IS MTN KEYNES’ PRETTY GIRL? -Does it matter more whether we think MTN is pretty or whether we think other investors think MTN is pretty?

British economist John Maynard Keynes, in his book The General Theory of Employment, Interest and Money, famously compared the stock market to a type of beauty competition. A contest in a London newspaper of his day featured pictures of about a hundred young women. To win, one had not to pick the prettiest, but a list of the five women one thought most other readers would pick. It is easy to see how this quickly becomes a game of second (and third and fourth etc) guessing. Each potential entrant (investor) ignores his or her taste in beauty (fundamental value) and instead tries to predict what others will think.

Imagine the outcry of foul play if the newspaper printed one photo clearer, larger or more revealing than the others. That iswhat the local investment community has achieved with the so-called SWIX index, which has contrived to increase the weight of MTN from 7.2% in the unfettered All Share Index to 10.7% in the manipulated SWIX index, to the detriment of economically much larger listed companies. The SWIX index was designed to closer mimic the actual average holdings of the asset management community, or to look like what most other readers thought was the prettiest girl. This strikes us as a rather unambitious approach to investing.

Meanwhile, the vaunted MTN/Bharti deal appears to have floundered. We remain puzzled by MTN’s management’s eagerness to do a deal. Could it be that they, like us, wonder whether they can continue to grow at the rate of the past decade; something the market seems to expect but is unlikely to be achievable? Another headwind for MTN which has attracted surprisingly little attention is the weakness of Nigeria’s naira against the rand. Nigeria’s contribution to MTN’s EBITDA is about 45%, so we imagine that the chart below is unsettling to management, as it should be to shareholders. For the record, EBITDA is hardly our favourite metric, but MTN’s financial statements do not provide a geographical breakdown of contribution to bottom line earnings.

Another victim of the rand’s strength is the price of gold. It has been trumpeted that gold’s dollar price per ounce has goneabove $1,000. Ordinarily, that would justifiably be received as good news for South Africa’s gold mining companies. However, the more important issue for them is the rand price of gold, which is hardly getting our vuvuzelas going, especially as the mines’ production costs have been escalating quite noticeably.

So, given that gold shares were up 4% in September, we are left to assume that for now that sector of the market is in a Panglossian frame of mind. Incorrectly, the dollar gold price seems to be the palliative to the less palatable facts.

During September, ABSA announced that it is prepared to grant mortgages to the value of 110% of the value of the mortgaged houses, provided that the buyers earn below a certain amount. In a country that patted itself on the back for having escaped the worst excesses of sub-prime, this is an astounding bit of news, the more so since interest rates are not generally expected to fall any further and retrenchments are on the increase.

Some company news during September:
First Rand Limited(held) reported final results. Normalised earnings were down 31% and return on equity declined from 22% to 14%, both measures being reflective of a downturn in the performance of the investment banking franchise, which was previously a significant beneficiary in terms of internal capital allocation. Consumer banking did not escape unscathed with impairment charges increasing by 58% to R8 billion, resulting in a credit loss ratio of 1.8%. It was heartening to see, however, a deceleration in the rate of increase of bad debts, hopefully signalling an easing in client distress.

Investec Plc(held) gave a pre-close briefing. The Group has been focussing on conserving liquidity as evidenced by a number of balance sheet measures: loan growth moderated to a conservative 3% but deposits were up 16%. Cash and near cash are now up to £6.6 billion with the South African banking business gaining traction in the retail market. Investec indicated that it is experiencing inflows of about R1.7 billion per month in South Africa and £200 million per month in the U.K. In November last year, the Tier 1 capital target was revised to 11% with an expectation that the target would be achieved in 2010. Indications are that this target will be achieved this year. More broadly, there are early indications of improved operational performance, especially when compared to 2H09. Investec is currently trading at about 1.6x tangible NAV, still comfortably off a long run average of 2.8x.

Sasol (held) management took an ultra-conservative stance, cutting the full year dividend for the 1sttime in Sasol’s history (-35% to R8.50), slashing the capex budget, and guiding 2010 earnings further down from 2009’s depressed levels.The latter view (certainly not shared by consensus forecasts at the time) cited their expectation of a $65 -70 /bbl oil price and arand/US$ exchange rate averaging R7.90/$ for FY 2010. The company is currently unleveraged, despite a target gearing range of 30% -50%.

Equities are followed much more publically than bonds, so the awful recent bear market, which doomsayers tried their damndestto relate to the 1929 Great Crash, was widely reported.

