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.

Global equity markets rebounded in June, with the MSCI World Index posting a US Dollar total return of +6.6%. All the MSCI World regions recorded positive total returns in June: North America +7.0%, Europe +6.8%, and Pacific +4.7%. In the US, the Dow Jones finished its best June since 1938.

MSCI Emerging Markets recorded a total return of +6.3%, while MSCI Frontier Markets only managed a return of +2.4%. Within Emerging Markets, MSCI Asia (+6.4%) was the best performing region, boosted by robust performance from South Korea (+8.9%) and China (+8.1%). MSCI EMEA gained +5.9% in June, with the largest outperformance coming from Russia (+9%). MSCI South Africa (+6.3%) was the fifth best performing country within this region. In commodities, the US-Iran standoff and falling American stockpiles have propelled oil towards its biggest monthly gain since January ahead of the OPEC meeting in July. Bullion rocketed to a six-year high and prices are holding above US$1 400 an ounce. Gold prices have climbed by 8% in June, their best return in many years, driven by global economic uncertainty and the US Dollar.

For the second quarter of 2019, MSCI World recorded a US Dollar total return of +4.2% (+12.6% in 1Q19), outperforming MSCI Emerging Markets (+0.7% in 2Q19 vs +10% in 1Q19). MSCI South Africa (+6.8%) outperformed both MSCI World and MSCI Emerging Markets in Q219. For the first half of 2019, MSCI World delivered a total return of +17.4%, outperforming MSCI Frontier Markets (+12.1%) and MSCI Emerging Markets (+10.8%). Within MSCI World, North America was the best performing region with a return of +18.9%, followed by Europe's 16.5% and the Pacific region's +11.3%. In fact, the S&P 500 Index posted its best first half in 22 years as a banner June followed a dismal May. The S&P ended 2Q19 up +3.8% and has risen +17% in 2019.

Within MSCI Emerging Markets, most countries posted positive US Dollar total returns in the first half of 2019, with Russia (+31.6%) the best performing country among the major markets and Brazil (+16%) and China (+13.1%) also strong. MSCI South Africa returned +11.7% during the period. All equity sectors within MSCI World delivered positive US Dollar total returns in the first half of 2019, with the best performance coming from IT, Industrials and Consumer Discretionary. Consumer Discretionary, Real Estate and Energy were the top performing sectors within EM. Within MSCI South Africa, Communication Services and Energy outperformed, while Health Care and Industrials posted negative US Dollar total returns. In Rand terms, SA equities staged a recovery in June with the All Share Index recouping its losses of May with a Rand total return of +4.8%, its best monthly performance since April 2018. Blue-chip large cap stocks delivered the best performance, gaining +5.3%, while mid-caps were up +2.5%. Small caps posted a loss over the month, albeit only -0.2%. The All Bond and SA Listed Property indices each returned +2.2% in June.

SA Resources delivered a solid total return of +10.2%, driven by Gold Mining (+24.5%) and Platinum (+14.8%). SA Industrials remained steady, returning +3.8% in June. Healthy total return performance came from Personal Goods (+12.3%), Media (+9.9%), Beverages (+4.6%) and Software (+4.4%). SA Financials managed to eke out a total return of +1.3% in June. Real Estate Development & Services returned +3.9%, followed by General Financials (+3.2%). The worst performance came from Equity Investments (-1.4%).

In the above described quite volatile environment, the Optimised Equity Fund outperformed its benchmark during June, with positive contributions coming from a variety of alpha sources, including overweight and underweight exposures, global and domestic stocks as well as large caps and small caps, all highlighting a diversification of risk. Main detractors included the structural underweight exposure to Naspers for risk management reasons, given its outsized weight in the index. An underweight position in Richemont, which is deemed expensive, and overweight positions in Standard Bank and SPAR Group also dampened performance.

With the first half of 2019 now gone, many of the issues concerning markets at the beginning of the year are still lingering, either in the same form or in just slightly different guises: US-China trade tensions, monetary policy outlook by central banks, Brexit, geopolitical risks, particularly in the Middle East. And while here in South Africa successful parliamentary elections took place at the beginning of May, investors, business and consumers alike still have to see detail and implementation of some of the ambitious reforms and policies announced by the government, not least addressing the financial malaise of the parastatals, including Eskom.

