Sanlam Select Bond Plus 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.
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.
Portfolio performance and positioning
While valuations were attractive, the persistence of fiscal and ratings risks prompted us to maintain a neutral-duration stance versus the benchmark during the month. Notwithstanding the modest 10 basis points rally in yields during March, the relatively elevated duration and overweight position in the ultra-long end of the yield curve resulted in a meaningful contribution to performance from our government bond holdings. We remain overweight in the 15- to 20-year and ultra-long end (25- year plus) areas of the curve, as well as in the 3- to 5-year area via senior bank debt. These are countered by underweight positions in the 7- to 15-year and in the 20- to 25-year areas.
The Fed’s dovish stance, confirmation of the end of quantitative tightening in 2019, and downside data surprises spurred a sharp rally in US yields. This was partly offset by a rising SA-specific risk premium in the lead-up to the Moody’s rating review on 29 March. As a result, the SA 10-year yield was largely range bound during the month. Given the still-benign inflation outlook, notwithstanding the jump in the Rand oil price, implied real yields are attractive. However, the nominal 10- year yield is trading close to the bottom end of the 8.60-9.10% fair-value range, justifying a neutral stance, at best, given limited risk premium in the yield curve.