Sanlam Select Optimised Equity comment - Sep 19
The ongoing trade war between the US and China continues to be flagged as a key downside risk to global growth, with the International Monetary Fund (IMF) revising its global growth forecast to a post-recession low of 3.2% for 2019. The World Bank is more bearish, with a global growth estimate of 2.6% for 2019 and a marginal pick-up to 2.7% in 2020 and 2.8% in 2021.
Central banks continued to ease policy in response to slowing growth expectations, with both the US Federal Reserve (Fed) and the European Central Bank (ECB) lowering rates. The Fed also eased a dramatic liquidity shortage, while the ECB will restart asset purchases.
Global developed and emerging equities delivered positive US Dollar total returns in September. MSCI Developed Markets returned 2.2%, slightly outperforming MSCI Emerging Markets (+1.9%). MSCI Frontier Markets underperformed, posting a negative Dollar total return of 1.9%.
Within the MSCI World regions, the Pacific and European regions recorded total return gains of 3.2% and 2.7% respectively, while North America gained 1.8%. Japan, Sweden and the UK were the top performing countries, each posting a Dollar total return of 4.2% in September.
Within MSCI Emerging Markets (EM), the Latin America region gained 2.6% in September, while Asia gained 2% with heavyweights Korea and Taiwan returning 7.2% and 4.3% respectively. MSCI EM countries in Europe, the Middle East and Africa (EMEA) managed to eke out a positive total return of 1%, with South Africa a drag posting a negative 1.2%.
In Q3, the MSCI World Index posted a Dollar total return of just 0.7% vs 4.2% in Q2 and 12.6% in Q1. MSCI EM lost 4.1% over the quarter vs gains of 0.7% for Q2 and 10% for Q1. Within MSCI World, the North America region gained 1.5% and the Pacific region 0.3% in Q3. The European region, however, lost 1.8% in Q3. Within MSCI EM, the best third-quarter performance came from Turkey (+11.7%), Egypt (+7.4%) and Taiwan (+5.9%). Argentina was the worst performer (-46.8%), followed by South Africa (-12.4%) due to Rand depreciation of c-7% over the quarter.
South Africa’s Rand ended the month 0.3% weaker vs the Dollar and 1% weaker against the Euro, while gaining 0.8% against the Pound on the back of their Brexit woes. In commodities, oil prices spiked dramatically, up 20% during the month, following drone attacks on Saudi Arabia’s production, affecting c5% of global supply. Following the attacks and partial restoration of the damaged facility, oil prices dropped again close to previous levels due to demand concerns around slowing global growth.
On the macro front in South Africa, both, the SACCI and BER Business Confidence indices plummeted to multi-decade lows in August and Q3 respectively, with executives extremely downbeat about prevailing business conditions. Business confidence is usually a precursor to gross fixed capital formation growth. Interestingly, feedback from a large investor conference in Cape Town in late September suggested a ‘cautiously optimistic’ tone from corporate managements, in stark contrast to last year’s event, where sentiment was extremely depressed.
Moody’s also believes growth will likely rebound strongly from the second half of 2019, underpinning its current ratings view.
Foreigners were large net sellers of SA equities in September to the value of R11.3 billion and even stripping out the dual-listed companies, foreigners were still sellers to the same value. Foreign selling activity ex dual-listed companies was dominated by SA Industrials, with outflows to the value of R7.5 billion, driven by Naspers, which saw outflows of R5.2 billion as the Prosus unbundling took place. Smaller outflows took place in Resources and Financials to the value of R2 billion and R1.8 billion respectively.
The FTSE/JSE All Share Index (ALSI) started the month on a strong note, reaching a monthly total return of 5.3% by 16 September before global political and economic risks weighed on the market. The ALSI ended September virtually flat (+0.2%). Bonds posted a total return of 0.5% and the FTSE/JSE SA Listed Property Index (SAPY) a total return of 0.3%.
The largest positive equity performance in September came from SA Financials (+3.5%), with Equity investments posting a positive total return of 8.3%, followed by Banks (+4.8%), Life Insurance (+4.6%) and Non-life Insurance (+4.5%).
SA Industrials lost 0.7% in September. Among the best performers were Pharmaceuticals (+7.6%), Tobacco (+5%) and Food Retailers (+4.9%). Household Goods (-18.3%), Media (-11.4%), Fixed Line Telecoms (-11.3%) and Mobile Telecoms (-3.4%) were among the worst performing SA Industrial equity sectors.
SA Resources shed 1.1% in September. Following the strong performance of Gold Mining in August, the sector lost 14.9% in September with investors taking profits. Chemicals were down 11.3%. Platinum and General Mining, however, posted positive total returns of 4.6% and 4.3% respectively.
