Sanlam Select Optimised Equity comment - Mar 19
The MSCI World Index outperformed frontier and emerging markets in March, posting a US Dollar total return of +1.4% versus +1.2% for the MSCI Frontier Markets (FM) Index and +0.9% for the MSCI Emerging Markets (EM) Index. All the MSCI World regions recorded positive total returns in March: North America (+1.7%), Pacific (+0.8%) and Europe (+0.7%). Within EM, MSCI Asia outperformed with a total return of +1.8% in March. India returned +9.2%, followed by China (+2.4%). South Korea (-3%) and Malaysia (-2.8%) were the worst performers within the Asian region. MSCI Europe, Middle East & Africa (EMEA) and MSCI Latin America underperformed, posting total returns of -1.3% and -2.5% respectively. MSCI Turkey (-14.8%) was the worst performer within MSCI EMEA (and MSCI EM). MSCI South Africa shed -1.6% in March in US Dollar terms as the Rand weakened. Chile (-4.4%) and Brazil (-3.8%) were the worst performers within MSCI Latin America.In March, Real Estate was the top performing equity sector within both MSCI World and MSCI EM. This was followed by Consumer Staples and IT within MSCI World, and Communication Services and Consumer Discretionary within MSCI EM. Financials was the worst performing sector within MSCI World, while Industrials was the worst performer within MSCI EM in March.
Within MSCI SA, Energy (Exxaro), Consumer Discretionary (Naspers) and Communication Services (MC Group, MTN) posted solid US Dollar total returns. Health Care (Aspen, Netcare) and Industrials (Bidvest) were the worst performing sectors in March.
Year to date, MSCI World has provided a US Dollar total return of +12.6%, as the S&P 500 Index posted its best quarterly return in a decade, and the Russell 2000 Index its best quarter since 2011. All amid hopes of a trade deal between the US and China, an overly dovish Federal Reserve (Fed), which has changed its outlook to no more rate hikes this year (from the prior view of two), strong quarterly earnings results and buying momentum after the December stock swoon. Emerging markets returned +10% in US Dollars since the beginning of the year. The relative underperformance of EM comes as money continues to leave emerging markets and go back to developed markets, as the Dollar refuses to weaken. Emerging markets have been unchanged since the beginning of February and has now underperformed the S&P 500 by 3.5% since the start of the year. Year to date, EM Asia returned +11.1%, boosted by the strong performance from China (+17.7%), while Latin America returned +7.9%, boosted by Brazil (+8.2%). Within EMEA (+5.6%), the best country performance has come from Egypt (+15.9%), Greece (+12.8%) and Russia (+12.2%) while MSCI South Africa returned +4.6%. Turkey (-3%) is one of only three emerging market countries to post negative total returns in the year to date.
The Rand had another volatile month, ending March -3.1% lower against the US Dollar. Across asset classes, the Citigroup Investment-Grade Bond Index yielded a total return of +1.3%, as the Fed announced a pause in its hiking cycle. Meanwhile, South African bonds lost ground on an absolute and a relative basis: in US Dollar terms with SA 10-year bonds falling -1.2%. Commodity correlations moved away from their long-term norms over the past month, ith metals in particular shrugging off lacklustre underlying demand. Bulk and base metals strengthened, with iron ore prices closing in on US$100/ton, boosted by supply disruptions in Brazil and Australia. Within precious metals, palladium saw a stellar rise to close to US$1 600/oz before spectacularly collapsing by about 20% just before the month end. Oil prices also continued to firm, jumping over 30% the first three months of the year, posting the best return in a decade. In South Africa, March 2019 was a particularly eventful month: Eskom implemented load shedding stage 4 for nine days in a row, severely hampering economic growth, while the SA Reserve Bank (SARB) left interest rates unchanged as expected, and the anxiously awaited Moody's announcement at the end of the month ended with a positive 'no-change' message to the market, preserving South Africa's investment-grade rating. In Rand terms, the South African equity market as represented by the FTSE/JSE Shareholder Weighted Index (SWIX) continued to show positive performance for the fourth consecutive month in March of +1.2%. This gain was driven by the +2.3% total return from the Large Cap stocks. Mid-Caps and Small Caps shed -1.8% and -2.7% respectively. Bonds as represented by the FTSE/JSE All Bond Index (ALBI) underperformed versus equities, with a total return of +1.3%. The FTSE/JSE SA Listed Property Index (SAPY) showed the largest underperformance, shedding -1.5% in March.
In South Africa, March 2019 was a particularly eventful month: Eskom implemented load shedding stage 4 for nine days in a row, severely hampering economic growth, while the SA Reserve Bank (SARB) left interest rates unchanged as expected, and the anxiously awaited Moody's announcement at the end of the month ended with a positive 'no-change' message to the market, preserving South Africa's investment-grade rating.
In Rand terms, the South African equity market as represented by the FTSE/JSE Shareholder Weighted Index (SWIX) continued to show positive performance for the fourth consecutive month in March of +1.2%. This gain was driven by the +2.3% total return from the Large Cap stocks. Mid-Caps and Small Caps shed -1.8% and -2.7% respectively. Bonds as represented by the FTSE/JSE All Bond Index (ALBI) underperformed versus equities, with a total return of +1.3%. The FTSE/JSE SA Listed Property Index (SAPY) showed the largest underperformance, shedding -1.5% in March.
