We have been consistent in our message over the last few years in that we believe many of the levers available to policy makers for asset price growth have been used. Central bankers around the world have been very accommodating with low interest rates and the provision of excess liquidity. Many of the tools in their tool kit have been tried, we struggle to see what can be used next.

In the US, the government has reduced taxes for companies and provided incentives for the repatriation of US dollars held offshore. The new administration has introduced tariff protection for several industries in an attempt to assist local producers - something which might help in the short-term, however, in the long-term is more likely to hurt the country as inefficiencies are introduced and products and services become more expensive for the consumer. China’s full reaction to these tariffs are yet to be seen. They have, in the meantime, responded by stimulating their economy and introducing some of their own protection policies.

Globally, companies continue to buy back their own shares funded by cheap debt made available by the central banks, instead of investing in productive assets. We note that most of these loans have variable interest rates and as rates rise, interest bills will follow. The US long bond currently trades at above three percent and it is not inconceivable that we might see four percent quite soon. The implication of this is obvious: as the reserve currency reprices, all other weaker currencies, in particular emerging market currencies, will have to live with higher borrowing costs. For example, at the current rate of three percent earned on the US long bond, is nine percent sufficient to be earned on the South African R186? Is that enough to incentivise investors to stay or invest in South Africa?

Commodity prices have edged higher over the last few years led mainly by the oil price. A higher oil price affects emerging markets more than they affect developed markets. It remains to be seen whether the frackers that previously reduced oil prices return to apply pressure to the price again. It does not help that the US has punished Iran for reintroducing oil into global markets.

In general, the political environment has been abysmal with no shortage of drama. There is not a day without some headline that rattles confidence and has investors selling assets. A good example is the UK government which continues to erode confidence. One wonders how Brexit will end. Hopefully some sanity will prevail, and it doesn’t happen.

Anyone who has started a career in the financial services market in the last ten years has not witnessed a bear market. Bankers appear to have poor shortterm memories and have seen some lending on terms similar to those that led to the financial crisis of 2008. The debt markets look vulnerable with all forms of lending at record levels. Global debt to GDP is now 217 percent, up from 179 percent in 2007. Howard Marks has recently written a very good piece on this topic which does a good job of explaining the risks associated with the current high levels of debt.

We concur with Marks that should something go wrong in the markets, it is not going to come from the equity markets, but more likely from the public and private debt markets. Will this result in rising inflation, debt defaults, rising interest rates and more trade disputes? We simply do not know but prefer to remain cautious. We will continue to invest but need even more safety from our investments coupled with lower expectations in terms of returns.

We are fans of a strong balance sheet and try to value businesses in a way that takes into account an uncertain future. Businesses that sell products and services that are understandable, are required on a day-to-day basis and cannot be easily replaced are businesses we like. Industries such as tobacco and food companies come to mind, as well as companies like Oriental Watch Holdings and Bowler Metcalf with their cash flush balance sheets and simple business models.

We are finding more value in South Africa than offshore. The major reason for increasing our investment exposure to South Africa despite the pessimism, is that asset prices more than reflect the problems our country has, whereas offshore asset prices (in general) do not. We concede that short-term prospects for South African companies don’t look great, but the prices we are currently paying do not require much optimism. While we have not introduced many new ideas to the fund, you will notice that we continue to allocate capital to companies we know intimately and that command strong positions in their markets.

As previously mentioned, the R186, South Africa’s long-term bond currently yields about nine percent. At one stage it was trading to almost double inflation - a premium we don’t think is warranted and therefore an attractive asset. With the exception of a weak rand, we see no reason why rates should increase: confidence is low, the political environment uncertain and the petrol price increases are tantamount to a rate increase on an already struggling economy.

Investing in South Africa with its struggling economy and the pervasive pessimism will feel uncomfortable to many but this pessimism feels familiar. It wasn’t long ago when we were investing in commodity companies that were priced for Armageddon, an investment which turned out to be very rewarding. The local investments will require time and patience, but we don’t think it is impossible that with a bit of growth and improvement in the sentiment of our country, share prices of some of the businesses we are buying today could double.