Market commentary

It is increasingly difficult to find “green shoots” of hope when surveying the current South African economic landscape. The economy rebounded by 3.1% in 2Q2019 after the -3.1% recorded in 1Q2019. The mining and finance sectors contributed positively while manufacturing and trade detracted from economic growth in the quarter. For 2019 GDP growth of 0.6% is projected. Recent inflation updates and expectations show that inflation is at or near the midpoint of the 3%-6% target range despite fuel prices having risen 14.5% year-to-date and administered prices being hiked. Headline inflation of 4.2% is forecast for 2019. At their July meeting, the SARB elected to lower the bank rate by 0.25% to 6.5% while the prime rate was lowered to 10%. Effectively, the SARB returned to the SA consumer what it took away in November 2018. Business confidence (SA Chamber of Commerce and Industry Index) continued to drop in August to levels not seen in 34 years. The NHI Bill was released, setting out the architecture for an NHI fund. This has raised questions over the future of private healthcare and the cost and funding implications on government revenue. Prevailing policy uncertainty, the Eskom debt burden, an increasing budget deficit, and worsening debt-to-GDP ratio make a Moody’s rating downgrade ever more likely in the foreseeable future.

Credit must be given to Finance Minister Mboweni for publishing a paper offering a detailed examination of the structural reforms needed to reverse the downward trend in South Africa’s growth potential and competitiveness. Sadly, it was met with much resistance from alliance partners and some members in the ruling party. We hope that consensus could be reached sooner rather than later by all major role-players on implementing much needed economic and job growth initiatives as a matter of urgency.

Internationally, two interest rate cuts of 25 basis points each were announced by the United States Federal Reserve. Further import tariffs on Chinese goods were extended by the Trump administration until after the end-of-year festive season as trade negotiations between the world’s two largest economies continue with no clear solution in sight. The United States Treasury bond yield curve inverted at the two-year and ten-year maturities which caused some investors to speculate that a recession could be looming. The last time the yield curve inverted at these maturities was in 2007. In July, Boris Johnson was elected as the new Prime Minister of the United Kingdom. Johnson promised to deliver on the withdrawal of the United Kingdom from the European Union even if it comes at the cost of having no trade agreement (a so-called Hard Brexit). Early indications are that Johnson will struggle to win the necessary parliamentary support to deliver on his promise (as was the case with his predecessor).

Portfolio commentary

The Fund is focussed on delivering consistent above average capital growth over the medium to long-term. It may be that in the short term, returns are volatile due to the high equity mandate of the Fund. During this quarter, the ongoing trade war between the US and China and the global economic slowdown dominated headlines, while a drone attack on Saudi Arabian oil fields, causing oil supply disruptions, sent the oil price spiralling higher adding to prevailing investor nervousness. In an uncertain global and local economic environment where downside risks are elevated, it is prudent to place a greater emphasis in capital protection. For the quarter under review the Fund’s return was flat (-0.05%) against its benchmark of 0.15%. The JSE All Share Index returned -4.57% and listed property stocks reporting a similar -4.44%. Cash returned 1.83% and the All Bond Index a positive 0.78%. It is worth noting that foreigners have continued to be significant net sellers of SA equities in the period under review. A below benchmark weighting to equities and higher fixed interest weighting helped to preserve capital. Poor fundamentals for listed property caused the Fund to reduce to zero its direct property exposure by exiting the Sesfikile Property Fund. This is an asset allocation decision despite us liking the Sesfikile management team and investment process. The offshore diversification in the Fund is obtained through shares held directly in global listed stocks. Berskshire Hathaway and Fedex shares were sold while shares in Coca Cola were added. The offshore component of the Fund returned 5.2% in the quarter. The specialist managers selected for the Fund have remained mostly unchanged over the quarter apart from selling the Mazi Capital Prime Equity Fund and lowering exposure to the other equity managers as the Fund’s equity exposure was pared back in favour of fixed interest assets. The Prescient Money Market Fund was sold and holdings in the Stanlib Income Fund and Nedgroup Investments Core Income Fund added. Caution remains our default stance until signs of a turnaround in local economic fortunes emerge.

