While yesterday’s National Elections will provide more certainty for South African markets in the months ahead, this period also provides a window of opportunity to reflect on the first quarter’s performance to determine the path required for a better 2019.
On the global front, equity markets reversed course in the first quarter, with indices such as the S&P 500 and the JSE All Share Index recording their strongest first quarterly rise in a decade. A key catalyst igniting the rally in risk assets was the US Federal Reserve’s (Fed) unexpected decision to put their rate hiking plans on hold for the remainder of 2019. Political tensions eased this quarter, given the temporary US-China trade war truce, while China’s slowing economic growth showed tentative signs of improvement.
Markets moved swiftly this quarter, pricing in the possibility of a less dire outlook than initially expected. Offshore growth asset classes were the greatest beneficiaries, with global listed property and global equity the best performers. South African equities gained a muted 3.9%, driven largely by economically sensitive industries. Resources stocks rallied (+16.2%), tracking commodity prices higher, while industrials rebounded (+8.8%), driven by a recovery in large caps, which had sold off steeply during the prior quarter. SA listed property eked out a relatively small 1.5% gain this quarter, with mixed sentiment still prevalent across the sector. SA bonds rallied, with the All Bond Index climbing 3.8%, ending only fractionally behind the SA equity market.
How has the global growth outlook changed?
Global growth continues to slow. The International Monetary Fund (IMF) is forecasting 3.3% growth for 2019. Trade tensions, emerging markets stresses, tighter Chinese credit policy, and the normalisation of monetary policy in developed markets have all contributed to the weaker growth outlook.
This could be short-lived however, with a pick-up expected later this year. The US has paused rate hikes, Europe, Japan and the UK have adopted more accommodative stances, while China is stimulating their economy to offset the negative effect of tariffs. The IMF therefore expects a modest pickup in growth heading into 2020.
Though growth forecasts appear constructive, there is some trepidation around the slope of the US yield curve at present, which is currently flat and briefly inverted during the quarter based on some metrics. This omen typically forewarns of a US recession 18 months or so down the line.
When will South Africa turn the corner?
South Africa is on a markedly different growth path. Economic growth continues to disappoint with the South African Reserve Bank (SARB) expecting just 1.3% growth in 2019, while National Treasury only expects SA government debt to stabilise in 2023/4 at 60.2%. The IMF is more pessimistic however, on both our growth as well as debt trajectories. Stats SA’s Q1 2019 GDP figures, which will be released next month, will provide further indication of growth.
The pause in the Fed’s tightening cycle reflects softening of the economic growth outlook and subdued inflation in the US. This, however, gave emerging markets some breathing room, with the SARB being able to leave interest rates unchanged at both its January and March meetings, supported by benign inflation domestically.
Against the backdrop of sustained global growth, we remain constructive on pro-growth asset classes, and continue to hold meaningful exposure in portfolios that are geared towards capital growth. International equity remains our preferred asset class and we maintain being over-weight in our house view. Though equities have de-rated and are celebrating the Fed’s dovish pivot, while looking forward to a possible China-led pickup in global growth, we do not anticipate upweighting international equity at present. Our portfolios are meaningfully exposed should risk assets continue their breath-taking ascent from here.
We are still broadly neutral on SA equity and despite the recent rally which has made up some of last years’ lost ground, we are not yet convinced that an overweight is called for. Admittedly valuations are more attractive locally than abroad. We are comforted to some extent that ’SA Inc’ exposure is mitigated by the proportionately large share of JSE listed companies with earnings that accrue from abroad, but our preference remains to access offshore exposure directly, where the opportunity set is wider.
In the fixed interest space, we are still neutral on South African bonds. South African government debt is priced as if it was already sub-investment grade, and offers an attractive yield given contained inflation forecasts, despite market concern around contingent State-Owned Enterprise liabilities and economic growth forecasts. Moody’s opted not to downgrade South Africa’s sovereign credit rating. Perhaps yesterday’s elections will provide them with a better reading into how committed government might be to pursue the required reforms necessary for debt sustainability. We remain poised to upweight bonds should the opportunity present itself.
However, we remain negative on the outlook for global bonds. Should global growth stabilise, there is upside risk to yields, as well as the risk that inflation accelerates. With developed market yields as low as they are, global bonds offer ’return-less risk’, and while in theory they could provide some utility in a global risk-off event, we currently prefer short duration fixed interest exposure or cash over long-term bonds.
What is the outlook for the rest of the year?
Global equities have run hard coming into this year and it would be highly unusual for the current pace to be sustained for the remainder of the year. Extrapolating this quarter’s gain for example, would imply a 50% ’melt-up’ for the full year, which seems rather unlikely under current conditions. A consolidation before the next move therefore seems in order. The market will go where it goes however, and rather than spend time anticipating its likely course, we focus on ensuring that our portfolios are positioned to benefit sufficiently should the rally continue, while also being appropriately diversified should the outcome differ.