Dear Fellow Investors and Friends,
Welcome to my newsletter, where I share my efforts to understand markets and the world around me.
I do appreciate you taking the time to read this. I love getting feedback; feel free to drop me a line. It’s great to start conversations.
Today is Thursday, May 7th, the 127th day of the year. There are 238 days left until the end of the year. The Scottish philosopher and a key figure in the enlightenment, David Hume, was born on this day in 1711. Hume famously argued that reason alone cannot motivate action. Morality and human behaviour are driven by emotions, sentiments, and desires (“passions”), with reason acting only to guide them.
I think Hume was a closet fund manager.
A lot of what passes for research in the investment industry is simply emotions and desires expressed in numbers. To avoid falling into this trap, it’s useful now and then to review one’s investment strategy as objectively as possible. That is what I intend to do this week.
For quite a while now, I have been saying that many listed businesses in South Africa are undervalued due to South Africans’ strong desire to invest offshore, coupled with a lack of foreign appetite for South African assets. As such, these businesses offer high prospective investment returns.
Why South Africans have this strong preference for offshore investing is a puzzle wrapped in an enigma. South Africa is filled with smart entrepreneurs, building great businesses. But the first thing these entrepreneurs say when they are the recipients of a liquidity event is: “Take my money offshore, this country is uninvestable”.
Can you spot the irony?
I guess the answer to this puzzle lies in a combination of
- Highly incentivised, fearmongering “helpers” who are only too happy to help their clients move their money into offshore “investments” – most of which end up performing poorly;
- A “grass is always greener” effect; and
- An understandable reaction to our inept government’s absolute inability to build trust with the business community.
This offshore flow happens despite South African assets performing much better than investors want to believe, which will be the topic for a future piece. But it is this persistent outflow of a “wall of money” that has created the investment opportunity.
Over the past few years, my “base case” investment thesis implied that these undervalued South African assets would do even better than they have done historically. However, considering developments in Iran this year, it’s worth re-examining this base case scenario to see how the war has affected it:
- Geopolitical tensions and Western financial vulnerability are fracturing the world into a multipolar system, away from the previously unipolar world in which the USA ruled the roost.
- This is placing increasing barriers in the way of the free movement of goods, capital, and people globally.
- In this environment, countries will have to become more independent and reconstitute their supply chains locally (“reshoring”).
- This is good for the demand for commodities, and will put upward pressure on their price, which will, in turn, cause inflation rates to be higher than otherwise.
- Due to high debt levels in Western developed markets (DMs), upward pressure on interest rates from higher inflation will be resisted by fiscal authorities through repressive measures such as exchange controls, prescribed assets, and other regulatory interventions.
- This is a good mix for emerging markets (EMs): low real interest rates, high nominal growth, and high commodity prices.
- Within emerging markets, South Africa would be a key beneficiary due to its high resource endowment and (relatively) strong fiscal and monetary situation.
With this backdrop, I would want:
- Exposure to undervalued EM currencies and specifically undervalued Asian currencies.
- Little or no exposure to developed market bonds, preferring shorter duration high-yielding EM bonds.
- In equities, I prefer EM equities over DM equities, and within that, I prefer high-quality durable businesses – valuations permitting. The South African small and mid-cap situation is a subset of this category. Hence, my bullishness on this particular asset class.
- A significant exposure to inflation-resistant hard assets.
This is exactly how the cockroach is positioned.
The war in Iran has changed some things, though:
- Food and energy prices will face upward pressure, with emerging markets bearing the brunt. As a result, EMs could destabilise – recall that the 2007/08 food price spike helped trigger the Arab Spring. Early warning signs are already visible (e.g., protests in the Philippines over rising food costs). Locally, diesel prices are hurting.
- EMs face a double whammy of higher expected inflation and a bigger risk premium. This means higher bond yields, such as we have experienced recently in South Africa, with the 10-year yield moving from a low of 7.8% just before the war to its current level of 8.9%. To the extent that asset prices are the present value of future cash flows, discounted by an appropriate interest rate, higher interest rates (i.e. bond yields) reduce asset prices.
