Fund Manager Comment - Jun 19
During a relatively uneventful first month of the quarter, the two biggest central banks in the world, namely the US Federal Reserve (Fed) and the European Central Bank (ECB), took centre stage.
First up was the ECB, which on the back of weakening economic conditions in the Euro Area decided to keep their short-term interest rates unchanged and that they will continue to reinvest maturing principal payments on securities, as well as maintain favourable liquidity conditions and an ample degree of monetary accommodation. Similarly, the Fed kept their rates unchanged at the end of the month, maintaining their ‘patient-flexible monetary stance’ in the context of slowing global growth. Overall these actions are supportive for emerging market countries like South Africa.
In the SA Reserve Bank (SARB)’s Monetary Policy Review (MPR), they emphasised that the current global economic conditions, with global growth slowing and rates easing, are considered thoroughly in their decisions and economic forecasts. They argue that SA’s potential growth rate is probably lower now, near long-term lows of 1.3% in 2019 and only 1.5% by 2021, with ‘state capture’ being largely responsible. With regards to longer-term inflation, they stated that it is now more converged towards the 4.5% mid-point of the target range.
One of the most important events this quarter was undoubtedly the National Elections. The ANC obtained 57.5% of the votes in the election, which was their worst result so far. This did not have ramifications for the markets, seeing that a lower result was expected.
At the SARB’s May Monetary Policy Committee meeting, they voted to keep the repo rate unchanged, with three members voting for no change and two voting for a 25- basis point cut. They stated that the risks to inflation are balanced now and they also reduced their forecast across the entire horizon. Considering that first-quarter highfrequency economic activity data point to negative GDP growth, together with the forecasts of analysts, a rate cut at the next few meetings seems more imminent now.
In the lead-up to the announcement of the new Cabinet, markets weakened somewhat, because of dissatisfaction with some potential Cabinet member selections and uncertainty with regards to a smaller Cabinet. The actual Cabinet announcement revealed the appointment of David Mabuza as deputy president, a reduction in ministerial appointments from 36 to 28 and the merger of various other positions. All this was interpreted positively by markets.
S&P left South Africa’s BB foreign currency and BB+ local currency sovereign credit ratings unchanged with a Stable Outlook. Unlike Moody’s, which decided to include Eskom’s government-guaranteed debt under the SA government debt, S&P decided to leave it separately. Moody’s stated that they did this because of the already large government support that Eskom receives for its operations and debt servicing. Globally, the trade wars continued to batter markets as President Trump decided to consider adding tariffs on European cars.
July featured the State of the Nation Address (SONA) where newly elected President Cyril Ramaphosa was expected to shed light on a number of important issues. The most critical among these issues was information regarding further financial and operational support for Eskom. First it was stated that the R23 billion provided this year will be enough for it to meet its obligations until October. Secondly, a large portion of the R230 billion support over the next ten years will be allocated earlier to allow Eskom to operate as a going concern for two years, during which time it must be unbundled into three separate state entities. Furthermore, a chief restructuring officer (CRO) will be appointed by mid-July. The CRO must produce a plan by end-2020 on how to restructure Eskom’s mounting debt, without any creditors being forced to take losses.
Other stated SONA objectives with less detail were goals to eliminate hunger, provide jobs for two million young people, improve educational outcomes and halve violent crimes over the next decade. On plans relating to kick-starting growth, he mentioned previous plans of rebuilding SA’s industries using the model of the motor vehicle industry and ‘master plans’ for clothing, textiles, gas, chemicals and plastics, renewable energy and metals.
First-quarter 2019 GDP surprised significantly to the downside, declining by 3.2% quarter-on-quarter (q/q), compared to consensus expectations of a decline of 1.7%q/q. This first-quarter contraction was the worst quarterly contraction since the global financial crisis in 2009. It mainly shows the effects of Eskom’s power cuts on the mining and manufacturing sectors. The International Monetary Fund remained cautiously optimistic about SA’s growth prospects, saying that longstanding growth impediments must be removed. Moody’s issued a statement saying that weak firstquarter 2019 growth is credit negative because it makes the government’s objective of lifting growth while consolidating its fiscal position more difficult. It also lowered its 2019 GDP forecast from 1.3% to 1%.
ANC Secretary-General Ace Magashule announced that the party had agreed to expand the SARB’s mandate to include growth and employment objectives, which was swiftly contradicted by Finance Minister Tito Mboweni. This uncertainty surrounding the SARB’s mandate continues to be a drag on investor and business sentiment. President Ramaphosa also later said that the ANC supports the SARB’s independence and that nationalisation of the central bank is ‘simply not prudent’.
Headline inflation in March and May was 4.5% year-on-year (y/y). Core CPI declined from 4.4% y/y in March to 4.1% y/y in May. PPI inflation increased from 6.2% y/y in March to 6.4% y/y in May. The Rand/US Dollar exchange rate strengthened to 14.11 from 14.42 during the quarter. The 10-year SA government bond strengthened to 8.69% from 9%. The trade balance decreased from a surplus of R5 billion to a surplus of R1.74 billion. The unemployment rate increased from 27.1% in the last quarter of 2018 to 27.6% in the first quarter of 2019.
The money market yield curve flattened significantly over the quarter as a consequence of persistent low inflation expectations and the struggling economy. The curve (market) is now pricing in about two 25-basis point rate cuts over the next year, compared to a neutral rates outlook three months ago.
What we did
All maturities were invested across the money market yield curve, exploiting the term premium as well as adding some higher-yielding fixed-term negotiable certificates of deposit (NCDs). Quality corporate credit, which traded above the three -month JIBAR rates, was added to the portfolio. We preferred a combination of floating rate notes in the portfolio, together with some fixed-rate NCDs. The combination of corporate credit, high-yielding NCDs and floating rate notes will enhance portfolio returns.
Our preferred investments would be a combination of fixed-rate notes, floating rate notes and quality corporate credit to enhance returns in the portfolio. With the money market curve flattening significantly over the quarter, fixed rates are even lower now. Accounting for one 25-basis point interest rate cut, floating rate notes still outperform fixed-rate notes.
This fund aims to deliver a higher level of income than fixed deposits and call deposits over time. Capital preservation is of primary importance and the fund offers immediate liquidity. The fund has no offshore exposure.
The fund invests in a range of money market instruments which include negotiable certificates of deposit, bankers' acceptances, debentures, treasury bills and call accounts. The fund may only invest in money market instruments with a maturity of less than 13 months. While capital losses are unlikely, they can occur if, for example one of the issuers of an instrument held by the fund defaults. In this event losses will be borne by the fund and its investors.