THE RETURN OF REAL RETURNS
DAVE MOHR & IZAK ODENDAAL, OLD MUTUAL MULTI-MANAGERS 2
2017 is suddenly shaping up to be a very good year for investors.
Global growth has picked up, and companies are reporting solid profit
numbers as a result. At the same time, low global inflation suggests
the world’s major economies are far from overheating, and therefore
interest rates need to gradually rise to more normal levels. While the
Bank of England hiked rates for the first time in a decade last week,
it is unlikely to move much further given the uncertainty around Brexit.
Jerome Powell’s appointment as successor to chair of the US Federal
Reserve, Janet Yellen, also removes an element of monetary policy
uncertainty. Powell is seen as pragmatic and likely to follow Yellen’s
gradual and measured approach.
Global equities were positive in October. The MSCI All Countries
World Index returned 2% in US dollars, lifting the 2017 return to a
solid 17%. US equities are leading the pack among developed markets
and the S&P 500 gained 2.2% in October, lifting its year-to-date return
to 15%. The tech-heavy NASDAQ gained 3.5% in October and is up
25% in 2017.
Emerging markets returned 3.5% in US dollars in October, beating
developed markets. The 2017 US dollar return of the MSCI Emerging
Markets Index is at a staggering 29%.
Commodity prices rose on a broad front in October, despite the stronger
US dollar (usually a headwind), as optimism over global growth has
lifted. Copper was up 4.9%, aluminium increased by1.4% and nickel
was 12% higher in October. The oil price jumped 7% to close above
$60 per barrel as OPEC gears up to negotiate an extension of
production cuts next year. Palladium continues to outshine platinum,
gaining 4.5% in October and 45% year-to-date, while platinum was
up 1% in October and only 1.9% in 2017. Gold ended October
marginally lower at $1 271 per ounce, capping the 2017 increase
at 10%. Soft commodities were negative in October, with dollar prices
of wheat and maize declining.
LOCAL MARKET UP STRONGLY
October was also a very strong month for local equities, despite
elevated political uncertainty (following another Cabinet reshuffle) and
a disappointing Medium Term Budget. The FTSE/JSE All Share (Alsi)
Index followed global markets higher and benefited from a weak rand,
returning 6.3% in October. Returns for the first ten months of the year
is a very solid 19.6% (including dividends). In June the Alsi fell to
50 000 points, a level it first crossed three years earlier. Last week it
almost hit 60 000 points.
The FTSE/JSE Shareholders Weighted Index (SWIX), the preferred
benchmark for local fund managers, returned 6.5% in the month and
17.7% for the year so far. The Capped SWIX Index, which limits the
Naspers weight to 10%, lagged behind, demonstrating Naspers’s
incredible performance on the back of its shareholding in Chinese
internet giant Tencent. Naspers has gained 71% in 2017, of which
a staggering 17% came in October alone. Therefore, the Capped
SWIX Index lagged with a 4.8% return in October and 13%
The strong local equity returns came entirely from large caps, in other
words from the big global companies on the JSE, including Naspers,
but also Richemont, British American Tobacco (BAT) and Anglo American.
The Top 40 Index has returned 22% in 2017 but the Small-Cap Index
only 1.8% while the Mid-Cap Index was flat.
Industrials led the way in October and returning 7.6% and 26%
year-to-date respectively. Within the broad industrials sector there was
quite a divergence between subsectors in 2017. Media (Naspers),
personal goods (Richemont) and tobacco (BAT) delivered 71%, 45%
and 21% respectively. However, healthcare is down 3% this year, while
telecommunications is flat. General retailers are down 5% in 2017,
but food and drug retailers are up 18%.
Resources had a strong month in October, returning 7% thanks to a
22% rebound in platinum miners and an 8% gain by the general miners.
Forestry and paper were negative for the month. Year-to-date, resources
have returned 20%.
Of the three broad sectors, financials have lagged this year returning
only 6.5%. It is also the sector most negatively affected by political
uncertainty, downgrades and a weak rand. Interestingly then, banks
returned 2.8% in October despite the disappointing mini-Budget, while
life insurers returned 3.4%. Financials returned 2.4% in the month.
Listed property is classified as part of the financials index but is treated
by investors as a separate asset class. Listed property returned 1.9%
in October to lift the year-to-date return to 10%, ahead of bonds but
BONDS AND RAND WEAKER RECENTLY
Local bonds and the rand were already under pressure from
mid-September as the dollar firmed up and US Treasury yields rose in
anticipation of tax cuts in the US. The shock of much wider projected
deficits in the Medium Term Budget only accelerated the selling. The
All Bond Index (Albi) lost 2.5% as the yield curve steepened, with the
R186 long bond yield kicking up 55 basis points during the month.
This means the 5.3% return on the Albi for the first 10 months of the
year lags cash.
The rand lost 4% against the US dollar, 3% against the pound and
2.7% against the euro during October. It was 2.8% weaker against
the dollar over 12 months and this has boosted the returns from global
markets for domestic investors (rather than subtracting from returns, as
was the case earlier this year). The weak rand also supports the JSE,
given that it is dominated by global companies.
RISING REAL RETURNS
All in all, Morningstar data shows that the one-year return for the
average retail balanced fund was 12.6% at the end of October
(7% above inflation), while it was only 1.5% in June. Good short-term
performance also lifts long-term numbers. The three-year annual return
for the average balanced fund was 4.5% in June and below inflation,
but 7.8% at the end of October, more than 2% ahead of inflation.
The decline in inflation from an average of 6% in the first quarter to
4.7% in the third quarter is another boost for real returns. While the
softer rand and higher oil price over the past month or so will put further
upward pressure on the petrol price, the overall outlook is for inflation
to remain around 5%.
An important lesson from 2017 is that returns are lumpy. While the
JSE is up strongly for the year, February (-3.1%), May (-0.4%), June
(-3.5%) and September (-0.9%) were negative months. You have to sit
through the negative months to benefit from months like October and
July (+7%). Missing out on such strong short-term rallies can substantially
reduce long-term returns from equities. Over time, the market trends up
and there are more positive than negative months, but trying to time
the market successfully and consistently is not possible.
The other lesson is that most investors sitting on the side lines wait for
“the dust to settle” before getting back into the market. However, the
JSE surged from July onwards despite there being little meaningful
improvement in the political and economic situation in South Africa.
October’s rally came despite a gloomy Medium Term Budget that could
very well lead to further credit ratings downgrades. This is because
the global backdrop matters more for the JSE than local developments,
despite the fact that local investors often obsess about the latter. By the
time the dust has settled, the market has already priced in the new
reality and investors would have missed out.
November 6, 2017
The Wealth Room