7.7% 9.3% 13.2%

Headline CPI (last available figures)

9.4% 8.6% 6.4% 6.7%

Source: Investec

Commodities: value on weak US$?

Source: Investec

Commodities (US$) 

Commodity June ‘09 3 months 6 months 12 months YTD

Precious Metals      Gold Spot (US$/oz) -5.34% 0.8% 5.3% 0.2% 5.3%Palladium PM-fix (US$/oz) 5.51% 15.8% 36.1% -46.7% 36.1%Platinum Spot (US$/oz) -1.26% 4.3% 27.0% -43.1% 27.0%Silver Spot (US$/oz) -13.54% 4.9% 19.7% -21.9% 19.7%

           Industrial Metals      

Copper Cash LME (US$/ton) 6.95% 26.6% 76.0% -41.8% 76.0%Nickel Cash LME (US$/ton) 16.27% 70.2% 48.1% -26.1% 48.1%Steel Hot-rolled Coil price FOB (US$/ton) China Ex

-5.00% -3.1% -9.5% -53.9% -9.5%

Vanadium Spot Price 98% CIF ($/lb v205)

0.00% -17.0% -38.5% -76.1% -38.5%

Zinc Cash LME (US$/ton) 3.05% 19.6% 38.8% -17.1% 38.8%           

Energy      Brent Crude IPE $/Barrel) 8.63% 50.3% 86.6% -50.3% 86.6%

Stocks: Long-term perspective

Developing Country stock index performance since the last major crisisLocal currency, local index levels

Source: Bloomberg

Stocks: South Africa outperforms

Country/ Region Index June 2009 3 months 6 months 12 months YTD

World MSCI World Free -0.4% 21.0% 6.8% -29.0% 6.8%EM MSCI Emerging markets -1.3% 34.8% 36.2% -27.8% 36.2%Pacific MSCI Pacific 2.1% 25.7% 9.7% -24.3% 9.7%Europe Dow Jones Euro Stoxx 50 -2.69% 25.7% 1.9% -33.8% 1.9%                 

Developing CountriesBrazil Bovespa -2.8% 47.7% 63.1% -35.8% 63.1%China MSCI China 4.1% 35.8% 37.6% -8.1% 37.6%India MSCI India -2.2% 59.8% 57.4% -5.0% 57.4%Russia MSCI Russia -14.3% 37.8% 45.9% -61.1% 45.9%South Africa MSCI South Africa 1.2% 31.3% 26.1% -11.9% 26.1%                 

Developed MarketsFrance Cac 40 -4.7% 22.1% 1.8% -34.2% 1.8%Germany Dax 30 -3.6% 24.4% 0.9% -33.3% 0.9%Hong Kong Hang Seng 1.6% 37.7% 30.4% -13.1% 30.4%Japan Nikkei 225 (not TR) 3.5% 25.7% 5.6% -18.8% 5.6%UK FTSE 100 -1.4% 26.0% 12.7% -34.6% 12.7%USA Dow Jones Industrial 30 -0.4% 12.0% -2.0% -23.0% -2.0%

Source: Investec

Bonds: safe & suffer by comparison

Bond and Money Market (local currency returns)

Name     June 2009 3 months 6 months 12 months Year-to-dateAll Bond -0.23% 0.3% -4.9% 19.3% -4.9%

GOVI -0.23% 0.3% -4.6% 18.6% -4.6%OTHI -0.24% 0.4% -6.0% 22.1% -6.0%

Bonds 1-3 Years

0.11% 1.4% 3.7% 16.8% 3.7%

Bonds 3-7 Years

-0.28% 0.6% -1.8% 20.7% -1.8%

Bonds 7-12 Years

-0.03% -0.1% -6.0% 19.9% -6.0%

Bonds 12+ Years

-0.52% 0.1% -10.7% 24.1% -10.7%

               Barclays BESA Govt Inflation-Linked Bonds

0.10% 3.4% 5.9% 7.7% 5.9%

Source: Investec

Take Warren Buffet’s advice

BUY WHAT YOU KNOW

Global Economic background• China, India to drive economic recovery• Investment momentum into those markets is strong• USA due to recover next year; EU late 2010

Africa is the new Far East – 10-year horizon• Undiscovered in terms of large investor flows• Chinese and Indian investors have forged strong ties• African leaders are tired of being pushed around, are giving as

good as they get

South Africa, largest & most advanced economy, to lead

Africa asserts itself on world stage

Kikwete admonishes IMF/World Bank/UN at WEF (Business Day, frontlineafrica.com, FT)

African Leaders Want Bigger Role in IMF, Push for Aid (Bloomberg)

Africa seeks a voice in global financial management (Africa Renewal)

G20 Summit: Did Africa get what it wanted? (The Independent, UK)

Ethiopian PM and IMF to represent Africa’s voice at G20 summit (afrik.com)

Tsvangirai raised money overseas

Africa asserts itself and the value it represents to the world via resources.