- The closure of the Strait of Hormuz will drive a surge in global capex to reduce future dependence on this chokepoint. It will take years to build the necessary infrastructure to reduce Hormuz’s importance to the global economy, but it will happen. Pipelines and LNG terminals will be built, and alternative oil and gas resources will be exploited (such as the ones off Namibia and South Africa’s South Coast?) – this will, eventually, further strengthen the demand for resources.
- Globally, there are massive reserves of carbon-based energy (oil, gas, and coal). Eventually, energy prices will revert to much lower levels, where profits for energy companies are more reasonable while energy remains cheap for consumers.
On the face of it, markets have taken these developments in their stride. Since the war started, the MSCI World is down only 3%. Counterintuitively, EM continues to outperform, up 2.4%. But the biggest contributor to EM equity strength over the past month has not been strong growth and commodity demand, but AI-related hardware and technology manufacturing, particularly in Taiwan and South Korea.
In the short term, higher energy prices and higher bond yields are negative for South Africa, and particularly for SA small and mid-caps – even the high-quality ones. But if one looks at current events, the process of Balkanisation of the global economy will accelerate, supporting the South African investment thesis.
The war in Iran creates a paradox. The short term is uncertain and could be painful. The medium- to long-term (i.e., the next 2–5 years) is much more predictable and, I would hazard to say, prosperous for us here in the Southern tip.
Overall, though, the war has merely interrupted my investment thesis – it has not superseded it.
In The Markets
1. Unhappy endings
A long time ago, RMH was a highly respected investment holding company. It was effectively the incubator of many wonderful South African businesses – FirstRand, Discovery, OUTsurance and Rand Merchant Bank.
Around 10 years ago, RMH embarked on a “value unlock” strategy – as most investment holding companies eventually do – by selling and/or unbundling the bulk of its assets.
With the end of the road in sight, and not being shareholders, the directors sought to prolong their highly lucrative positions as fiduciaries at RMH. What better way to do so than to diversify into property, always the first port of call for the investment dimwit. In a presentation to shareholders in June 2016, RMH disclosed that it had acquired a trophy asset: a 27.5% minority stake in the unlisted Atterbury Property Company.
At the time, the RMH CEO said, “Our new property investment strategy meets our stated objective of creating shareholder value…” – at the time, they only announced the strategy and the acquisition. It was only much later that shareholders learned that directors had paid an 83% premium to net asset value (NAV) for this trophy property asset.
Guess what? Viljoen’s First Law of Investing kicked in. Fast forward 10 years: RMH’s initial investment of R484 million in Atterbury, at NAV, was worth R504 million. The only successful part of this strategy was that the directors of RMH had 10 more years of sucking the marrow out of the RMH bone. Shareholders, lurking in the shadows, were placated with a scrap of sinew now and then.
Today, after spectacularly successfully executing a decade’s worth of job retention strategy, the directors of RMH say shareholders should be happy to accept an offer of 47 cents per share, representing a 3% discount to RMH’s stated NAV. Of course, this NAV is after an impairment of R272 million which has now belatedly been recognised. Adding this back means the offer is a 30% discount on the value at which Atterbury had been carried over the past decade.
My take: As always, Caveat Emptor. And the signs were there. The directors of RMH never had any significant shareholding in the business – they were there to maximise their annual income. Which they did, at the expense of shareholders, ushering in a truly ignominious end to one of South Africa’s greatest investment stories.
2. The FOMO trade
The fear of missing out is one of the strongest drivers in the market.
Today’s headlines scream that:
- The world faces drastic energy and fertiliser shortages due to the war in Iran; and
- Markets are making new highs – the MSCI World index, the S&P500 index, the MSCI Emerging Markets index – all at new all-time highs.
It seems like a contradiction! What’s going on? Basically, semiconductor (i.e. chip) stocks are driving markets, as John Authers points out in his Bloomberg column:
Grants Interest Rate Observer reports:
“Earnings-driven euphoria reigns supreme, with a quartet of chipmakers, along with Alphabet, Nvidia and Amazon, having accounted for 80% of the capitalisation-weighted S&P 500’s 6% gains in the year-to-date. Only 23% of S&P 500 components managed to outperform the blue-chip gauge during April’s ferocious rally, marking the fourth-smallest single-month share since Bank of America began tracking that data series in 1986. Similarly, the median index member sits 13% below its own high, per Goldman Sachs, the second-largest level during a regime of market highs since the dot-com bubble.”
