I have been asked by many clients in the past week or so, how can markets sustain their recent rally, and stand not far from previous highs when economies are contracting significantly and profits are likely to fall by 30-50%? To answer this, it is important to understand that the present value of stock prices are the Net Present Value (NPV) of the future stream of profits generated. This is mainly a function of three things:

1. The forecast stream of profits for as long as the company is likely to be in existence.

2. The risk free interest rate prevailing which is used to discount those future earnings to a Present Value (PV).

3. The equity risk premium to be added to that risk free rate to reflect the greater risk of investing as an equity owner.

We know that the current year’s profits will be materially down; however we also forecast that these profits will recover in future years. We also know that the risk free rate (both globally and in SA) is materially lower. The equity risk premium is probably currently quite high, given recent market volatility. Take all these together and you can see that there are a number of positives (recovery in earnings and substantial fall in risk free interest rates) to offset the near term negatives.

To date, however the market recovery has been as swift as the decline and there must be a risk that markets have rallied too hard and too fast. The range of uncertainties remains wide, from the progression out of lockdown, to a potential second wave of infections, to what normal really looks like when we do emerge back into society. Indeed we are already seeing in China that, despite the fact that new cases have been for now eradicated, people remain wary of engaging actively in society and consumer spending thereby remains subdued.

7 MAY 2020

INVESTMENT GROUP

MONEY MATTERSBy Hywel George

This week’s new risk is, as flagged in previous newsletters, Trump’s risks around re-election in November given an economy still in or just recovering from recession. As such he has identified a common enemy; and ratcheted up the anti-China rhetoric this week, citing strong evidence of the virus being sourced in a lab in Wuhan. He is pushing on an open door as "anti-China" feeling has grown substantially in the US this year, across all demographics.

Trump needs to shift support and bolster his position; it only requires a small swing in his heartland mid west states to lose him the election.

And if China doesn’t work, he may well look to a more aggressive stance, where a war like footing can bolster Presidential support.

Meanwhile in South Africa, as more testing is done, the number of daily cases is rising. The number of excess deaths meanwhile, thankfully remains very low. A conundrum for the government as they ease the lockdown; what is clear is that as time goes on, SA really needs to get back to work.

I would like to turn now to this letter’s focus issue. I have long been fascinated by sports, and how the great players and teams emerge, and sometimes dominate for years. I believe we have much to learn from the great professionals, as well as the great teams.

WHAT CAN WE LEARN AS INVESTORS AND BUSINESS PEOPLE FROM THE WORLD OF SPORTS?About 20 years ago, I was lucky enough to play a round of golf with Tom Watson in a Pro-Am Tournament in America. As many of you may know Tom is one of the most famous golfers of all time, winning eight Majors, and Number 1 in the World from 1978 to 1982. We were walking down the 10th fairway, and given we were all playing quite well, and in contention, I asked him what he focused on during the back nine of a Major – the moment where greatness is achieved, or all is lost. He said immediately – “I focus on keeping my shoulders level”. Now, I had expected some blinding insight from a golfing great, so was somewhat disappointed. It is only recently that his words have started to make sense. What he was saying was, focus on one, simple thing, to allow the mind to be calm and for your talent to shine through unimpeded.

This letter is about sport and what we can learn from the great sports people of our age. I have long believed that sport and business (and investing) have much in common. A highly competitive field, many talented players, much motivation to succeed, naturally competitive people, and a significant prize for the winner. Let’s explore the many facets where we can learn and grow as investment professionals.

I wrote an article a few years back, that still resides within LinkedIn.

In it I attempted to define the traits of great portfolio managers. In addition to the obvious necessities of strong analytical knowledge, ability with numbers, a certain level of intellect and interest I identified the following personality characteristics.

Curiosity, an ability to see the world differently, courage, humility, hunger and passion, an ability to frame an issue and identify necessary detail, identify signal from noise, control emotion

and hold an unpopular view, often for quite some time. The lessons that follow will refer back to these traits, and add more, common to both business and investing.

CONTEXT MATTERSIn sport, this is often referred to as spatial awareness. When Clive Woodward took on what would become the World Cup winning team of 2003 (the only time England have won the Rugby World Cup) one of his first initiatives was to improve the players spatial awareness in the moment, when the pressure was at its most intense. It was this that allowed England to keep pushing forward in the last minutes of injury time, until the whole team knew that they were in the right part of the field to allow Jonny Wilkinson to drop the goal that won them the World Cup.

For an investment professional, it takes an unerring ability to be able to focus on the correct detail whilst appreciating the big picture. You cannot understand the likely movement in the share price of Sasol, unless you have an appreciation for where Trump is and what effect his likely actions would have on the oil price.

YOU NEED A GREAT COACH/MENTORAngelo Dundee was born in Philadelphia in 1921, to poor Italian immigrant parents. He served in WWII and found experience in army boxing. A quiet humble man, he found solace in family and friends. He was also trainer to Muhammad Ali, and in all he coached 13 world boxing champions, including Sugar Ray Leonard. Before the ‘Rumble in the Jungle’, one of the most famous bouts of all time, before Ali left the dressing room to face George Foreman, Dundee put his arm around Ali, and gave him quiet reassurance. As Dundee said, “Ali was an enigma. He was utterly convinced of his own destiny, but he also needed reassurance”.

