Sanlam Select Managed coment - Mar 19
Markets stayed firm in March, buoyed by dovish monetary policy in the US as the US Federal Reserve kept policy rates unchanged and ongoing stimulus measures in China. As a result, first-quarter returns from almost every asset class were strong, including equities, bonds (especially developed market bonds) and commodities – a complete reversal from the dire fourth quarter of 2018.
However, the outlook is not all rosy. US company earnings growth has slowed from the high rates of 2018, when tax cuts provided a boost. Together with peak-cycle employment levels, markets have thus remained somewhat watchful and nervous. The inversion of the three-month/10-year US yield curve during the month of March is a predictor of slower growth and possible recession ahead. Political developments have also remained unsettling. Optimism over resolution of US? Chinese trade tensions has not yet resulted in final agreement, while UK Brexit and European tensions remain high. We have also seen renewed volatility in Turkey and Venezuela.
Domestic economic growth conditions remain lacklustre, exacerbated by low confidence ahead of the May elections as well as recent severe load shedding by Eskom – unstable power supply has a negative impact on economic activity as well as sentiment. Consumer confidence and household consumption also remain constrained by low employment growth, electricity price hikes and higher petrol prices. Softer growth conditions were recognised by the South African Reserve Bank (SARB) in their March Monetary Policy Committee meeting, where they downgraded GDP forecasts to average 1.3% in 2019, 1.8% in 2020 and 2% in 2021. The SARB’s inflation forecast was broadly unchanged from their January meeting and remains comfortably within their target range. Inflation expectations also reflected a notable improvement of 4.8% for 2019 and 5.2% for 2020, with average five-year expectations falling to 5.1% – the lowest level since they were first surveyed in 2011. The combination of all of these factors allowed for a more dovish tone in the statement, with a unanimous vote to keep the repo rate at 6.75%, and resulted in the market pricing in unchanged interest rates across the short end of the curve. All of the above kept our bond yields and the Rand under pressure, and led to SA domestic equities and banks selling off.
The domestic bond market spent much of March trading with a nervous tone in anticipation of the Moody’s rating update scheduled for the end of the month. In the end, there was no action taken by Moody’s, which prompted a relief rally across the curve. Although a Moody’s review committee wasn’t convened, a credit opinion released by the lead analyst for SA was released in early April, and did provide support for market sentiment, as reflected in a stronger SA credit default swap spread, and lower domestic bond yields. We are, however, aware that a formal review meeting could hold differing views to those held by the lead analyst, and we will be conscious not to become complacent about potential ratings outlook risk in the coming months.
The Tantalum funds enjoyed another strong month, with good returns being posted by our large holding in British American Tobacco (good recent results, plus a positive development pipeline presented at their Capital Markets Day in London, which we attended), as well as from Northam, Naspers and Sasol. Detractors from performance were mainly Aspen, which had a torrid time after weak results, as well as our (reduced) bank share holdings and Blue Label Telecoms. The portfolio benefited from exposure to nominal bonds across the belly and long part of the curve. Credit enhancement further positively contributed to returns. Exposure to inflation-linked bonds marginally detracted from returns. Weakness in UK property was compounded by depreciation of the Pound as the UK’s exit of the European Union remains unresolved post 29 March 2019 (the original ‘leave’ date).
We feel that yields fairly reflect dynamics in the bond market at present, and are comfortable with our current duration positioning. The curve remains steep, with long-dated yields still remaining attractive (at around 9.5%), and we would look for stronger market levels before reducing portfolio duration risk. We continue to find short-dated inflation-linked bond yields attractive, as well as select credit enhancement and structured note opportunities in the 0-3-year area of the curve. We have found shorter-dated credit opportunities to be more attractive at this point in the credit cycle and remain disciplined in our fair value estimation in a (still) weak economic environment.