What were some of the events that impacted on the market this quarter?
The second quarter began on a positive note, with growth assets fuelled by the shift towards a more dovish stance from central banks globally, in anticipation of global growth rekindling. Confidence was however shattered, and markets were buffeted mid-quarter by a breakdown in US-China trade talks that had been portrayed as constructive until that point.
The situation unravelled, with Donald Trump accusing China of backtracking on their commitments, and further tariff hikes were threatened on Chinese imports. Protectionism fears spiked again when the US blacklisted a host of Chinese technology firms, including Huawei, banning local firms from doing business with them over security concerns. Tensions however died down in the lead up to the G20 summit, Trump softened his tech stance, and markets rallied into quarter-end on increasingly aggressive rate cut expectations.
On the domestic front, local stocks moved in tandem with offshore. The ANC won the National Election by a reduced majority, GDP growth disappointed heavily, and Ace Magashule called for quantitative easing locally, displaying a fundamental misunderstanding of the notion.
How have global and local asset classes performed?
Equity markets were somewhat of a rollercoaster ride this quarter, with a sharp downdraft in May sandwiched between two fairly strong up-months in April and June. The net result for the quarter, however, was low single digit returns overall for both growth and income asset classes.
Despite facing weakening local economic fundamentals, domestic asset classes were the best performers, with SA listed property (+4.5%) outperforming SA bonds (+3.7%) and SA equity (+2.9%).
Offshore asset classes contended with a stronger rand, but global equities still managed to eke out a positive result (+1.3%). This was in line with global bonds (+1.3%), while global listed property on the other hand lost ground (-2%), all measured in rand terms. The global backdrop for risky assets was largely overshadowed by softer growth data, and was compounded by concerns over rising trade barriers. Markets however remained optimistic regarding a trade resolution, while also anticipating the return of easy monetary conditions in the form of lower interest rates and renewed quantitative easing.
Global growth has deteriorated. What can we expect going forward?
The global economy is still expanding, but the growth rate has slowed from 3.9% in 2017 to a projected 3.3% in 2019, according to the International Monetary Fund’s (IMF) estimates. Reasons behind the slowdown include: tighter US policy from higher rates and the fading benefit from tax cuts, a slowdown in China’s economy in response to tighter credit policies, while Germany, which is reliant on global activity, has weighed on Europe.
While conditions have cooled, growth is expected to pick up in the second half of this year and reaccelerate to 3.6% in 2020, supported largely by policy accommodation. Although the globally economy is not on the cusp of a recession, it appears central banks are leaning towards pre-emptive easing because inflation is still largely absent, growth has tapered off and risks have increased. For example, the threat of a full-blown trade war poses a significant risk to global supply chains.
SA’s economic growth has disappointed. What weighed this down?
Economic growth locally remains out of sync with the rest of the world and GDP growth has taken a new leg lower. According to recent data, the South African economy shrank 3.2% in real terms quarter-on-quarter during the first quarter in 2019. This was the largest contraction since the 2008 global recession, and was partly due to the electricity cuts, as well as weaker global activity. Year-on-year growth was flat, and speaks to the difficult conditions felt locally in terms of both job creation and tax revenue collection.
With the muted growth outlook, can we expect interest rate cuts locally?
Subdued growth and measured inflation opens the door to interest rate cuts, which would provide some relief to consumers and businesses. Unfortunately, our economic malaise leaves us increasingly vulnerable to a credit ratings downgrade. Our investment grade rating currently hangs in the balance and Moody’s is becoming frustrated with our worsening fiscal deficit and deteriorating debt profile. Given SA’s reliance on foreign capital, it needs to maintain its standing as an attractive destination for capital, which means the South African Reserve Bank’s (SARB) scope for cuts is potentially reduced.
How are our portfolios positioned under the current conditions?
We have guarded against becoming overly pessimistic on equities, and have not been swayed by the prevailing news flow. We are mindful that economic uncertainty has increased, and geopolitical risk has flared up, while the current de-globalisation trends have the potential to unsettle economic progress. In the absence of any prominent signs of an oncoming global recession, however, it is appropriate to stay the course and to maintain your portfolio positioning.
There is some potential for near-term downside for global equities should the Fed not bow to the market’s expectation of aggressive rate cuts, or should trade talks collapse again. Another risk to bear in mind is the mixed signal being sent from the bond and equity markets at present. Safe-haven demand has increased with the yields on US treasuries and German bunds being driven lower, while at the same time risk assets have been bid higher, with the US stock market making new all-time highs. Time will tell whether the equity or bond markets have been right, but for now the risk reward trade-off appears favourable for global equities, while global bonds on the other hand offer little reward for their risk. Therefore, we remain overweight global equity and underweight global bonds.
The SA equity index has been resilient in the face of low levels of domestic economic activity and the concomitant poor earnings growth environment for SA corporates. This is however more a function of the make-up of the index, which is weighted more heavily towards large cap global multinationals that earn profits abroad, compared to the small and mid caps, which are more geared to the floundering local economy. We have remained neutral on SA growth assets this quarter, including both equities and listed property. While SA equity is not a pure play on the frail local market, we continue to favour offshore equity over local. In terms of SA property, though a fair amount of bad news is currently priced in, the sector is not yet attractive enough to move to an overweight.
SA fixed interest remains somewhat attractive at current yields, but we have favoured cash over bonds. With interest rate markets having moved swiftly to discount rate cuts, this has counted against us in the near term, but the risks to local bond yields that have kept us from upweighting the asset class remain elevated. At the same time, while the risk of a ratings downgrade is too large to ignore, the global re-emergence of “lower for longer” interest rate policy, and a weaker dollar environment could increase demand for emerging market yield plays, including SA bonds. For now, cash offers a satisfactory risk free real return, but we are poised to upweight bonds should the opportunity present itself.
Looking ahead
Markets are inherently always in a state of flux, but what is unusual about this juncture is that there appears to be a few important, yet conflicting, signals facing investors. Most notably, policy easing in the face of reasonable growth and a countercyclical rally in cyclical assets. Despite the complexity, our job is to filter out the noise, focus on what is important and remain committed to long-term plans in managing our investors’ portfolios. We rely on our rigorous investment process to add value through manager selection and risk management, and our house view process keeps us on the look-out for important inflection points and potential areas of value in the market. We are confident that our world-class team and process will continue to serve our clients’ needs well by growing their wealth in a risk-conscious framework.
