Truffle SCI Flexible Income Fund - Mar 19
Global markets enjoyed a strong 1Q 2019
Global financial markets bounced strongly this quarter, recovering from the weak close to 2018. Global equities made impressive gains, with the MSCI World Equity Index delivering a 12.6% USD return, compared with a decline of 8.2% in the previous quarter.
Emerging market equities were not far behind, producing a 10% USD return for the quarter, having fallen by 14.2% in the previous quarter. Global government bonds returned a positive 1.9% for the quarter in USD's.
South African equity returns for the quarter were strong, but lagged other emerging markets, producing an 8% return for the quarter in Rands, and a 7.7% return in USD. South African Bonds were up 3.8% in the quarter.
The global economy is giving mixed signals
Since late 2018 global developed market bond yields have fallen significantly, signalling the market's expectation of the first synchronised slowdown since the 2008 economic crisis. Already weak numbers have emerged from Germany with the rest of the Euro area likely to follow. More and more company profit updates are warning of slowing sales across many industries. Brexit is also not helping and remains a source of major uncertainty even though it may be delayed.
In the United States, economic growth still remains strong with consumer confidence at high levels and unemployment at record lows. However, business confidence is deteriorating and earnings downgrades have not yet troughed. However, a more dovish FED will help maintain expansionary financial conditions which will aid in extending one of the longest US economic cycles in history.
China's slowdown, which started in the last quarter of 2018, might be nearing its end as fiscal stimulus and a positive credit impulse bring its economy back to the boil. A turn around in Chinese growth would help lift other Asian economies, as well as Europe, which benefits via its export industries.
Despite the possibility of a global turnaround, we remain concerned by the record low unemployment rate and elevated profit margins in the US. Furthermore, the exceptionally low real yields in developed bond markets do not bode well for future financial market returns.
Monetary policy will likely remain accommodative
With the South African repo rate set at over 2.5% above the inflation rate, South African real yields screen as globally attractive. While there is some scope for the SARB to cut interest rates in the quarters ahead, the need to protect the currency, and prevent the knock-on inflation effect, remains.
The South African economy is facing major challenges
South African economic growth has been anaemic for some time now. This has been driven by numerous structural issues. Whilst government spending has remained strong, our lack of employment growth, very high and increasing levels of indebtedness and a tax burden that is already high, are now putting a huge strain on the consumer. Official growth forecasts are all pointing to a very lacklustre economic performance in 2019 that will make the worryingly high inequality gap difficult to address. In addition, the parlous state of many of the country's parastatals, notably Eskom, is making efforts to stimulate growth more challenging.
On the positive side, if President Ramaphosa is returned to power with a strong mandate after the May elections, the country could see a major initiative to tackle corruption and service delivery, issues that have been plaguing the country for some time. If combined with increased policy certainty and fiscal discipline, South Africa could start to meaningfully address the structural issues which have been holding us back. This would no doubt be good for overall business and consumer confidence and could attract higher levels of investment that would raise growth rates and living standards over the medium term.
Domestic equity values continue to improve
In previous commentaries we have observed that domestic equities are not cheap, although value has steadily been improving. Given that the global monetary environment is likely to remain benign and that domestic inflation is under control, domestic interest rates are currently poised for either a cut or at worst, remaining steady. Equity returns, in our view, will be determined less from rating changes than by earnings growth. The poor economic outlook points to earnings growth remaining weak, suggesting that equity returns will, at least in the quarters ahead, continue along the path of subdued returns similar to the last few years. Earnings growth needs to accelerate if equities are to enter a new bull market.
Property returns are expected to be subdued
In line with equities, property returns are also expected to be subdued as the growth in distributions is likely to remain weak for the foreseeable future. Although the running yield appears attractive, this needs to be balanced against the poorer quality earnings we are seeing from the property counters.
The fund performed well during the first quarter 2019. This was mainly due to excellent 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.