Less well reported has been the spectacular crash in the bond market. In December, giddy hordes rushed into euphemistically named "safe haven" US Treasury Bonds amid fears of apocalyptic outcomes in equity markets, helping to drive three months Treasury yields to an incomprehensible minustwo basis points and even 10-year yields to a low of 2%. At the time (January 2009 commentary) we cynically remarked that we had an era not of risk-free bonds but of return-free bonds. We were wrong: 10-year Treasuries were about to deliver hugely negative returns off this absurd base. In our careers, there has been one other notable bear market in US bonds. In February 1994, Fed Chairman Greenspan surprised markets by raising overnight rates from 3.00% to 3.25%. This sparked a sell-off in 10-year yields, from 5.87% to 7.11% and was the cause of the spectacular bankruptcy of Orange County, California, which had up to that time been the wealthiest county in the USA. So, recent market events led us to compare the current bear market to the 1994 market for 10-year US bonds.

The current bond bear market is worse than the 1994 crash. Once again, high prices (low yields) begat negative returns. Whereas the South African equity market plunged headlong with US equities, perhaps ominously, the local bond market has ignored a substantial part of the sell-off in US bonds. Ceteris paribus, this renders local bonds expensive.

Technical analysis
A wonderful quote from veteran stockbroker Dr James Greener: "Considerable excitement has been caused on Wall Street by the news that the Coppock Index has given a buy signal. This allegedly nearly infallible technical indicator is brewed from a mesmerising mix of market momentum metrics". We detest the pseudo-science of technical analysis, also known as charting. In this case, the Coppock Index missed a 40% rise in the S&P500, and in the short while since its most recent buying trigger, Wall Street has dropped back by 6%. Chalk that up as another loss for the chartists. It is easy to think of a more apt, rhyming name for the Coppock Index.

China
We have long been sceptical of rapid and smooth releases of Chinese macro-economic data, so we felt a bit vindicated by the following remarkable admission: "Despite the NBS [National Bureau of Statistics, China] assurance, the head of the bureau, MaJiantang, cited the need to "continuously improve the quality and credibility of China's official data" on 17 April 2009 following a critical commentary on the Wall Street Journal website, Xinhua News Agency reported. The National People's Congress has found "serious fabrication" in official statistics, the report said.

The real economy
Last month, after the release of the surprisingly poor first quarter GDP growth data, we pointed out that there is a poor correlation between financial markets and GDP growth. The past month provided further evidence of this fact. Whereas a large number of companies, across a variety of industries, either reported or warned of large decreases in their earnings, the FTSE/JSE All Share Index declined by only 3%. Examples are Sasol (oil & chemicals -warning of a 40%-50% decline), Grindrod (freight & logistics -warned of a 50%-60% decline), Aveng (construction -warning of a 15%-20% decline), Eqstra (equipment & vehicle leasing -warning of a 85%-95% decline), Firstrand (financial services -warning of a 28%-33% decline), ABSA (financial services -warned of a 25%-35% decline), Naspers (media -reported a 22% decline in diluted headline earnings per share) and Telkom (telecommunications -reported a 46% decline in headline earnings per share). This bad news is clearly what the market saw coming last year and partly warranted the 45% drawdown that appears to have ended on 20 November 2008. Hopefully the 24% bounce we have seen since that low point will prove to be equally prophetic!

Some company news during May that is of relevance to our clients' portfolios:

BHP Billiton announced a JV with Rio Tinto for all its Western Australian iron ore production assets. The two companies will market and sell the output from the JV separately to their clients. Billiton expects to pay Rio $5.8 billion to raise its interest in the JV from 45% to 50%. The JV will require regulatory approval and is slated to realise $10 billion (NPV) from synergies.

FirstRandannounced that Sizwe Nxasana will succeed Paul Harris as group CEO, in what looks to us like a well-planned, gradual succession. Later in the month, FirstRand hosted an investor update at which the message relayed was quite disappointing. The group pointed to conservative earnings expectations for the second half of the 2009 financial year driven by increases in impairments and bad debts as well as poor performance in various businesses, most notably Private Equity, FICC (fixed income, currencies and commodities) and the SPJI (Special Projects International) portfolio. In a significant change in strategy, FirstRand indicated that they would be de-risking the balance sheet with reduced capital to be allocated to the investment bank. Further, FirstRand will also be exiting most of its developed markets businesses in order (in concert with its competitors) to focus on growing its business into Africa.