In short, the market is once more driven by a small number of stocks. For instance, here’s the MSCI Emerging markets index, at its all-time high:
But what’s in the index? You would guess companies from the banks, telecoms, mining and manufacturing sectors, the natural mainstays of emerging market economies. You would be wrong.
23% of the index is from the semiconductor industry – basically three companies, Taiwan Semiconductor, Samsung Electronics and SK Hynix. Tencent is the 4th biggest at a 3.5% weight. The biggest bank is China Construction Bank at 0.9% of the index. Apart from Naspers, the first real South African company in the index is FirstRand at a 0.3% weight.
So basically, if you are buying the MSCI Emerging Markets index, you are getting mainly chip exposure, with very little exposure to actual emerging-market economic activity.
Here’s the thing: Fred Hickey (editor of the High-Tech Strategist) reports that accounting conventions are serving to front-load benefits from the AI-related spending sprees, thereby inflating the index level data:
“Component suppliers (such as Nvidia and Micron) report their shipments as revenues immediately, much of which flows to their bottom lines as earnings, yet the hyperscalers’ capex costs for their massive datacenter buildouts are mostly put on the balance sheet (under property, plant and equipment) and do not subtract from their bottom lines until the data centers are put into use. Even then, the costs are spread out over several years into the future (as depreciation).”
In a nutshell, either the chipmakers’ earnings are inflated, or the hyperscalers’ (Amazon, Meta, Google, et al) earnings are inflated. Or both, for that matter. But it is causing a massive FOMO rally in cyclical stocks. John Authors again does a good job of describing what is happening in a chart:
Basically, quality stocks are struggling while FOMO is driving investors into cyclical, momentum-driven stocks.
On X, this investor highlighted the pressure FOMO is piling on professional investors:
My take: If you want to dance this dance, make sure you’re close to the exit. When the music stops, there will not be many chairs around. FOMO is not a sensible investment strategy.
3. On Point
My colleagues at Merchant West Investments, under the leadership of their new CEO, Alyssa Viljoen (no relation), put out quite a neat quarterly review, called – you guessed it – On Point.
In this quarter’s edition, they cover some interesting, high–quality stocks that are not generally discussed elsewhere. They also speak about the leadership transition at the firm. Something about which I am very excited.
My take: I think their newsletter is pretty good. You can read it here.
In the cockroach
This week, I want to focus on the equity component of the fund. It currently looks like this:
As you can see, the fund is overweight in equities, mainly due to the performance of her Emerging Markets ETF. The stocks – LSEG, Disney, Berkshire, Nestle and DSM-Firmenich are all high-quality businesses. And all of them have performed poorly recently.
As a recap, I aim to allocate 25% of the cockroach’s equity exposure to what I call my “10 stocks, forever” – each at a weight of 2.5%. However, this is subject to their being available at reasonable valuations. So far, I have been able to buy 5, but the others are still too expensive.
But this week, I have started adding a sixth: Hermès – the ultimate luxury-goods business.
At the current price of around €1,600 per share, Hermès is still on the expensive side. Its return on equity (ROE) – albeit with net cash on the balance sheet – is 25%, and you are paying a price-to-book of 9.3x to acquire this profitability. As a result, I only expect to earn 2.7% on the current market price. Factoring in annual growth of c.7%, you are looking at less than 10% in annual returns.
The dividend yield is only 1.6%, so it doesn’t materially add to the expected return.
Another way to look at expected returns is to note that, over time, the earnings yield will approach the ROE as incremental retained earnings are reinvested. At the current earnings yield of 2,6% and dividend yield of 1,6%, around 40% of earnings are retained and reinvested, which yields a ROE of 25%.
Earnings per share is $50, so $20 per share is being reinvested against an existing net asset value (NAV) per share of $211. So, 10% of NAV is reinvested at a higher rate of return. I estimate it will take three years for the overall return to get to satisfactory levels at the current run rates.