SA poised for leadership.

African growth will be substantial

African economies are termed ‘frontier economies’ by major investment banks

Profit potential over the next 10 years is large, based on fundamentals and what people hope will happen

BUY WHAT YOU KNOW

China/India to lead economic growth – but do you know those companies? What are costs to invest?

SA companies are • Capitalising on domestic demand• Moving into Africa to capitalise on rand, continental progress

Where to from here?

Tough time for savers

Interest rates have fallen• Repo rate down from 12% in November 2008 to 7.5%

(down 37%)• Futures markets forecast further 0.5% to 1.0%

decline• 3 month money market rate currently 7.0% pa• After tax yield 4.2% (lower than inflation)

Global rates significantly lower• US 3 month 0.5% pa• UK 3 month 1.0% pa

Preference shares are down with lower prime rate – but still appealing relative to short term rates

Corporate debt market more attractive but riskier – although spreads have fallen

Equity markets appear to have bottomed – but the outlook for growth and earnings remains uncertain – companies conserving cash, reducing dividends

But downside risk in equities lower than upside

JSE ALSI Indexup 22.5% since March low

Snapshot of South African economy

Economy in recession – first in 2 decades

Heavily dependent on buoyancy of global economy – exports plus imports make up 74% of economic activity

Manufacturing (18% of GDP) and mining (7%) contracting sharply

Consumers (61% of GDP) paying down debt – no appetite to spend although lower interest rates, food prices and petrol helping

Housing market in decline but share market stabilising

Government infrastructure programmes valuable – but with savings rates low, financing dependent on foreign investors

There are some rays of light…

Sensible fiscal and monetary policies have anchored the economy (up to now)

Government debt levels remain low – recently raised $1.5bn at reduced spread

Banks operating normally – prudentially managed

National Credit Act and Forex controls protected economy from worst of the global crisis

Corporates in good shape – satisfactory results under difficult trading conditions

Still opportunity for growth domestically as well as in emerging Africa

Lower rates and easing prices put more money in consumers’ wallets

2010 World Cup and other sporting events providing short-term kickers

JSESector breakdown of top 180 companies

Property2.40%

Industrial12.20%

Financials13.30%

Foreign income31.40%

Resources40.70%

JSEMarket cap of top 10 listed companies

CompanyMarket Capitalisation

Rbn% of Total Market

Capitalisation

British American Tobacco 449 11.5

BHP Billiton 385 9.9

Anglo American 297 7.6

SAB Miller 269 6.9

MTN 219 5.6

Sasol 173 4.5

Standard Bank 138 3.5

Angloplats 127 3.3

Impala Plats 108 2.8

Anglogold 101 2.6

58.2%

Equity markets recovering- green shoots appearing

Signs of stabilisation in world economy – “getting worse more slowly”• China restocking – commodities prices picking up

• US existing and new homes sales steadying - mainly at low end of market

• Credit increasing – spreads tightening

• US banks repaying government rescue money

• Certain business confidence indicators bottoming

Equity markets recent performance suggests most of the bad news has been absorbed

Over past 10 years real return on US stocks -47% versus plus 71% on bonds - no risk taking will end capitalistic system

Hurdle rate – shares should beat bonds/money market

Bears still having their say

Commodity prices expected to fall after China completes restocking – “treat China’s stimulus package with caution”

US treasury yields rising on inflation fears – “can’t have stimulus without inflation”• Rising yields hurting mortgage refinancing• Obstacle to economic recovery• Oil creeping up – adding further doubt to recovery

Views that the US stimulus package, although sizeable, isn’t large enough to sustain growth

Still questions about the drivers of US growth• Global economy down• Consumers still under pressure - rebuilding their

balance sheets and fearing job losses• Corporate recapitalising and cleaning up their

business portfolios

Corporate profits in a decline• Down in last 7 quarters – still falling

Quotes from recent result presentations

“Global economic conditions and consumer demand weakened during the year and there remains little visibility as to the timing of any recovery.”

SAB Miller

“There are currently very few encouraging signs in the global picture. We cannot predict when an overall improvement in trading will come.”

Richemont

“Retail trading conditions are expected to remain challenging in the coming months.”

Nu Clicks

“Reduced economic activity and the likelihood of declining inflation will result in lower turnover growth.”

Spar

“The indebtedness of the consumer remains a concern.”JD Group

“Difficult conditions are expected to remain until at least the second half of 2009.”