Anglo American received an unwanted merger proposal from Xstrata. The board is reported to have taken less than two hours to reject the proposal.

Sasol issued a profit warning, suggesting that headline earnings per share for the year to June 2009 will be down 40% to 50%. Consensus expectations were for flat earnings -this just days before year-end. Once again we marvel at the futility of forecasting.

The bubble asset has faced some severe headwinds! In the UK, a routine government bond auction recently failed. We would not be the least bit surprised if the same happened in the USA in the near future. Insatiable central bank demand for bonds smacks of market manipulation, which always ends unhappily. At home, the ebullience surrounding the new measure of inflation was extremely short-lived. Bond bulls ecstatically applauded the new methodology as it was certain to provide them a windfall. Yet, in only its second month in its new livery, inflation rose from 8.1% to 8.6% thus once again humiliating a bandwagon full of forecasters. A yield of 8.5% on 10-year RSA bonds hardly seems to offer adequate compensation.

It may not feel like this, but from its recent low point (20th November 2008), the All Share Index's total return has been +21% (to 3rd April 2009). The most frequent question we have received from clients in the past year has been "When do you think the bear market will bottom" and we gauge that we are expected to answer something along the lines of "within 18 months". We guardedly, nervously and hopefully think the answer may transpire to be - "It bottomed in November 2008". We have stated before that stock markets and economies are not very well correlated, and that just as global equity markets turned down long before we had hard evidence of a recession, so they would probably recover long before we knew that positive real GDP growth had resumed. For now at least, that course of events appears intact.

Given the documented asymmetry of amnesia, perhaps the next observation accords even less well with general recollection: now that all December financial year-end companies have reported, we can measure actual 2008 year-onyear earnings changes for the weighted average components of the JSE All Share Index. The answer is a growth rate of positive 6%. Agreed, that is not a tremendous achievement and is slightly negative in real terms, but it is a lot higher than doomsayers had been predicting. For bears who like to scavenge for vindication, consensus earnings growth expectations for the All Share over the next 12 months are negative 5%. Our first retort is to exhort them to examine the woeful track record of such forecasting. Our second is to observe that the index's historic PE multiple is barely an undemanding 10 times. So, we think that at least some of the awful economic news, such as vehicle sales being down 35% year-on-year, has been adequately discounted.

Among large cap financials to report in March (including Old Mutual, Nedbank, Liberty, Sanlam, FirstRand's interim results and Standard Bank), mostly grim headline earnings numbers masked many much less problematic releases, such as higher than expected embedded values, ROEs, advances growths and capital adequacy ratios. One rating agency downgraded portions of Investec's and Old Mutual's debt, thereby confirming our long held view that rating agencies tend to be no more than lagging indicators with sorry track records.

Some recent results have drawn our attention back to another facet of business: overseas expansion. FirstRand had to take a substantial loss from a trading desk it runs in the UK and Old Mutual announced the cessation of all new business in its Bermuda operation. With pitifully few exceptions, notably in the mining arena and in other African countries, the graveyard of South African corporations' offshore subsidiaries is growing. Almost all talk of "hard currency earnings", "synergies", "untapped markets" and so on has ended up being claptrap. Think of the retailers in Australia and the financial services companies in the UK and USA. Having observed so many of these aspirations evaporating, we have become highly suspicious of the motivations. Could it be that senior management has ever squandered shareholders' funds to arrange for lavish emigration and early retirement? Surely not. The cosiness of a second passport? Are we too cynical? Among financials, Sanlam has probably been the most insulated from the global financial crisis, as it remained the most focused in its home market. Now it has announced its intentions to grow its international asset management business. For its sake, we hope it can become more of an exception than a rule.

Gold seems to be back in vogue. In previous reports we have explained why we currently hold no gold shares. Maybe we also need to try to justify why we also hold no physical gold or equivalents. We offer three main reasons:

1. We don't really buy the popular storyline that gold is a safe haven asset in times of trouble. In that endeavour it has failed miserably several times in our careers.
2. We honestly can't forecast the price of gold. We don't think anyone else can either.
3. It produces no earnings or dividends yet incurs holding costs. We're just more comfortable buying assets for you that we can show with some conviction to be attractively valued and income producing.