Three years is not a long time in the bigger scheme of things. But given the downside risk, I am only prepared to take a small position right now and then see if I can improve the average price over time.
The question then becomes: “Do they have sufficient reinvestment opportunities to deploy additional capital at the existing ROE levels?”
The answer, in my opinion, is yes. Given that they have net cash on the balance sheet, their actual return on invested capital is higher than the disclosed 25%. But it’s not limitless either, as they can’t risk overproduction. Hermès is deliberately supply-constrained. The global personal luxury goods market was about €358 billion in 2025. Hermès’ €16 billion in revenue is only about 4 – 5% of that market, so the total addressable market (TAM) is not exhausted.
Although not mouth-watering in absolute terms, Hermès’ valuation is starting to look interesting relative to other options. Its price/earnings multiple relative to the market is as low as it was in 2008/9, with the price-to-book ratio at similar levels.
Given its recent poor performance – down 40% from its recent highs, I think it’s time to start nibbling.
To fund this purchase, I will sell units in the Emerging Markets ETF. The fact that the cockroach has so much exposure to this go-go part of the market is pure accident; I claim no special insight on my part. But in the current environment, I am happy to sell FOMO assets to fund the purchase of high-quality businesses.
In other news, the latest quarterly report for the cockroach has been published. If you want more in-depth background information on the fund, you can read it here.
* I manage the fund on behalf of Merchant West Investments (Pty) Ltd (FSP 44508)
In The Media
1. The best music of 2001
After the damp squib of Y2K and everything working much better than anticipated, 2001 came as a shock. The TMT (tech, media and technology) bubble finally popped, dragging down the performance of everyone who couldn’t resist the FOMO of buying “blue-chip but eventually bankrupt fraud” Worldcom, “growth as far as the eye could see” Cisco and “a chip in every computer” Intel on P/Es of 100 to 200.
It was a time that cemented my investment philosophy as a value manager. This came from experiencing the joy of not losing a lot of money when everyone else was losing tons. The previous pain of not making as much money as those who “played the game” into the bubble faded into insignificance.
I learned firsthand that it’s not the one who makes the most money in a bubble who wins, but the one who loses the least in the inevitable downturn that follows. The lessons from the 1998 to 2001 bubble have stayed with me throughout my investing career.
Listening to the music of that fateful year brings back such good memories!
Here are the best albums of the year, on Apple Music and on Spotify.
And here are the top 20 songs of the year, on Apple Music and on Spotify.
As usual, they are ranked from nr 20 to nr 1. They also reflect my view on the best music, which may or may not coincide with yours. But I do hope you find some songs you really like here! Personally, Last Nite by The Strokes is one of my top songs ever – a song of and for its time. Also, Sweet Relief by Tindersticks is wonderful. I never knew of the band at the time – I only discovered them this year. But it’s a happy discovery.
Finally, here is the long list of the best songs of 2001, available only on Apple Music.
2. Book review: The Slip, by Lucas Schaefer (2025)
The Slip is a debut novel by Schaeffer, which won the Kirkus Prize last year. It’s the type of novel I like best – one where multiple characters are introduced and developed, with the associated different narrative threads coming together in a surprising denouement.
The Slip has a boxing gym as its focal point and uses the slip – a boxing term that denotes a defensive action – as its narrative driver. Over the course of the book, the main characters, and even some of the secondary ones, “slip” into different identities. They do so either to protect themselves or to become a better version of themselves.
The main plot concerns that of missing boy, Nathaniel Rothschild, and reads like a mystery novel. The narrative jumps between past and present and switches between first and third person. As such, it keeps your attention, as it takes some surprising twists.
The Slip is not the next great American novel, but it does have some superb characterisation and a plot that keeps you engaged. I started reading it last weekend and finished the 500-page book a week later. Two long weekends in a row gave me extra reading time.
Most enjoyable, and I would highly recommend it for some escapism.
That’s it for this week, from a cold and rainy Cape Town.
Happy Mother’s Day to all who celebrate – especially Amanda, my amazing wife and mother of my two stepsons, Ben and Zac. But also, Marina, the wonderful mother of my son Nic.
Piet Viljoen
RECM
7 May 2026