Truffle SCI Flexible Income Fund - Jun 19
Financial markets bounced back from May's retreat Global markets bounced back strongly from May's contraction despite many of the market's pressing issues remaining unresolved. Firstly, while the trade negotiations between the US and China are back on track it will take compromise from both sides to reach an agreement. Brexit is firmly on hold as the UK Government's Tory party is still struggling to find a new leader to replace Theresa May even before a revised strategy can be contemplated. The global economy is currently going through a synchronised slowdown that has seen developed central banks pivot towards more accommodative monetary policy. This more dovish stance by developed central banks has opened up room for emerging markets to also cut rates. Given the limited room for the conventional monetary policy, we may yet see central banks turn more aggressively toward fiscal policy, in an attempt to avoid a recession in the years ahead. The S&P 500 Index advanced 6.9% in June, representing one of the strongest moves seen in recent times, driven, in the main, by the pivot on interest rate policy from the US Fed.
Much has been said about the demise of the current global equity bull market that, by many measures, is very mature. Having been in place for over a decade, it will rank as one of the longest in history. However, the excesses that normally signal the end of the cycle are not that apparent. But earnings have already enjoyed a very strong advance over the last half-decade and are looking like they are in top-of-cycle range. It is unlikely that earnings growth on its own can sustain further equity gains. The key risk to the current equity bull market would be earnings disappointments into 2020, or an unexpected rise in interest rates resulting in an upward spike in equity yields. As this does not appear to be on the very short-term horizon the global equity backdrop is likely to remain a benign influence with regard to domestic financial markets.
South African markets followed suit In June the JSE All Share Index produced a total return of 4.8%, having fallen by 4.8% in May. This brings the year-to-date return of the ALSI to 12.2%. All sectors contributed to the performance in June, although the Financial sector and the Resource sector outperformed the Industrial sector by 3% and 2% respectively. The more broadly-based SWIX experienced a more modest advance but was still up 3.1% in the month and by 9.0% year-to- date. Bonds too enjoyed a good month with yields at the long end softening by about 20bp. Real yields remain high by historical standards. However, the Property index continues to lag, being barely in positive territory year-to-date. As the sector generally lags the economy, distribution growth is likely to disappoint for several years to come.
Precious metals also enjoyed a strong advance Both gold and PGM's had a strong June and no doubt was a significant factor behind the good performance from the Resource sector. Equity returns could have been even better being it not for the currency strengthening by 3.5% against the US$. The gold price breached the 1400 $/oz mark for the first time in six years and the prices of the entire PGM basket rose, possibly indicating a change in sentiment with regard to precious metals that could signal a more sustained move.
SA's economic performance is cause for concern
The SA economy is currently trapped in a cycle of low economic growth and high unemployment that if not arrested soon, could result in a major crisis. The current trajectory is leading to greater levels of poverty and inequality that increase the probability of economic instability. Recent statistics on credit growth and retail sales suggest that the currently employed SA consumers are at their limits and are unable to meaningfully take on more debt. Spending on badly needed infrastructure is also declining as seen in the demise of the local construction industry. Barring an export-led windfall the only sustainable path to higher economic prosperity is to increase employment bringing in more people into the consumer economy. Despite President Ramaphosa's positive message at the State of the Nation Address, we have yet to see decisive action taken on critical structural reforms that are necessary to move us out of the low growth environment.
The currency has been surprisingly strong Given the country's disappointing growth outlook it might have been expected that the Rand would remain weak; however, this has not been the case. A consequence of our low growth environment has seen imports decline and with rising commodity exports the country has experienced an improvement in the external trade balance over the recent months. Inflation has also been stable, surprising most economists on the downside. These metrics have underpinned the strong Rand and are likely to lend stability to the currency in the short term, in spite of the weak fundamentals.
Financial markets should produce modest positive returns Low economic growth prospects for the year mean that SA focussed corporates will struggle to grow earnings and dividends in real terms over the next twelve months. Despite this, a large proportion of the SA market is dominated by resource and rand hedge stocks which are still enjoying the benefits of a growing global economy and should still produce modestly positive returns.
Over the shorter term, the outlook for fixed income assets is encouraging. The weak economy and the stable currency are taking the pressure off the inflation rate and are providing the SARB with the data to cut short term interest rates. Given that yields across the yield curve are positive, real returns can be expected from fixed-income investments over the next few months.
The fund continued to perform well during the second 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.