We have a bond bubble! In recent years we have experienced a few bubbles, including the Asian Tigers, the TMT saga, the BRICs hoax, and construction stocks. All of these have been related to equities. Bonds are supposed to be august, sanguine, conservative; anything but exuberant. And yet last month, three-month US Treasury Bills briefly traded at minus 2 basis points (investors were paying the US government for the privilege of lending it money) and six-month Treasury Bills traded at 0.25%. That's hardly rational. In fact, current short term rates are forcing the closure of many American money market funds, which cannot deliver positive returns after costs. In South Africa, at 7.3% we have the lowest yields on 10- year government bonds since August 1970. The notable difference is that then inflation was about 4.5% and now it is about 12%.

The commentators who continually fret about supply or demand of bonds and what it will mean for yields (we have never believed in these arguments) are having another very bad day at the office, maybe their worst. The bail-out packages that have been announced in many countries mean that we are on the verge of seeing by far the greatest ever issuance of bonds in the US and Europe, yet we are witnessing extremely low yields. The Nedgroup Investments Balanced Fund retains its short duration position within bonds.

Whatever our views on low bond yields, these (which appear in the denominator of the fair value equation for equities) have not been very helpful to the case of equities. That said, at one point in 2008, the loss in the total return of the All Share Index was a sickening 45.4%, against which the calendar outcome of -23.2% almost seems a relief. The net situation is that we now have a negative bond risk premium and a very attractive equity risk premium, notwithstanding a grim earnings outlook. The fund's domestic equity performance was assisted not only by some shares we held on your behalf, but by shares we chose not to hold and which were widely held by our competitors. Chief among the latter were two "darling" stocks, MTN and Murray & Roberts. The allure of these stocks was easy enough to see at the beginning of the year (great stories about turnover growth, expansion outside South Africa, the 2010 World Cup and so on), but how much of this supposedly bright future was already discounted in the share prices was somewhat more difficult to ascertain. Our endeavours in this regard showed that not only did these ambitious forecasts have to come to pass, but they had to be exceeded in order for the share prices to be vindicated. Alas, the outlook actually dimmed and the share prices crashed. MTN's drawdown in 2008 was 54% and Murray & Roberts' was 63%. We recall the first time we ever saw a presentation by a listed company to the analyst community in which a laptop was used (rather than the diabolical old overhead projector slides, usually covered in fingerprints). The company was within the IT sector and was being idolised at the time. Hilariously and ironically, this great IT company could not rise to the challenge of getting its own IT to work and the presentation floundered, as did the share price not long afterwards. We cannot help but mention that during the recent quiet holiday season, when markets were moribund, the entire MTN network shut down completely for almost a day. A "nothing can go wrong" prospect is always a dangerous investment.

The rot that set in as a result of sub-prime et al first manifested itself, understandably enough, in banks' share prices. And yet banks ended the year as one of the best sectors on the JSE, losing only 10%. Our error, in common with many value investors worldwide, was to be invested in banks too early. Still, that was better than not having a bus ticket when the bus did eventually arrive. From its nadir, the bank sector rose 35% and outperformed the overall market by 82%. Losses, rumoured losses and mark-to-market losses related to sub-prime or blamed on the evaporation of financial market liquidity surfaced earlier within the banks than within the life assurers but were actually much less injurious to banks' share prices. The beleaguered life assurance sector lost 47% in 2008. Somewhere during this temporal dislocation, (certainly not at the ideal moment) we switched our financial sector preference from the banks to the assurers, some of which are now trading at significant discounts to their break-up values, let alone their embedded values or the erstwhile, higher benchmarks - appraisal values. So management could do us a favour and abandon bothering to show up to work and you as our unit holders would do rather well. More likely though, they will persist with their generally pell-mell approach to grinding themselves out of trouble, and will actually emerge again as going concerns, which would be a very good thing.

In these monthly reports, we have already written extensively about the fund's biggest holdings, Anglo American and BHP Billiton, so now we will turn to a share that we bought too early, but reappraised regularly and retained, to be rewarded ultimately. Imperial fell spectacularly from grace (it was once the favourite share among the growth investing community) and was beset by a number of problems, not least the ill-health and then untimely death of its inspirational founder. As often happens in these "hero to zero" cases, the price fell far below a level commensurate with its corporate problems. This eventually (much too late for our liking!) became widely apparent, and between early June and year-end, it outperformed the overall market by 78%. The story of Bidvest is fairly similar, as is that of Telkom relative to MTN.

After the annus horribilus that was 2008, 2009 should turn out much better. For one thing, we start the year at a PE ratio of just 9.5 compared to 14.5 a year ago. The weighted average PE of the equity component of your fund is even more attractive, at about 8.0.