In Q3, the ALSI posted a Rand total return loss of 2.2% vs gains of 3.9% for Q2 and 8% for Q1. SA Industrials shed 2.5% in Q3, while SA Financials and SA Resources lost 6.8% and 6.4% respectively. The FTSE/JSE All Bond Index (ALBI) was virtually flat with positive total returns of 0.7% in Q3 vs 3.7% in Q2 and 3.8% in Q1. The SAPY shed 4.4% in Q3 vs gains of 4.5% in Q2 and 1.5% in Q1.
Year to date, the ALBI posted a positive total return of 8.4% vs 7.1% for the ALSI and 1.3% for the SAPY. Cash posted a year-to-date total return of 5.5%.
Within equities, SA Resources (+13%) outperformed SA Industrials (+8.9%) and Financials (-2.1%).
The Optimised Equity Fund outperformed again during September despite increased stock volatility, particularly around the unbundling of Prosus from Naspers. Value-adders included the underweight positions in Sasol, which we still deem expensive given the LCCP project implementation risk, and Goldfields, as well as overweight positions in Anglo American, Spar, British American Tobacco, Libstar and FirstRand. Many of the positions in global markets, such as Apple, Ulta Beauty, NetEase, Adidas and Daimler also contributed. Value-detractors included the underweight positions in Capitec, Old Mutual, Shoprite and Impala, while overweight positions in Harmony and Sappi also hurt. Is it worth mentioning though, that due to our robust portfolio construction process, many of the detracting underweight positions had offsetting overweight positions in the same sector, for example, so that the overall portfolio effect came through in a positive fashion!
The outlook for the rest of the year remains very unclear: Global event risks remain the key drivers of risk sentiment, with the US–China trade negotiations the elephant in the room. Further uncertainty over Brexit negotiations, geopolitical tensions in the Middle East, and global central banks’ monetary policy responses are all likely to remain key risks.
This, as a serious case can also be made that potential growth in EM is now overestimated. Basically, three inter-related factors that have been important in driving growth differentials towards DM in recent decades seem at risk to do so going forward.
The first is demographics: high rates of labour accumulation almost mechanically drove growth to higher rates. A second is ‘globalisation’, the process that triggered a benign relationship between the removal of trade barriers and the receipt of foreign direct investment flows. The third is China, whose era of rapid, investment-led growth triggered a surge in demand for commodities and intermediate goods.
If this is correct, this does not bode well for EM growth potential. Population growth is slowing, globalisation has peaked a while ago and China’s slowdown and change towards consumptionled growth are expected to continue.
For SA, specifically, the Medium-Term Budget Policy Statement (MTBPS) in October will remain on investors’ radar as a key policy event, while a Moody’s sovereign credit rating review is scheduled for 1 November.
Given the recent surprise in PPI and CPI, still below the South African Reserve Bank (SARB)’s 4.5% target rate, the SARB could reduce the repo rate by a further 25 basis points in November 2019 (or early 2020) should SA avert a Moody’s downgrade and the Fed shows any further signs of dovishness.
Any further downside inflation surprises would also be supportive of the repo rate projection in the SARB’s Quarterly Projection Model. Any prospects of reducing expenditure at the MTBPS will likely appease credit rating agencies in the near term. The medium-term impact would depend on whether or not these expenditure cuts actually materialise. In our opinion, the MTBPS has become a critical rating downgrade event at both Fitch and Moody’s. Without any sort of meaningful ‘plan’ to reduce expenditure or reignite growth, there seems a high likelihood that Moody’s will change its outlook to ‘Negative’.
On the positive side, inflation looks to remain subdued over the medium term, while further repo rate cuts could materialise, which could lower financing costs further. However, in the current environment of policy uncertainty, political instability and rising socioeconomic discontent, political and socioeconomic risks remain a hurdle vis-à-vis the boon of lower financing costs.
In summary, investors need to navigate carefully given the late stage of the global capital market cycle, the slowing global economy and a precarious political landscape. Research indicates that the global economic expansion could persist for the next six to 12 months, although growth is likely to be sluggish. Yet the political landscape has become more problematic, especially following the start of a presidential impeachment inquiry by the US House of Representatives. In the final analysis, while we retain our moderately upbeat outlook for the global economy, heightened uncertainty globally and only slow progress towards economic reform here in South Africa mitigate our current appetite for risk.
This is a pure equity strategy diversified across all sectors on the JSE and is applicable to aggressive investors who have a time horizon greater than 5 years. The investment manager screens the entire investment universe looking for companies that are undervalued relative to their realistic growth prospects with the aim of constructing a strategy that will achieve consistent market beating returns over the long-term but at lower levels of risk.