Sanlam Select Optimised Equity comment - Jun 19
Global equity markets rebounded in June, with the MSCI World Index posting a US Dollar total return of +6.6%. All the MSCI World regions recorded positive total returns in June: North America +7.0%, Europe +6.8%, and Pacific +4.7%. In the US, the Dow Jones finished its best June since 1938.
MSCI Emerging Markets recorded a total return of +6.3%, while MSCI Frontier Markets only managed a return of +2.4%. Within Emerging Markets, MSCI Asia (+6.4%) was the best performing region, boosted by robust performance from South Korea (+8.9%) and China (+8.1%). MSCI EMEA gained +5.9% in June, with the largest outperformance coming from Russia (+9%). MSCI South Africa (+6.3%) was the fifth best performing country within this region. In commodities, the US-Iran standoff and falling American stockpiles have propelled oil towards its biggest monthly gain since January ahead of the OPEC meeting in July. Bullion rocketed to a six-year high and prices are holding above US$1 400 an ounce. Gold prices have climbed by 8% in June, their best return in many years, driven by global economic uncertainty and the US Dollar.
For the second quarter of 2019, MSCI World recorded a US Dollar total return of +4.2% (+12.6% in 1Q19), outperforming MSCI Emerging Markets (+0.7% in 2Q19 vs +10% in 1Q19). MSCI South Africa (+6.8%) outperformed both MSCI World and MSCI Emerging Markets in Q219. For the first half of 2019, MSCI World delivered a total return of +17.4%, outperforming MSCI Frontier Markets (+12.1%) and MSCI Emerging Markets (+10.8%). Within MSCI World, North America was the best performing region with a return of +18.9%, followed by Europe's 16.5% and the Pacific region's +11.3%. In fact, the S&P 500 Index posted its best first half in 22 years as a banner June followed a dismal May. The S&P ended 2Q19 up +3.8% and has risen +17% in 2019.
Within MSCI Emerging Markets, most countries posted positive US Dollar total returns in the first half of 2019, with Russia (+31.6%) the best performing country among the major markets and Brazil (+16%) and China (+13.1%) also strong. MSCI South Africa returned +11.7% during the period. All equity sectors within MSCI World delivered positive US Dollar total returns in the first half of 2019, with the best performance coming from IT, Industrials and Consumer Discretionary. Consumer Discretionary, Real Estate and Energy were the top performing sectors within EM. Within MSCI South Africa, Communication Services and Energy outperformed, while Health Care and Industrials posted negative US Dollar total returns. In Rand terms, SA equities staged a recovery in June with the All Share Index recouping its losses of May with a Rand total return of +4.8%, its best monthly performance since April 2018. Blue-chip large cap stocks delivered the best performance, gaining +5.3%, while mid-caps were up +2.5%. Small caps posted a loss over the month, albeit only -0.2%. The All Bond and SA Listed Property indices each returned +2.2% in June.
SA Resources delivered a solid total return of +10.2%, driven by Gold Mining (+24.5%) and Platinum (+14.8%). SA Industrials remained steady, returning +3.8% in June. Healthy total return performance came from Personal Goods (+12.3%), Media (+9.9%), Beverages (+4.6%) and Software (+4.4%). SA Financials managed to eke out a total return of +1.3% in June. Real Estate Development & Services returned +3.9%, followed by General Financials (+3.2%). The worst performance came from Equity Investments (-1.4%).
In the above described quite volatile environment, the Optimised Equity Fund outperformed its benchmark during June, with positive contributions coming from a variety of alpha sources, including overweight and underweight exposures, global and domestic stocks as well as large caps and small caps, all highlighting a diversification of risk. Main detractors included the structural underweight exposure to Naspers for risk management reasons, given its outsized weight in the index. An underweight position in Richemont, which is deemed expensive, and overweight positions in Standard Bank and SPAR Group also dampened performance.
With the first half of 2019 now gone, many of the issues concerning markets at the beginning of the year are still lingering, either in the same form or in just slightly different guises: US-China trade tensions, monetary policy outlook by central banks, Brexit, geopolitical risks, particularly in the Middle East. And while here in South Africa successful parliamentary elections took place at the beginning of May, investors, business and consumers alike still have to see detail and implementation of some of the ambitious reforms and policies announced by the government, not least addressing the financial malaise of the parastatals, including Eskom.
