Sanlam Select Defensive Bal comment - Mar 19
South Africa’s own goals continued in March as power rationing intensified, macro data weakened further, President Ramaphosa committed to nationalising the South African Reserve Bank (SARB), and the ANC submitted a less-than-wholesome party list for the 8 May general elections.
Operational challenges, diesel shortages, and lower power imports due to Cyclone Idai in Mozambique triggered Stage 4 load shedding mid-month. This, in turn, dampened confidence, evident in the BER Business Confidence Index falling further. Our GDP tracker points to a contraction in 1Q19, which could weigh on SA asset prices given concern about implications for tax revenues. SARS has already confirmed a R14.6 billion tax revenue shortfall for FY19.
Inflation remains contained, printing at 4.1% in February, with a notable moderation in inflation expectations – five-year expectations fell to 5.1% in 1Q19. This, alongside a less hawkish US Federal Reserve (Fed), allowed the SARB to move to a neutral stance in its March meeting, which resulted in a unanimous decision to keep the repo rate unchanged at 6.75%.
Turkey once again showed itself as the lightning rod in emerging markets with the Lira suffering another bout of volatility as falling reserves and more evidence of domestic Dollar-hoarding spooked investors. While the Rand temporarily suffered from Turkey contagion, the weakness was short-lived as the currency and bonds benefited from Moody’s decision not to review the credit rating (Baa3/stable outlook). While this ‘skip’ has not quelled ratings fears, it has bought SA assets more time to benefit from the recovery in risk appetite. The Fed’s dot plot almost flatlined in March as the median shifted to only one hike, in 2020. Moreover, quantitative tightening will end in September, and there is a high probability that substantial Treasury purchases will resume from 1Q20. Data out of Germany remain disappointing, but China is turning a corner. However, downside risks remain elevated with the delay in Brexit and the US/China trade deal. The US 10-year/three-month yield spread inverted briefly in March, with many believing this is confirmation of the coming recession.
While the end may be near, this is probably only the beginning of the end of the US expansion. For SA, this is but only the end of the beginning of the leadership transition. All eyes will be on the 8 May elections as a gauge of structural reform, even if we know that reform is tough to implement, particularly with low growth and a divided party.
Strong global risk appetite kept local equities (1.6%) in the lead for March’s asset class performance. Bonds (1.3%), fixed-rate credit (1.2%), and floating-rate credit (0.9%) outperformed cash (0.6%), while inflation-linked bonds (-0.8%) and listed property (-1.5%) were relative laggards.
The Dollar’s resilience continued, gaining 1.2% versus developed market majors and 2% against emerging market currencies. The Rand was a slight underperformer, losing 3% against the Dollar due to load shedding and ratings risk. Even so, the Rand/Dollar exchange rate remains in line with our 14.00-14.50 fairvalue range.
Confirmation of the end of quantitative tightening and the paring of growth expectations pushed the US 10-year yield to below 2.40%. Again, SA-specific issues – load shedding and the Moody’s review – ensured that local rates lagged the decline in global yields. Foreigners remained modest net sellers of SA bonds (R1.3 billion) in March. At 9%, bonds are fairly priced relative to our 8.60-9.10% fairvalue range.
The dovish Fed and signs of a nascent recovery in global trade activity boosted equity markets further in March. The S&P 500 Index gained 1.8%, the Eurostoxx 50 rose by 2.1%, and the Shanghai Composite jumped by 5.1%. The MSCI South Africa Index (USD) lost 2.1% in March, underperforming the modest gain in the MSCI World (1%) and MSCI Emerging Markets (0.7%) indices. The FTSE/JSE All Share Index (ALSI) rose by 0.8% in March, with varying underlying sector performances. The weaker Rand and higher industrial commodity prices supported resources (3.7%), while the surge in Naspers boosted the technology sector (9.3%). Consumer-related sectors were under pressure with consumer services (-3%) suffering from Rand weakness and SA pessimism, while financials (-4%) were impacted by the weaker Rand, ratings fears, and disappointing earnings announcements.
Portfolio performance and positioning
The fund’s performance (1.7%) was driven largely by domestic equity (0.5% contribution), foreign cash (0.4%) and foreign equity (0.3%) due to the depreciation in the currency during the month. These were followed by contributions from domestic bonds (0.3%) and domestic cash (0.2%), while local property (-0.02%) detracted only marginally from the fund’s performance in March.
Our asset allocation was unchanged during the month. We maintained a relatively light allocation to domestic equities (24%) and foreign equities (8%), while retaining an underweight-duration position in domestic bonds (40%). We still favour a slightly larger exposure to offshore cash (14%) versus domestic cash (10%), with a moderate exposure to local property (4%).
Domestic real activity data, confidence indicators and consumer metrics remain disappointing, but have been countered by improving global risk appetite and the lower local repo rate expectations. South African asset valuations have moved towards neutral relative to the anticipated growth recovery, given elevated downside risks. Uncertainty persists, centred on political risks in an election year, fiscal pressures, Eskom’s liquidity position, and the risk of load shedding as we move into the high-demand winter period. As such, we remain cautious and still prefer global defensive stocks and resources, but have increased our allocations to domestic retail counters given recent underperformance.