SIX MONTHS DOWN, SIX TO GO
DAVE MOHR & IZAK ODENDAAL,OLD MUTUAL MULTI-MANAGERS
The halfway mark of 2018 provides a good opportunity to take
stock of returns from the main asset classes, the factors shaping
them and the outlook for the months and years ahead.
An interesting place to start is remembering how bleak things were
only a year ago. June 2017 was an eventful month for all the
wrong reasons. Stats SA released first quarter GDP numbers that
were unexpectedly negative. Since the economy also contracted
in the fourth quarter of 2016, South Africa was in a technical
recession, defined as two consecutive negative quarters.
The recession was subsequently revised away although nobody
realised it at the time. Moody’s followed the other ratings agencies
in downgrading South Africa to junk status after the earlier shock
firing of Finance Minister Pravin Gordhan. A new draft mining
charter was widely criticised and challenged in court by the
industry. The BER/RMB Business Confidence Index slumped to its
lowest level since the 2009 recession, with a reading of 29 index
points (with 50 being the cut-off between net positive and net
negative). The Public Protector controversially proposed that the
clause in the Constitution on the SA Reserve Bank’s mandate be
changed. Politics in general were messy and uncertain.
The month of June 2017 was also a negative month for local
equities with the FTSE/JSE All Share Index losing 3.4%. The index
level at the end of June 2017 was the same than in June 2014.
In other words, over this three-year period, dividends were the
only source of return from local equities, the biggest asset class
for most local investors. At the halfway mark of 2017, pessimism
about markets and the local economy was therefore widespread
and with good reason. And yet, starting with an incredible surge
in July, the FTSE/JSE All Share jumped 20% in the following six
JSE IN THE RED IN 2018
June 2018 was a volatile but positive month for local equity, but
the FTSE/JSE All Share Index remains in negative territory for the
first six months of the year. One-year returns are back in doubledigits
and comfortably ahead of inflation (4.4% in May), helped
by the low base from a year ago.
However, the lesson learnt from last year was that, faced with the
negative returns from local equities in the first six months of 2018,
one shouldn’t become too despondent. Markets can turn around
quickly and without warning, making it impossible to time.
The other important lesson from June 2017 is that, despite all the
negativity on South Africa’s political situation, state capture, midnight
Cabinet reshuffles and junk status ratings, the rand rallied during
the month. In fact, it appreciated around 15% in the preceding
12 months. In contrast, the rand has lost 16% since President
Ramaphosa’s swearing in as president in February. Clearly, the
local currency is not driven primarily by local factors, but rather
by the big global forces: expectations of US interest rates (and the
direction of the US dollar), sentiment towards emerging markets
and commodity prices. Remember that when the land reform debate
heats up, the economy stumbles or the Springboks disappoint.
THE BIG GLOBAL DRIVERS
Looking at those three factors in turn, the US dollar has been
strengthening since mid-April against the major currencies (euro,
yen and pound), hammering emerging market currencies, including
the rand. It is not always clear what drives such a sudden shift.
Interest rates are rising in the US. In theory this should attract capital,
but interest rates rose throughout 2017 and the dollar weakened.
Over the past few months, the US economy has strengthened
relative to other major economies and this has boosted perceptions
of where interest rates will rise to in the future. At the same time,
the European Central Bank (ECB) confirmed that they were not
hiking before sometime in 2019. Also in the mix now is the potential
for further escalation in the trade disputes between the US and the
rest of the world. Higher import tariffs at American borders could
lead to a stronger dollar, but it is not clear whether the President’s
tweets are a negotiating tactic or a permanent feature. Though
2017 saw the dollar decline, it appreciated strongly in the previous
five years and is probably already in expensive territory. A stronger
dollar from this point forward is not a given.
There was much excitement and trepidation when the US 10-year
bond yield broke through 3%, but it fell back to below 3%, even
as the Fed pushed ahead with hiking its short-term policy interest
rate. The flattening US yield curve (higher short-term rates, but flat
long-term rates) suggests that the bond market does not believe that
the Fed will hike rates as much as commonly being forecasted by
analysts. So the US dollar could lose this source of support sooner
rather than later.
Sentiment towards emerging markets has definitely deteriorated,
but this too is mostly linked to the dollar and the uncertainty created
by Trump’s trade war talk and not to changes in growth fundamentals
in these economies. Turkey and Argentina have large current account
and fiscal deficits as well as large foreign-currency denominated
debts. They were always vulnerable to a stronger dollar. In contrast,
South Africa’s foreign currency debt levels are relatively modest.
But there has been contagion to other emerging markets, including
South Africa, as global investors often buy or sell emerging markets
as a basket, rather than based on individual country considerations.
Emerging market equities surged ahead in 2017 (returning an
astounding 37% in US dollars) but in the first half of the year, the
MSCI Emerging Markets Index underperformed developed markets
and fell in dollar and in local currency terms. The JSE has mirrored
Commodity price trends have also not been in South Africa’s favour
of late either. The dollar price of our main import – oil – has shot
up over 19% this year. But the dollar prices of our main exports
– gold, iron ore, platinum, palladium and gold – have all declined
between 5% and 10%. Only coal prices, trending in sympathy
with oil, moved in our favour. Commodity prices thus also weighed
on the rand.
The US dollar return of global equity was disappointing against
the backdrop of some strong corporate earnings reports driven
by solid global growth and the US tax cuts. Geopolitics have
come to the fore strongly this year. Trump’s trade wars, his showdown
with Iran and North Korea (and even his allies in the G7) and the
Italian government merry-go-round have all weighed on markets.
History shows that these events tend to be unimportant for long-term
returns. What matters more are economic fundamentals, and these
are still healthy for the time being. Global growth is solid and
while the local economy is stuck in low gear, it should improve.
The South African Reserve Bank’s index of leading indicators
slipped marginally in April but the overall trend still points to an
improvement in local growth. And with the rand having pulled
back sharply, local investors experienced a 10% rand return
in global equity.
BEHAVIOUR MATTERS MORE
What matters the most for generating solid long-term returns,
however, is often the behaviour of investors. Nothing destroys
long-term returns as quickly as selling after equity prices have fallen
a few percent, rushing money offshore after the rand hits a new
record low or constantly trying to switch into the fund that is currently
topping the performance tables. Markets are inherently volatile
and returns tend to be lumpy and unpredictable, and so too
is fund manager performance.
The sound approach is to do the homework upfront, set an
appropriate strategy with the proper allocation to local and global
assets, choose a manager with a proven and repeatable track
record and then stick to the plan. Our information-rich modern
world can lead to poor decision-making if investors overreact
to market volatility and judge fund returns over inappropriately
short periods. So while this is the halfway mark for the year, it is
not the full-time whistle for investor returns. Successful investing
requires lots of patience and discipline.
July 4, 2018
The Wealth Room