Macroeconomic overview

The Autus Investment Team customarily begins the year with a strategic investment workshop to consider the economic and investment factors likely to influence the markets in coming year. This year the mood was less sanguine because members identified several risks to keep an eye on in the coming months. These include the dire state of the government finances and its ever-increasing debt exacerbated by the perilous state of the SOE’s -especially Eskom, credit downgrade potential, the looming national election and a slowing global economy amongst others.

During the quarter the national budget, read by Finance Minister Tito Mboweni, confirmed government’s desperation to raise additional revenue, cut rising expenditure and reduce financial demands from poorly functioning SOE’s. Eskom’s crisis deepened and the intermittent load-shedding is retarding national productivity and economic growth. SA GDP grew by 0.8% in 2018 and is forecast to grow by 1.5% in 2019. Goldman Sachs recently predicted that the electricity crisis could subtract 0.3% from Q1 GDP growth. The RMB/BER Business Confidence Index slumped to a low of 28 index points in the first quarter of 2019. Seven out of ten business people polled expressed dissatisfaction with the current business environment. Particularly concerning is that the declining confidence cuts across all sectors of the economy including the building, retail and manufacturing sectors. The consumer remains constrained and with rising petrol costs, hikes in electricity tariffs and a weaker rand, inflation may begin to tick up. For February 2019, a consumer price inflation rate of 4.1% was recorded. This was comparatively benign mainly because food costs remained relatively constant. Inflation for 2019 is expected to remain within the 3-6% SARB target range. With a frail local economy, slowing global growth and moderate inflation the SARB is not expected to raise interest rates in 2019. At their March review, Moody’s left their rating unchanged.

Internationally, global growth is beginning to slow. Interest rate hikes in the US are looking less likely this year as consumer spending weakens. Talks of a US recession are beginning to emerge. Interest rates in China were lowered during the quarter to support flagging growth there. The lack of consensus in the UK on an acceptable Brexit and the concomitant uncertainty is harming new investment and the prospect of growth in the UK. European economies are forecast to remain stable in 2019. The Brent crude oil price has risen by 27% to end the quarter at US$69.00. The global inflationary impact of these higher prices, if sustained, will be closely monitored. These factors combined with the ongoing trade negotiations between China and the US have fuelled investor jitters. We expect more of this jostling to occur in the markets until these major issues are resolved.

Portfolio commentary

This high equity multi-asset fund aims to generate constant capital growth over the medium to long-term. The Autus multi-fund process undertakes active asset allocation and selects asset class specialists to manage the various asset components of the Fund. Investors in the Fund therefore achieve diversification of assets as well as asset managers. The asset allocation process is informed by the team’s assessment of macro and well as micro economic factors both local and international. The offshore component of the Fund is directly managed by Autus Fund Managers. The Fund began the quarter under review with an underweight exposure to risk assets and an overweight holding in cash and fixed-interest investments with a short duration. During the quarter the equity holding was gradually increased to a neutral benchmark weight. Property remained underweight while within the fixed-interest asset class, the mix between short-term and longer duration bond funds was tilted in favour of the latter. The Fund’s cash holding was reduced.

The specialist managers selected for this Fund combine large as well as boutique managers with investment pedigree. During the quarter, the Satrix Alsi Index Fund, Coronation Equity Fund, Marriott Dividend Growth Fund and Coronation Bond Fund were added to the portfolio. The RECM Money Market Fund, Momentum Bond Fund and Coronation Money Market Fund were sold. The offshore shares held include includes global blue-chip stocks such as Mastercard, Microsoft, Visa, Amazon, Apple and Alibaba shares. A holding in the Vanguard S&P 500 Index provides low cost exposure to US companies. For the quarter, the Fund returned 3.6% versus its benchmark of 6%. For the six-month since its inception at the end of September 2018, the Fund returned 4.8% compared to its benchmark of 1.3%. Most importantly the fund has not recorded a negative return albeit in a very short performance history. Uncertainty will prevail in the minds of investors as the general election approaches. The election outcome could have a significant bearing on the performance of investment markets depending on how economic and investor friendly policies are addressed. We remain cautious favouring capital preservation above return during this phase of the market cycle.