Astrapak

“The overall trading environment in the second half is expected to remain difficult.”

Barloworld

“Although interest rates are expected to decline further, Tiger Brands is expected to experience difficult trading conditions for the remainder of the year.”

Tiger Brands

“The company is well aligned with infrastructure, mining and power generation markets and will continue to benefit from anticipated government and parastatal spend on infrastructure spend.”

Steffanutti

Equities

Recent results have given us a glimpse of how companies are operating in the current tumultuous environment Badly hit:

• Platinum, base metal producers (ferrochrome)

• Companies servicing mining and motor industries

• Credit retailers – furniture, white and brown goods, motor vehicles

• Residential housing market – related construction companies

• Gaming industry – top end of the hospitality industry

• Financial services – especially non-retail banks

In the black• Banks

• Life insurers

• Cash retailers – food, clothing, building

• Low end hospitality

• Construction – civils, cement

• Tobacco and liquor

• Cell phones

• Resources - iron ore, coal, gold

• Health, pharmaceuticals

Africa – open for business

Shedding image that only growth industry is crimeNo longer associated with war, famine and tyrants Still poverty stricken but development boomingFinancial markets opening – FDI flows greater than aidDemocracy on the increaseStill relies mainly on commodities – oil, forests, minesGrowth over last four years over 6%; 2009 forecast at 2%China spending billions of dollars helping build infrastructure China trade increasing rapidly

Current 24 favourite stocks

Resources• BHP Billiton, Sasol, Exxaro

Offshore• British American Tobacco, SAB Miller,

Richemont

Africa• MTN, Naspers N, Shoprite, Aspen, Tongaat

Financials• Standard Bank, Metlife, Discovery, JSE

Consumer• Pick and Pay, Mr Price, Truworths, Tiger

Brands, Nampak

Hospitality• City Lodge

Infrastructure• PPC, Basil Read, Raubex

Lessons learned from the current crisis

The US retains its power to command the global economy and create disorder• Humbled and reputation of its iconic institutions

damaged but the nation still leads the worldUS and China will probably lead the turnaround with their huge stimulus packages• Fortifying China’s standing as a major power• India in the wings• Europe slipping away

The credit crisis demonstrates that the dollar remains the leading reserve currency• Despite fears that high debt levels may compromise

dollar’s status• Dollar recently endorsed by Japanese, Russian and

Chinese finance ministersDownturn highlighted the vulnerability of economies heavily reliant on exports – minerals and manufactured good (eg China, Germany, Japan)Heady days of easy credit have passed – risk premiums will riseSelf regulatory risk management techniques proved inadequate – need for greater vigilance in financial markets

Global equity markets

Commodity markets

International interest rates

Situation in the worldanything but normal

Good news

Aggressive government stimulus policies and financial rescue packages beginning to lift confidence

Spreads between government and other more risky bonds declining – inter-bank rates also easing suggesting an increase in money flow

Risk appetite improving – share prices up sharply since March lows – all the bad news appears to be in the market

Situation in the worldanything but normal

Bad newsHouseholders still overextended and feeling

pressure from bust in housing market and stock markets and fear of unemployment – will inhibit spending while they rebuild savings

Huge fiscal deficits could push lenders to demand higher returns to compensate risk

Companies deleveraging – focusing on core businesses – avoiding expansion projects or mergers

Banks may have turned corner but could still face more asset write-downs

Countries will soon need to rebuild their balance sheets – higher taxes

Government involvement in economies could raise spectre of protectionism

Challenges ahead

Remedial actions by authorities have removed risks of a major bank failure

Investment industry faces a huge regulatory overhaul that could lead to tougher controls

Government relationship with banks will probably reduce liquidity levels in financial markets

Capitalistic system at the mercy of government and regulators - hamper entrepreneurial ventures and hinder m&a/private equity funding

Need to rebalance global economy – encourage borrowing countries to export and saving countries to spend -

Rising call for protectionism – urge to keep jobs and capital at home – break globalisation

Risk premium on equities could possibly increase - investors will seek higher return measures

Failed the stress test

Share options• Introduced to reward management • Align the interests of management with the

stakeholders• “Don’t give me options – issue me puts!”

Share buy-backs• Aggressive programmes destroyed wealth • Rethink the benefits of management’s wisdom

Valuation techniques• Analysts metrics over optimistic• Did not succeed in providing support

IFRS• Mark-to-market fed write-downs exacerbated crisis

Scrip lending• Allowed sellers to mark down shares dramatically

fuelling downturn

Risk managers• Sophisticated techniques failed to pick up

weaknesses in pooled products

Thank you