SA Resources again posted the best performance in March with a total return of +4.4%. This was on the back of a solid performance by Industrial Metals (+19.2%). General Mining returned +7.5%, and Chemicals returned +5.3% in March. Following three months of solid total return performance, Gold Mining shed -4.5%, while Forestry & Paper lost -4% over the month. SA Industrials posted a total return of +2.9% in March. Of the industry groups, Technology was the best performer with a total return of +9.3% (note that as of 1 March, Naspers was reclassified from Media to Software & Computers). Telecommunications returned +5%, with MTN posting a total return of +10% and Telkom a total return of +4.1%. Consumer Goods gained +1.8% in March with Tobacco returning (+18.7%) and Beverages (+10%). Health Care (-14.1%) was the worst performing industry group as Aspen lost -33.3% following their results. Industrials showed a loss of -5.3% in March with General Industrials shedding -5.9% and Construction & Materials shedding -5.7%. General Retailers were -5.3% lower while Media (MC Group, which was unbundled from Naspers during the month) gained +14.9%.
SA Financials lost -4% in March as negative sentiment around the Eskom load shedding and preceding the Moody's announcement at the end of the month led to a sell-off in the Rand and bond market. The worst performance in Financials came from Banks (-6%) and Life Insurance (-4.9%).
Year to date, the FTSE/JSE All Share Index (ALSI) has posted a total return of +8% versus total returns of +3.8% for the ALBI and +1.5% for the SAPY. SA Resources and SA Industrials have gained 17.8% and 7.4% respectively. SA Financials have been flat (-0.4%).Of the industry groups, the largest year-to-date outperformance versus the ALSI has come from Basic Materials (+18%) (Industrial Metals +54.9%, Platinum +49.7%, General Mining +22.4%) and Consumer Goods (+12.4%) (Tobacco +29.5%, Beverages +24.8%). The largest underperformance has come from Health Care (-12.7%) and Industrials (-3.9%).
The Optimised Equity Fund outperformed strongly during the month, with top positive contributions coming from overweight positions in British American Tobacco, BHP, Anglo American, AB InBev and the fund's offshore exposure, while substantial underweight positions in Aspen, Nedbank, Remgro and Discovery also added strongly. Detractors included the structural underweight holding in Naspers given the risk of its outsized weighting in the index, the fund's exposure to financials and mid-caps, as well as the underweight positions in Sasol, whose rise on the back of a stronger oil price was captured through exposure to BHP in particular.
What to expect going forward? Globally, it seems that the outlook for economic growth, while slowing, is not precarious as yet, while pockets of weakness, such as Europe, or concerns, such as China, need to be watched. Much will depend on the conclusion of a US?China trade deal and it looks likely that some form of deal will be announced, not the least because both parties need a deal: China needs to stem a structural slowdown, while the US will be heading into elections, with the Trump administration eager to use a deal in electioneering. While a US?China trade deal will be a relief for markets globally, it is worth pointing out that the ramifications for global trade are still murky: the potential deal being a bilateral agreement between the two largest economies globally, implications for third-party suppliers or marketshare losses in other large economies like Europe (Germany) or developed Asia (South Korea, Japan), are not easy to forecast, and could provide ample reason for further volatility.
The recent inversion of the US yield curve provided further reason for market nervousness, as an inversion usually heralds a recession following 12 to18 months later. While markets usually still rise strongly during that period, concerns about stock valuations and earnings delivery in the US in particular, keeps investors sceptical and hesitant to commit funds at this stage of the cycle. This keeps the current environment volatile as investors reluctantly 'climb the wall of worry' and put more money to work. Here in South Africa, following the positive Moody's decision, we see two key risk events until the end of the year: first will obviously be the parliamentary elections on 8 May and, until then, much electioneering-related news might keep markets relatively thinly traded and volatile. As mentioned before, while the market seems to have priced in an ANC victory of at least 55% ? with a lower number possibly leading to a selloff - most election outcomes should lead to some form of certainty and stability, something craved by consumers and businesses alike, in order to commit to investments and growth. A recent statistic showed that household deposits at banks are close to all-time highs as a percentage of GDP at 23% at the end of 2018, highlighting the potential for consumer spending, which in turn could lead to heightened business activity, as inventories and capex are at multiyear lows. The second risk is less precise around a date, but rather lies around the steps taken to solve the Eskom crisis. The challenges to prevent further load shedding and optimise the current assets operationally have to be seen in conjunction with the large potential fiscal and credit implications from financing the improvements at the SOE. A large part of creating sustainable economic growth going forward will depend on how this challenge is going to be tackled and markets will be watching closely.
Our view of the above is that we are likely to see some form of a US?China trade deal announced soon, and that markets are likely to squeeze higher on the back of positioning and improving earnings revision ratios again. We also believe that any recession fears at this stage are overdone and priced in too quickly as well, since equity markets typically lead recessions by between six to 12 months, and there is no sign of that as yet. Other indicators such as high-yield corporate spreads, PMIs, wage growth, unemployment, volatility and house prices are not yet moving into worrisome territory. A slowdown in global growth will likely occur into 2019 but recession fears may be pre-emptive for now.
In addition, central banks have turned distinctly dovish, which will probably support a growth rebound in the second half of 2019, which will also support equity markets. In South Africa, the potential is for an upside surprise in markets, given overall negative sentiment, growth expectations and positioning. With all of that, the fund remains constructively positioned, as we continue to believe that the latecycle bull market is still intact, while a balance remains to cater for expected higher volatility levels globally, and here in SA, particularly driven by currency movements.