If you want to succeed in any line of business or indeed life, find yourself a great mentor, or coach. It would be indeed strange to hear these days of any serious sportsperson to turn up without a coach. Imagine a Wimbledon Final with no coaching team in the players box. Or a Springbok Rugby team without a coach. Yet, often, I see investment professionals thinking they can progress their own career and prowess alone, finding their own way in what is a highly complex and competitive industry.

Find a coach, use them and improve.

PRACTICE MAKES PERFECTNow established as an accepted fact, Malcolm Gladwell first popularized the theory in his book Outliers, published in 2008, that 10 000 of deliberate practice are a necessary prerequisite for any sporting or musical achievement. That is 20 hours of practice per week for 10 years. There are no overnight success stories, in sports or in business. Tiger Woods exploded onto the golf scene aged 21, winning the Masters at Augusta by 12 shots. Only he didn’t just turn up out of nowhere; he had played golf since the age of two, and without question had

completed 10 000 of deliberate practice under the watchful eye of his father and coach, Earl Woods.

As investment professionals we are highly trained, often with well-earned CFA qualifications, necessitating many hours of hard work (practice). It is critical to keep practicing, and improving. In Hank Haney’s book about coaching Tiger at the peak of his powers, he said that if Tiger took a two-week break from practice, he would be completely out of contention...

SMALL MARGINS AND ATTENTION TO DETAIL MAKE THE DIFFERENCE BETWEEN WINNING AND LOSINGIn investing, and in business, your eye had better be on the ball, and every detail attended to. Improvement too can come more often than not in small incremental steps; the 1% improvements add up. For cycling fans, the best example is the Great Britain cycling team, coached by Dave Brailsford. At the 2004 Olympic Games Great Britain won two cycling gold medals, their best performance since 1908; they went on to win eight gold medals at both the 2008 and 2012 Games. Brailsford’s 1% philosophy has been taken on by countless sporting teams, and across business. As he said, “if you break down everything you can think of that goes into riding a bike (and the rider) and improved it by 1%, you will get a significant increase when you put them all together”

ZEN - FIND YOUR SWEET SPOTYou know when you have found your sweet spot in a work setting when the work becomes effortless; you love it so much, the hours fly by and your productivity and innovation soars. You are Zen-like. This is the state all great sportspeople attempt to attain, by calming their conscious mind and allowing their unconscious to take over (and all those hours of practice to deliver the required outcome unimpeded by the conscious mind). There are countless examples. When asked what was going through his mind before the second serve ace that won him the 1999 Wimbledon Final Andre Agassi replied, “absolutely nothing”. Ayrton Senna, often cited as the greatest racing driver of all time was lapping, and leading the Monaco Grand Prix in 1988 at a pace that was so fast that it was embarrassing his team mate at McLaren. The team engineer radioed him form the pit wall to slow down a little. His Zen state (that he later described as “an out of body experience; like flying”) was lost; he crashed at the next corner, leapt from the car and walked home to his apartment.

WANT TO WIN; NOT JUST AVOID LOSING. IT HAS TO MATTER – BUT IT CANNOT BE EVERYTHINGWe work in a competitive world; managed risk taking is essential if we are to succeed. As any football team will tell you (aside from maybe Chelsea!) you cannot win by simply defending your own goal. And to make a crunch putt, the outcome needs to matter, but it cannot be life or death. Be aware enough to know when to up risk, and when to step away.

BE CONFIDENT, NOT ARROGANTA fund manager has to be confident enough to take and hold an often unpopular (or even ridiculed) position, going against the grain of prevailing opinion. But they must not be arrogant and blind to the possibility of being wrong, and thereby selling out if needed. A dose of humility is essential. I have worked with both types of fund manager. Let me tell you arrogance kills.

STICK TO YOUR PROCESSBen Hogan was one of the most famous golfers of all time, with probably the best swing ever. Yet he did not win on the Tour for ten long years. During that time, he stuck to his process of swing dynamic and preparation for tournaments. Eventually it paid off.

This is one of the most important facets of successful investing, or success in business. When the pressure is on and events are against you, you deviate from your trusted process at your peril. Be true to it and it will provide the true north to get you through the storm.

DISCIPLINEPep Guardiola, current manager of Manchester City is regarded as one of the greatest football managers of all time. He took Barcelona to glory domestically and across Europe and defined a whole new way of playing football. Yet when the players are asked what made him special, it was the little things. Turn up to training on time. Be prepared. Practice hard. Be humble. No-one is bigger than the club. The little things that make up discipline, adherence to a team culture, something bigger than yourself.

Enough said I think.

Old Mutual Investment Group (Pty) Ltd is a Licensed Financial Services Provider

INVESTMENT GROUP