The just announced resumption of trade negotiations by US President Trump and China's President Xi at the G20 meeting, does not feel like a move towards a convincing solution in the US-China trade spat. While it is clear that both countries can do with a temporary reprieve - the former for political, the latter for economic reasons - the real battle is, in our view, not about trade, but about global political systems and structures, with China challenging the US's position as the ultimate super power. This battle is likely to last for years, if not decades to come, and will be particularly prevalent in the technology sector, given its increasing importance, not only in an economic but also a military sense. The sanctions imposed by the US on Chinese companies like ZTE and Huawei are not a coincidence, and any reprieve granted, like now in the case of Huawei at the G20 meeting, is likely to be temporary and will be replaced by other sanctions going forward.
Indeed, notwithstanding the resumption of talks, scope remains for re-escalation to emerge. Tracking how the talks evolve from here, and in particular the critical issues related to speed of tariff removal, non-tariff barriers, intellectual property rights and amount of purchases, will be key. Should we see re-escalation (i.e. the US imposes 25% tariffs on the remaining US$300 billion of imports from China and they remain in effect for four to six months), it would heighten the risks to the global cycle, and we could wind up in a global recession in about three quarters.
Heading into the meeting, it was clear that the global capex cycle had ground to a halt. Capital goods imports, a capex proxy, began their descent in mid-2018, when trade tensions first re-emerged. In July 2018, they were tracking at 18%Y on a three-month moving average basis but plummeted to 2%Y in January 2019 and an estimated -3%Y in May 2019. In aggregate, private fixed-capital formation (investments in fixed assets) in the G4 and BRIC economies fell from a peak of 4.7%Y in 1Q18 to just 2.8%Y in 1Q19.
Given the trade tensions between the two largest economies globally, central banks have turned markedly more dovish during the first half of this year, basically providing a 'put' to global markets. Across the G20, six central banks have loosened monetary policy either by cutting policy rate; announcing a more accommodative outlook for the balance sheet; easing the forward guidance; or using other alternative tools. Consequently, each individual central bank easing increases the likelihood of a global cascade of tit-for-tat easing. It is doubtful this will do much for the economy - but it could well trigger a renewed boom in asset prices.
With global money supply about to hit a fresh record high, the direction of the Dollar will thus be crucial for emerging and global risk markets. Although headlines from the trade war are likely to impact the market in the short term, the medium-term direction continues to be dictated by the provision of liquidity.
These easing efforts will impact the economy with lagged effects. Policy easing is necessary but won't be sufficient to revive corporate confidence and engineer a strong pick-up in growth. That would require a combination of monetary easing and an all-clear signal on both trade policy and geopolitics.
As mentioned before, for South Africa, the key ingredient will be the speedy implementation and successful execution of economic reform programmes and policies to create growth and thus instil confidence in consumers, business and investors. The next three to six months will be crucial here, in particular dealing with the financial situations at Eskom and the SOEs in general, notwithstanding widely anticipated cuts in interest rates by the South African Reserve Bank due to benign inflationary data and a benign global rate environment. Given the slow-growth environment, South African stock market valuations are not cheap anymore, with further risks to earnings rising. Further risks to the SA stock market are its dwindling weighting in global indices, reducing from >12% to about 6% currently in the MSCI Emerging Markets Index, with further downside to come as other markets get included (China, Saudi Arabia, Argentina, Kuwait). Unless economic growth filters through to our stock market, incentives for foreigners to buy our market and move away from their current underweight position in their portfolios, reduce even more, potentially rendering the SA market irrelevant to global investors in a worst-case scenario. The upshot is that if government reforms lead to growth, SA could become one of the few countries in the world with accelerating economic variables, thus attracting foreign flows and helping the economy along further.
Overall, as mentioned before, our base-case scenario has been that we are in a global 'soft patch' of the economy, where economic indicators are low enough as to not lead to inflation, giving central banks room to keep interest rates low and thus extending the maturing cycle, while trade wars are putting a spanner in the works. Those two opposing forces are likely to continue to create volatile markets, where successful stock picking and a robust portfolio construction framework will be key to deliver good returns.
The 'Optimised' approach refers to the investment style which will incorporate global best techniques in the investment risk management framework. These risk budgeting methods may be quantitatively implemented however the selection process is still based on fundamental research. The Fund aims to consistently add incremental alpha above the FTSE/JSE Shareholder Weighted Index. The Fund may hold offshore equity. The investment manager will also be allowed to invest in listed and unlisted financial Instruments as allowed by the Act from time to time in order to achieve its investment objective.