2019/05/23 00:00:00

After the sharp losses suffered at the end of 2018, investors were able to take heart in the first quarter (Q1) of 2019 with markets rebounding as a few negative factors appeared to reverse themselves. Although evidence of slowing global growth continued to mount, global equities and bonds rallied strongly after the US Federal Reserve announced a substantial change of view and decided to pause (and perhaps even end) its interest rate hiking cycle. At the same time, other developed market central banks undertook more growth-supportive moves, and considerable progress was reportedly made in resolving the US-China trade dispute. On the negative side, an even more chaotic Brexit environment and the uncertainty engendered by Trump's unpredictability remained bearish factors for markets. Emerging markets also benefitted from the more bullish sentiment and the Fed's rate pause, but some like Turkey and Venezuela faced idiosyncratic challenges. However, for South African investors, local equities and bonds posted respectable gains in rand terms thanks to several positive developments.
In the US, it was the Fed's more dovish rate stance that proved to be the key for turning last year's losses into this quarter's gains. The Bank emphasized that it would be 'patient' when it came to further raising interest rates, given that the case for hiking had weakened in the face of slowing global and US growth. This eased fears that inexorably higher rates could choke off growth. US GDP growth for Q4 2018 was revised down to 2.2% (q/q annualised) from 2.6% previously, sharply lower than the 3.4% in Q3 2018. Dismal US retail sales data were a key highlight. Not only did the Fed opt to keep rates on hold at its January and March FOMC meetings, but on 20 March its 'dot plot' showed it had slashed its own interest rate expectations from two 25bp rate hikes in 2019 to zero, and only one 25bp hike in 2020. Adding to the general positive news was the end of the 35-day US government shutdown in January, and that good progress was reportedly being made in the US-China trade negotiations to avert higher tariffs and a full-blown trade war. This was particularly beneficial for the global growth outlook, especially for trade-dependent countries like China, Japan and South Korea, and helped push the US dollar stronger for the quarter against most other currencies (although not the yen).
In the UK, agreement was reached with the EU to extend the Brexit deadline into April, and PM Theresa May effectively lost control over determining a way forward, forced to hand over to Parliament. However, MPs rejected every possible option for structuring the future relationship, worsening the chaos within government. Meanwhile, UK GDP growth slowed to 1.4% (q/q annualised) in Q4 2018 from 1.6% previously, with the EU area equally pedestrian at 1.4% for the quarter. This deteriorating growth was a factor in keeping interest rates on hold across both regions, as well as in the US Fed's interest rate view. The European Central Bank even introduced a new cheap long-term loan plan for banks to help avoid further deceleration, as Germany's manufacturing data was negative for three months in a row.
During the quarter it was revealed that the Japanese economy returned to growth in Q4 2018 after a contraction in Q3, although exports remained sluggish amid trade uncertainty and the slowdown in Chinese growth. Japanese GDP is forecast to reach around 1.0% in 2019, supported by the Bank of Japan's ongoing easy monetary policy, but expected to be hit by a new consumption tax on spending and consumer prices to take effect later in 2019. In China, meanwhile, 2018 GDP growth came in at 6.6%, its weakest in 28 years but meeting consensus expectations. The government's new 2019 growth target is even lower at 6.0%-6.5%. There was, however, renewed optimism amid the positive US-China trade news; government pro-growth measures, including easier bank credit, took effect; and manufacturing activity accelerated - China's PMI recorded its highest rise since 2012.
South African assets were boosted over the quarter primarily by the easier global monetary outlook, recording gains across all asset classes. This mixed with some still-gloomy sentiment locally. The economy emerged with growth of 0.8% in 2018, slightly above expectations. Still, this was a very weak absolute growth level, and the SARB is now projecting only 1.3% GDP growth for 2019 (down from 1.7% previously), not including the negative impact of any ongoing electricity cuts. In some growth-positive news, retail sales growth recovered somewhat to 1.2% y/y in January from the shocking -1.6% y/y in December. The SARB decided to keep interest rates on hold at both its January and March MPC meetings, with the latest interest rate projection model showing only one 25bp rate hike this year. Finance Minister Tito Mboweni's February Budget was greeted favourably by most analysts, reinforcing the government's commitment to reining in the budget deficit and cutting spending, while also reforming and reducing wastage at the parastatals.
