Lynx Cautious FoF comment - Sep 19
In the third quarter, local investors were not rewarded by risk assets, especially domestic facing stocks that continue to feel the lethargy of the South African economy. While there was a bifurcation in the performance between “Sa Inc” and “Rand hedge” stocks during the quarter (the former lagging significantly), both baskets on average ended the quarter in negative territory with the JSE All Share Index down 4.6%. In the absence of resources, Naspers and some of the other dual listed’s, the ALSI would certainly be in a bear market, and would more accurately reflect the sorry state of affairs in the country.
In the 3rd quarter, the Rand took direction from a gloomier global environment, weakening by close to 8% against the US$ and 4% and against Pound Sterling. After an initial rally early in the quarter, SA bonds moderated as the global risk-off sentiment came to the fore, generating a return of 0.7% for Q3.
On a more positive note, Stats SA released the 2nd quarter GDP figures which came in at 3.1% QoQ which was a welcome surprise following the significant contraction of 3.2% in the first quarter. Mining showed the largest growth of 14% followed by the financial sector (+4.1%), trade (+3.9%) and government (+3.4%). The main sectors that showed a decline were construction (-1.6%) and agriculture (-4.2%). While the stronger numbers have offered some relief to investor sentiment, the reserve bank have highlighted that the SA economy remains in its longest downward cycle since 1945.
Going into the 4th quarter, all eyes will be on ratings agency Moody’s, who is expected to review SA’s credit rating in November and could potentially downgrade SA sovereign debt by one notch to junk status. Their concerns rest with the increasing debt to GDP ratio which has been hampered by the ill effects of keeping Eskom (and other SOE’s) on life-support, the low economic growth rate, and the structurally high level of unemployment. Time is running out for the government to show ratings agencies that they have a clear plan to ignite growth and to improve the budget deficit that is currently showing no signs of narrowing. It is expected that we’ll get more clarity on governments plan of action for Eskom in, or at around the same time as the Medium-Term Budget Policy Statement (MTBPS), which is expected to be delivered on the 30th of October 2019.
From an investment perspective, it appears that a downgrade to junk status is mostly priced into local bond yields, but the potential increase in short term volatility remains a risk in the event of a downgrade due to the subsequent exclusion from World Government Bond Index (WGBI) and the implications of forced foreign selling. That said, relative to other emerging markets (with similar credit ratings), SA bonds look fairly attractive and should be supported by the weakening global economy and widening impact between DM and EM yields generally. Locally, inflation does not pose a serious risk, but the SARB remains caught between a rock and a hard place. On the one hand encouraging foreign portfolio flows by running high real yields in a world devoid of yield, while on the other hand keeping rates low enough to foster economic activity. On the SARB’s current trajectory and a continuation of quantitative easing/ further rate cuts in developed countries will make a SA bonds an attractive proposition for the “carry trade”.
There is no doubt that there are opportunities in the local market, and although South Africa has its own unique set of problems, it’s important to remember that SA is a small cog in a much larger machine and will take direction from the global economy. There has been a marginal economic slowdown in global growth recently but some finality on the US China trade deal has the potential to reignite global trade which stands to benefit emerging markets. An improvement in local consumer and business confidence could encourage a turnaround for many SA assets that are attractively priced relative to history and their global peers. Furthermore, policy certainty has the potential to secure much needed foreign fixed capital investments, which along with the successful implementation of a broad-based, investor friendly growth plan, has the potential to turn the economy around.
The fund aims to maintain a consistent growth rate of inflation plus 3% over a rolling 3-year period. This is a prudential, medium risk fund that is suited to clients seeking a stable real return. The fund invests in a diversified portfolio of collective investments. The fund conforms to Regulation 28 of the Pension Funds Act.