2019/06/10 00:00:00

Global Markets
MSCI developed markets experienced an exceptional quarter with a US Dollar return of 12.5%, outperforming emerging markets, which in turn also realised good absolute numbers of 9.9% year to date. After experiencing their worst December since 1931, global stocks posted their best January since 1987 and global equities had their second-best quarter on record. But the rally wasnft plain sailing with economic data releases surprising on the downside. Global growth is trending around the 3% mark, but the key question remains whether global growth has indeed bottomed at around trend levels.
The temporary ceasefire in the trade war and the postponement of the 25% tariff rate have provided the markets with some relief. The US Federal Reserve (Fed) joined the party with some dovish comments and markets now expect the Fed to cut rates both this year and the next, with only a modest rise in the US 10-year bond rate being anticipated. Finally, lower volatility provided a more favourable environment for risky assets.
Despite the S&P 500 Index posting its best start of the year in a decade, the inversion of the US yield curve at the end of the quarter put a damper on the initial bullish mood with concerns of a recession looming. The Fed will be using interest rates to target inflation, but Fed Chair Jerome Powell mentioned that the US was not at the neutral rate providing optimism that future hikes will be delayed. The Fed has effectively paused the federal funds rate at 2.5%, which is below the neutral level of 3%. This provided a boost to risk assets and weakened the greenback temporarily.
However, the possibility of a no-deal Brexit is also in the balance with another extension expected beyond the crucial 2 April vote. There is an increasing possibility that Britain will go for the customs union route (a so-called esoftf Brexit), but there remains the possibility of a referendum and an early election.
The Chinese economy continues to experience a soft landing with growth expected to be in the 6.0-6.5% p.a. range in the year to come, the slowest growth rate in three decades. The Chinese are stimulating their economy further with tax cuts . the latest measure to be implemented . and at the end of March the manufacturing PMI surprised on the upside with the biggest month-on-month increase since 2012.
Some key risk that remains for 2019 is that the tailwind of quantitative easing is turning into the headwind of quantitative tapering. Net purchases by central banks were running at $23 billion per month and could turn negative this year, especially in the case of the Fed. This is likely to add to the uncertainty and volatility during the course of the year. While inflation in the developed world remains contained with US inflation below 2.5% p.a., the pickup in wage growth is a concern (from 1.5% to 2.5% p.a.) in the US. But it is noteworthy that there is no inflation pressure in Europe and Japan.
The International Monetary Fund (IMF) is forecasting a slowdown in the US this year with the rest of world growth stabilising. The risk remains that the Fed may still tighten rates further. However, the risk of a recession remains low in our opinion.
Local Markets
In the past decade economic growth has been hampered structurally by poor productivity. The SA Reserve Bank (SARB) leading indicator has started pointing downwards due to low manufacturing confidence and orders. Manufacturing confidence and orders have remained low for 10 years with the latest data showinga deepening contraction. We expect, nonetheless, a mild recovery from the GDP shock suffered in the first half of 2018, which is partly linked to weakening terms of trade and a weaker exchange rate (PPP Rand/Dollar being closer to 13) to shift our growth rate back towards a tepid 1.4% run rate (structurally we remain stuck below 2%).
South Africa is experiencing a steep yield curve, which would suggest that the economy should be improving. But the poor fiscal position has meant that the government has crowded out the private sector. This, in part, explains the low rate of credit growth at a sub-par 6% p.a. South Africa needs the private sector to invest but the return on investment remains too low. We do, however, expect a rebound in agricultural production to boost growth.
A key risk remains Eskom with the electricity availability factor dropping to 65% at the beginning of the year, leading to stage four load shedding. This has already negatively impacted manufacturing output. In the National Budget government committed to provide some R69 billion of support to Eskom over the next three years, partly allaying short-term fears given its balance sheet hole of some R200 billion.
At the end of the quarter, Moody's also gave us a stay of execution postponing the release of its credit review until after the elections.
The JSE had a solid quarter with the FTSE/JSE Capped Shareholder Weighted Index (Capped SWIX) posting a return of about 3.85% (FTSE/JSE All Share Index (ALSI) return 7.97%) for the quarter, but is still staying in negative territory for the past 12 months. The market has rewarded businesses that have been stable and focused on organic growth while businesses that have been acquisitive and laden with debt have been punished. We are in an environment where there is a serious risk that liquidity will be withdrawn by central banks. Businesses which were very acquisitive and funded these acquisitions with debt have been at the mercy of the economic slowdown, which contributed to poor returns.
On a sectoral basis resources stocks were the stars of the JSE once again, up close to 18% this quarter. Platinum stocks continued to shine bright, up close to 50% aided by rising basket prices and the benefit of good cost management over the past few years. Financial stocks were flat this quarter with credit growth being very weak and corporate credit growth dipping below household credit growth for the first time in almost a decade. Industrial stocks posted solid returns, up close to 9% this quarter, a welcome difference to the recent past.
Portfolio performance, attribution and strategy
On the factor front globally, the year-to-date numbers are mixed. Quality, Low Volatility and Growth were the big winners with both Momentum and Value underperforming. The least surprising of these was Momentum, which tends to lag during major market reversals like the one we saw in the first quarter. The performance pattern of Value versus everything else has re-emerged and one that has been present more often than not since the Global Financial Crisis. This implies that investors globally are cautious on the economic outlook and will continue to tilt towards defensive styles, or putting it another way, there are significant headwinds for Value performance. The troubles with Value have flummoxed quant managers in general, most of whom try to exploit the Value anomaly in some capacity despite the belief that the factor should provide positive returns over the long run.
After Value signals domestically delivered an overall strong 2018 performance, the factor once again delivered some positive outcomes during the first quarter. Surprisingly, there was broad consistency between the sub-Value factors, as Price to Book, Price to Earnings, Price to Cash and Dividend Yield all showed pleasantly positive return spreads. This can almost be seen as anomalous given the often disparate spread across the Value family, but also reflects cyclical recovery being experienced domestically.
Unfortunately, the positive Value signal was - as sometimes happens - overwhelmed by a single stock selection misfortune. Due to the filtering approached used to select the top 30 stocks in the universe with the highest forward dividend yields, often large stocks can be screened out. This was the case with Naspers where the fund has zero exposure. The company announced a potentially value-unlocking corporate action and thus detracted from relative performance. This, coupled with the high beta nature of the stocks during a recovery, hurt the strategy significantly. Outside of Naspers, the strategy did well to add value through exposure to Kumba Iron Ore, Telkom, African Rainbow Minerals, BHP Group and Exxaro.
The fund’s positioning remains heavily overweight Resources relative to the FTSE/JSE Shareholder Weighted Index (SWIX) despite the market leadership in Resources over the recent period. In terms of constituent changes, the following stocks were added: Pioneer Foods and Old Mutual, while the following stocks were deleted: Coronation Fund Managers and Sasol.