Moody's sovereign credit rating report was expected on 29 March. While many were pessimistic, Moody's final decision not to review the rating and leave it at investment grade with a stable outlook granted the country a big reprieve on the final trading day of the quarter. However, the SARB remains concerned about future inflationary pressures arising from the weaker rand, as well as higher costs from fuel and electricity, among other sources. Other worries for investors remained Eskom's generation capacity and the negative impact of load-shedding on growth in 2019, the land expropriation debate, nationalisation of the SARB, and last but not least, the upcoming May elections.
Despite US dollar strength, the rand lost only 0.5% versus the greenback, but 2.1% against the UK pound sterling, while gaining 1.3% against the euro, which was hit by growth concerns and more dovish interest rate expectations.
PERFORMANCE
The fund delivered a return of 9.4% (net of fees) for the first quarter of 2019, while the benchmark returned 5.8% over the same period. For the 12 months ended March 2019, the fund delivered a total return of 6.1% (net of fees), outperforming the benchmark by 5.1%. This is an exceptional result for the fund and investors alike, although this level of outperformance is unlikely to be repeated.
Our overweight exposure to Altron, Datatec and Old Mutual were significant contributors to the fund's relative outperformance (to its benchmark) over the last 12 months. We have patiently held Old Mutual through its managed separation (announced in early 2016), and it is pleasing that we have been rewarded with some 'unlock of value', albeit lower than what we would have initially expected.
Naspers, the largest holding in the fund, contributed positively to performance in the first quarter, partly aided by corporate restructuring which saw the company unbundle MultiChoice Group to its shareholders. The fund acquired further MultiChoice post the unbundling as our work suggested that the price at which MultiChoice initially traded (below R105 per share, presumably as offshore shareholders could not, or did not, want to receive the unbundled share price) was at a substantial discount to our valuation of the group.
The biggest contributor to relative performance in the first quarter came from our overweight position in British American Tobacco (BAT), which increased some 30%. This, to some extent, reversed the losses it inflicted on the fund in the fourth quarter of 2018, when BAT de-rated significantly in the face of a possible ban of menthol cigarettes in the US by a more aggressive FDA. We continued to hold BAT (and acquired more during Q4 2018) as we felt the valuation (with the dividend yield around 7% - 8%) suitably compensated us for the re-emergence of risks in the tobacco sector. Furthermore the market's fear that BAT would be forced to cut its dividend to address its debt load did not materialise - indeed the group increased its dividend with the release of its FY18 results in February.
One of the biggest detractors from performance in the first quarter was the fund's underweight position in BHP, which rallied over 20% given the sharp rise in the iron ore price. The latter in turn was driven higher by supply disruptions following the Brumadinho dam disaster in January, which saw the bursting of an iron ore tailings dam in Brazil operated by Vale. The disaster claimed over 200 lives and brought into question the continued use of upstream tailings dams. Vale, which was also involved in the 2015 Samarco dam failure, was rightly forced to close some of its iron ore operations that operate such dams. The fund did, however, benefit from overweight positions in Anglo American, African Rainbow Minerals and Exxaro that similarly benefited from a more buoyant iron ore market.
STRATEGY AND POSITIONING
At the time of writing, we still have no more clarity on Brexit (originally voted on by a 'misled' UK electorate back in June 2016). UK Prime Minister Theresa May appears to be running out of time. Variants of her proposed deal have been continually rejected by a majority parliament - while the EU's patience to facilitate a 'soft' exit is now wearing thin. An unplanned 'hard' exit poses risks to the South African equity market given that a large number of companies derive meaningful exposure from the UK. We would expect our overweight positions in Investec plc and Quilter plc to be particularly sensitive to the final Brexit outcome. At home, Eskom's load shedding has battered consumer and business confidence, while Eskom's debt problems pose the single biggest risk to the economy. As we head into elections we remain underweight many of the consumer-facing sectors of the market. The ANC is expected to win the upcoming elections, but a bigger challenge for the governing party and President Ramaphosa will be to navigate the Eskom 'tight rope'. On the one hand, the country desperately needs Eskom to return to financial and operational health but that will require graft and excessive remuneration at the parastatal to be reined in.