Sanlam Select Strategic Income comment - Jun 19
Global While there is, on average, 4 400 hours in every half year, the pace, intensity, and effort required to manoeuvre this most recent set of hours (I have done a few sets…) seem slightly out of sample relative to norm. It is almost impossible to imagine that global markets have experienced its best first half in a decade given the hurdles that keep hurtling its way, none more so than in the form of Donald Trump. It is therefore appropriate that we end the first half with Trump news, this time in the form of G20 feedback. Analysts describe it as an uncertain pause - no immediate escalation, but still no clear path towards a comprehensive deal. One thing we can be sure of, Twitter will be busy in the coming days/weeks once more.
US stocks are up between 15-20% year to date, European stocks similar, and most Asian markets slightly less, but also well in the black. US$11 trillion developed market bonds are trading sub 0%. US Treasury yields dipped below 2% for the first time since late 2016 (while the S&P 500 is within a whisker of the magical 3 000 level - a far cry from the mid-600s late 2008).
Clearly markets will welcome any sign of a truce, but downside risks remain - Trump has made his intentions towards India, Europe and other nations clear. And if there is one thing we know about downside risks, especially where sentiment is concerned, it is that sometimes the impact on sentiment souring can be non-linear. This is probably why central banks are trying to pre-empt a souring of corporate and consumer sentiment, with all eyes focused on the US Federal Reserve (Fed) and European Central Bank (ECB) this month (or at least markets appear to be forcing central banks to pre-empt such souring). Incoming PMI data continues to surprise to the downside, with US ISM and employment data likely to dictate whether the market's 'demand' for at least a 25-basis point (bps) rate cut ('fast money' traders baying for a 50-bps cut) comes to fruition.
From a macro data perspective, the global capex cycle has slowed down significantly. Capital goods imports have dropped hard (in July 2018 they were tracking at 18% year-on-year (y/y) on a three-month moving average basis, but plummeted to 2% y/y in January 2019 and an estimated -3% y/y in May 2019), while private fixed capital formation in the G4 and BRIC economies fell from a peak of 4.7% y/y in 1Q18 to just 2.8% y/y in 1Q19.
Corporate sentiment has also declined to multi-year lows. Global PMIs for May fell in broad-based fashion (June data even softer, with about two-thirds of countries tracked reporting a PMI below the 50-expansion threshold). Crucially, consumer sentiment is also starting to sour, with the Conference Board's Consumer Confidence Index for June falling to the lowest point since September 2017. Interestingly, the Citi Economic Surprise Index for most major economies, as well as the composites for DM and EM, is trading close to multi-year lows. So, none of the above should be a major surprise.
Any sign of tightening financial conditions will concern central bankers. Given higher corporate leverage, particularly for companies with weaker balance sheets, defaults could accelerate, bringing corporate credit risks to the fore. These in turn lead to impaired lending and exacerbate the negative feedback loop to even weaker confidence, which lowers growth.
From a global perspective the only certainty in the short term is probably further trade policy uncertainty, which is expected to continue to weigh on economic prospects. It will be interesting to see if markets can continue to trade at elevated levels in anticipation of monetary and in some instances even fiscal support. Evidence indicates that risk markets are trading well ahead of what flow indicators will imply (some reports indicating some markets are at three-year highs based on this indicator).
Local Pretty volatile conditions were experienced in June, with markets allowed no time to settle post a draining National Election campaign, nervously awaiting Cabinet reshuffling, parliamentary committee announcements, news around Eskom support, detail from the second State of the Nation Address (SONA) of 2019 and finally G20 headlines - all in a month's work.
30-year bonds sold off (and rallied) 20-30 bps twice this past month (the R2048 sold off 35 bps between 4 and 7 June, rallied to 9.68% by 20 June, sold off back to 10% on 25 June, only to end the month below 9.70% again), impacting liquidity markedly. A further compression of global risk-free rates also brings into question views around fair value and what is currently priced in with regards to sovereign risk. (The five-year credit default swap, in anticipation of at least a rating outlook change to negative to end-2018, traded to a peak of 260, rallying to a low of 170 into the second round of Ramaphoria in early February, only to sell off once more to an intra-day worst level of 220 post a weaker than expected National Budget and ahead of the March Moody's review, but have subsequently at the time of writing rallied almost 60 points from these levels to trade at 162.)
If we were to score June on a scale of 0 to 10 from a local political perspective, we would be hard pressed to go beyond a 5. SONA was uninspiring, long, repetitive and for once I agree with the EFF in that we are not paying people to dream (our 3Q19 Scenarios even borrow from the SONA speech for its three scenario titles - our muddle-through title 'It's time to make choices' (who hasn't heard that one before from politicians, right?!); our bull case 'I choose to dream'; and our bear case 'Confronted by severe challenges').
Importantly, key committee appointments have gone to opponents of Ramaphosa's proposed reforms, with more than a few highly tainted individuals back in the mix.
Disappointingly we still await details on the front-loaded state support for Eskom - it seems lost on politicians that markets see a material difference between 'imminent' and 'about three months' with the likes of Pravin Gordhan and even the President guilty of interchanging between these timelines way too often. While we received further confirmation that the South African Reserve Bank's independence is nonnegotiable, noises around this issue just refuse to die down, with the latest comments from Gwede Mantashe raising concerns about the motives of some individuals.
Despite recent negative developments in domestic politics, the global backdrop continues to be the main driver of risk appetite and South African assets continue to benefit from global tailwinds (I know, an ironic word choice given macro data and political headwinds - but the irony is meant to be just that). From a local perspective, the government's ability to execute on the reform agenda remains key to any turnaround expectations, which remains questionable in the near-term.
Regarding the global backdrop - as well as global investor views on EM, and South Africa in general - the consensus view among many real money investors appears to be that duration is great to own, given the dovish Fed and slower global growth. But emerging market FX could be the shock absorber should trade tensions escalate. Therefore investors seem to tend to be overweight duration and underweight emerging market FX exposure in their GBI-EM portfolios.
Given volatility over the month tactical trading was required, with the fund the beneficiary of sound risk management processes across the balance of our business, while further gains were also derived from our long-held views on the progression of the monetary policy environment. Listed property continues to disappoint
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