Fund Manager Comment - Sep 18
South African currency, money and bond markets were mainly driven by a few global and local themes. Globally we had the continued US-China trade wars, interest rate normalisation in the US, higher oil prices and emerging market contagion originating mainly from Turkey and Argentina. Locally there were the continued risk of higher inflation, weak economic growth, budget pressures at the fiscus, expropriation of land without compensation and President Ramaphosa’s economic stimulus plan.
Seasonally adjusted annualized GDP for 2Q2018 contracted by 0.7%, following the 2.6% decline in 1Q2018. This means that SA is now in a technical recession. This was substantially lower than the expected 0.6% expansion. Agricultural output had a large contraction for the second consecutive quarter and services output also surprised with an unexpected decline.
Some economic indicators still shows that it will take time for the economy to recover. Both the ABSA and Markit PMIs declined further below 50, signalling weak economic activity at the beginning of Q3. July mining production contracted by 8.6% m/m compared to the 5.0% increase in June. Weak passenger car sales numbers in August and a decline in retail sales to 1.3% in July from 1.8% in June, signals weak consumer spending. Ratings agency Moody’s, reduced SA’s 2018 GDP forecast to between 0.7 - 1.0% from 1.6%, although it said that its global growth forecast of above 3.0% will be supportive for SA.
At the SARB’s MPC meeting in June, all seven members voted to keep the repo rate on hold at 6.50%. The tone of the MPC meeting was characteristically hawkish. The MPC increased its headline and core inflation forecasts for 2019 and 2020 by 0.4% and 0.2% respectively. In stark contrast to the June meeting, only four members voted for the rate to remain unchanged. Consequently the repo rate remained at 6.50% and the voting result signals that inflation risks are to the upside. The SARB kept its inflation forecast for 2018 at 4.8% and 2020 at 5.5%, but raised 2019 to 5.7% from 5.6%, due to higher oil prices and a weaker currency. It also lowered its growth outlook for 2018 to 0.7% from 1.2%, but kept 2019 and 2020 forecasts unchanged at 1.9% and 2.0%.
In September, government intervened to limit the increase in fuel prices. The Minister of Energy, Jeff Radebe, revealed that this intervention will only be a onceoff. The recent weakening of the SA Rand and the rise of the oil price (above $80), means that large future fuel price increases are imminent. It is important to note that the SARB explained that they are prepared to look through first-round inflationary effects of a weaker rand, if the cause of weakening was not domestic.
Early in the quarter SA hosted the 10th BRICS Summit under the theme, “BRICS in Africa: Collaboration for Inclusive Growth and Shared Prosperity in the 4th Industrial Revolution”. Before the start of the summit, China pledged to invest USD14.7 bn in SA. This, together with the USD20 bn, which Saudi Arabia and the UAE (each USD10 bn) committed to invest in SA, already makes up a significant contribution of President Ramaphosa’s USD100 bn foreign direct investment target.
Politically, President Ramaphosa announced that the ANC decided to change SA’s constitution to explicitly allow expropriation of land without compensation. Although they stated that land redistribution will be done in a “just and equitable” manner and without harm to the economy, the market still reacted negatively to the announcement. The issue of nationalizing the SARB reappeared again, when theEFF tabled a bill in parliament. The minister of communications, Nomvula Mokonyane, stated on behalf of the cabinet, that the proposed nationalization of the central bank will not lead to any changes to its operational mandate. The SARB also reiterated this, stating that its independence regarding monetary policy and financial stability is guaranteed by the SA constitution.
End August Argentina surprised the market by hiking their interest rates by 15%. Turkey followed suit by hiking interest rates by 6.25%, providing support for emerging market countries, including SA. Beginning September the US Dollar weakened as a result of further intended tariffs. Later in the month the Federal Reserve lifted their benchmark rate by 25 bps, maintaining their intended interest rate path and reversing dollar weakness.
GDP growth in 2Q2018 contracted by 0.7% q/q after contracting by 2.6% in 1Q2018. The unemployment rate of 2Q2018 increased to 27.2% from 26.7% in 1Q2018. During the quarter CPI YOY increased to 4.9% in August from 4.6% in June. Similarly PPI YOY increased to 6.3% from 5.9%. The USDZAR weakened to 14.17 from 13.76. The 10 YR SA government bond weakened to 9.22% from 9.03%. The trade balance decreased to 8.79bn from 11.9bn.
The MM yield curve shifted upwards and steepened substantially over the quarter, as a result of the weakening in the Rand. If the Rand will continue to remain at the current weaker levels, combined with the current higher oil prices, inflation will most likely be higher than expected in the coming months. This could potentially result in the SARB having to hike interest rates to keep inflation below the 6% upper limit of the inflation band.
What we did
All maturities were invested across the money market yield curve, exploiting the term premium. Quality corporate credit, which traded above the 3 month JIBAR rates, was added to the portfolio. We preferred a combination of floating rate notes (FRN’s) in the portfolio together with some fixed rate negotiable certificates of deposits (NCD’s). The combination of corporate credit, high yielding NCDs and FRNs 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. As a result of the steepening of the MM yield curve over the course of the quarter, fixed rate notes became relatively more attractive than floating 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.