Truffle SCI Flexible Income Fund - Sep 19
World economic growth continues to be revised lower
The International Monetary Fund continues to revise projections for the world economic growth rate lower. The latest revision forecasts global growth in 2019 to slow to 3.2%, compared with the previous estimate of 3.3% made in April 2019. This compares with a global growth rate of 3.7% in 2018. In a synchronised slowdown, the IMF expects economic performance in 2019 from the United States, Europe and China to be below 2018 levels, with Europe expected to record the weakest growth. Chinese industrial production growth continues to fall and is currently at all-time lows in China’s modern era. Although the IMF expects a recovery in 2020, the news flow continues to be negative and it is likely that next year’s forecasts could, in the future, be revised still lower.
There is no sign that the trade relations between the US and China are warming. On the contrary the latest utterings suggest that the Trump administration is considering quantitative restrictions on US private sector investment in China. This would represent an escalation of the differences between the two countries that is likely to have a negative impact on investor sentiment. On both sides since late last year, as a result of the trade standoff, export tariffs have been steadily increasing and this has had a negative impact on global trade. As expected, the decline in US exports was the largest contributor to the deceleration of the economy in the 2nd quarter.
Brexit still dominates European politics. The UK government continues to adopt a very hard-line approach to any opposition to its objective of delivering a break from the European Union on October 31. Parliament and the Executive are currently firmly gridlocked and it is apparent at this stage that all options from a hard no-deal Brexit to no Brexit and everything in-between are still possible with neither side in a consolatory mood.
Central Banks around the world have responded to the faltering economic prospects with a further round of monetary easing, but interest rates are currently so low that its effectiveness is questionable. Currently, according to the World Bank about a third of global debt is offering a negative yield. Global currencies continued to reflect the mid-year realignment with the US $ strong relative to Sterling and the Euro, driven largely by the move to quality and higher interest rates. The Rand remains weak but has been supported by the high interest rates on offer.
The PGM basket continues to outperform most commodities
Both the Palladium and Rhodium prices increased over the month of September, largely driven by potential supply constraints. As expected, Middle East tension drove the oil price higher but fortunately the price closed below intra-month highs, but a more serious conflict could have a very negative impact on the future oil price. With the exception of nickel, base metal prices were generally weaker over the month.
South Africa’s growth prospects continue to disappoint
South Africa’s economic performance continues to disappoint amidst calls on the government to adopt a more growth focused economic policy increasing by the day. Confidence remains fragile as the very necessary restructuring of the parastatals and municipalities holds the prospect of job cuts and further tax increases, both impediments to a meaningful recovery in the short term. There is some evidence of an embryonic pick-up in the construction sector, coming after many years of steep declines. This was reflected in a good share price performance from the sector in the month.
Global equity markets in a trading range
Global equities have been trapped in a trading range for the last two years. Although the historic bull market is very mature and valuations are modestly stretched, the current low interest rate environment is, in our opinion, not creating a sufficiently attractive alternative to encourage withdrawal of capital from equity markets. However, the risks are skewed to the downside given the limited scope for further monetary policy easing and the increased likelihood of negative earnings revisions. Global bond markets are not offering reasonable value either. Only in the US are 10 year yields roughly in line with the inflation rate but still not offering yields in-line with long term averages. Elsewhere developed market yields are either negative or only barely positive, as in the case of UK bonds.
South African financial markets require an injection of confidence
South African equity markets eked out modest gains in September. Resources lost ground in the month but still remain the top performing economic group this year. Despite overall declines from mining shares, platinum shares were up in the month. Industrial shares also contracted in September but financials recovered strongly from the prior months’ losses.
Indices have been driven by the divergence of strong performances of global and export orientated companies and poor performances from companies reliant on SA Inc.
Given the likelihood of the SA economy remaining weak for a protracted period and consequently earnings growth remaining lacklustre, valuations for domestically focused counters are not compelling. Some of the large offshore exposed companies including British American Tobacco and Prosus appear to be offering reasonable value at these levels.
SA bonds are offering very high real yields but are hostage to SA’s sovereign credit rating and economic woes. A downgrade by Moody’s, the only ratings agency to still maintain SA debt as investment grade, would be bad news, most likely preventing real yields from contracting much.
The fund continued to perform well during the third quarter 2019. This was mainly due to good performance from the preference shares we hold. Steinhoff preference shares are still suspended and we are hopeful that this issue will be resolved soon. The exposure to Steinhoff preference shares is around 1% of the fund.