The just announced resumption of trade negotiations by US President Trump and China's President Xi at the G20 meeting, does not feel like a move towards a convincing solution in the US-China trade spat. While it is clear that both countries can do with a temporary reprieve - the former for political, the latter for economic reasons - the real battle is, in our view, not about trade, but about global political systems and structures, with China challenging the US's position as the ultimate super power. This battle is likely to last for years, if not decades to come, and will be particularly prevalent in the technology sector, given its increasing importance, not only in an economic but also a military sense. The sanctions imposed by the US on Chinese companies like ZTE and Huawei are not a coincidence, and any reprieve granted, like now in the case of Huawei at the G20 meeting, is likely to be temporary and will be replaced by other sanctions going forward.

Indeed, notwithstanding the resumption of talks, scope remains for re-escalation to emerge. Tracking how the talks evolve from here, and in particular the critical issues related to speed of tariff removal, non-tariff barriers, intellectual property rights and amount of purchases, will be key. Should we see re-escalation (i.e. the US imposes 25% tariffs on the remaining US$300 billion of imports from China and they remain in effect for four to six months), it would heighten the risks to the global cycle, and we could wind up in a global recession in about three quarters.

Heading into the meeting, it was clear that the global capex cycle had ground to a halt. Capital goods imports, a capex proxy, began their descent in mid-2018, when trade tensions first re-emerged. In July 2018, they were tracking at 18%Y on a three-month moving average basis but plummeted to 2%Y in January 2019 and an estimated -3%Y in May 2019. In aggregate, private fixed-capital formation (investments in fixed assets) in the G4 and BRIC economies fell from a peak of 4.7%Y in 1Q18 to just 2.8%Y in 1Q19.

Given the trade tensions between the two largest economies globally, central banks have turned markedly more dovish during the first half of this year, basically providing a 'put' to global markets. Across the G20, six central banks have loosened monetary policy either by cutting policy rate; announcing a more accommodative outlook for the balance sheet; easing the forward guidance; or using other alternative tools. Consequently, each individual central bank easing increases the likelihood of a global cascade of tit-for-tat easing. It is doubtful this will do much for the economy - but it could well trigger a renewed boom in asset prices.

With global money supply about to hit a fresh record high, the direction of the Dollar will thus be crucial for emerging and global risk markets. Although headlines from the trade war are likely to impact the market in the short term, the medium-term direction continues to be dictated by the provision of liquidity.

These easing efforts will impact the economy with lagged effects. Policy easing is necessary but won't be sufficient to revive corporate confidence and engineer a strong pick-up in growth. That would require a combination of monetary easing and an all-clear signal on both trade policy and geopolitics.

As mentioned before, for South Africa, the key ingredient will be the speedy implementation and successful execution of economic reform programmes and policies to create growth and thus instil confidence in consumers, business and investors. The next three to six months will be crucial here, in particular dealing with the financial situations at Eskom and the SOEs in general, notwithstanding widely anticipated cuts in interest rates by the South African Reserve Bank due to benign inflationary data and a benign global rate environment. Given the slow-growth environment, South African stock market valuations are not cheap anymore, with further risks to earnings rising. Further risks to the SA stock market are its dwindling weighting in global indices, reducing from >12% to about 6% currently in the MSCI Emerging Markets Index, with further downside to come as other markets get included (China, Saudi Arabia, Argentina, Kuwait). Unless economic growth filters through to our stock market, incentives for foreigners to buy our market and move away from their current underweight position in their portfolios, reduce even more, potentially rendering the SA market irrelevant to global investors in a worst-case scenario. The upshot is that if government reforms lead to growth, SA could become one of the few countries in the world with accelerating economic variables, thus attracting foreign flows and helping the economy along further.

Overall, as mentioned before, our base-case scenario has been that we are in a global 'soft patch' of the economy, where economic indicators are low enough as to not lead to inflation, giving central banks room to keep interest rates low and thus extending the maturing cycle, while trade wars are putting a spanner in the works. Those two opposing forces are likely to continue to create volatile markets, where successful stock picking and a robust portfolio construction framework will be key to deliver good returns.

The MSCI World Index outperformed frontier and emerging markets in March, posting a US Dollar total return of +1.4% versus +1.2% for the MSCI Frontier Markets (FM) Index and +0.9% for the MSCI Emerging Markets (EM) Index. All the MSCI World regions recorded positive total returns in March: North America (+1.7%), Pacific (+0.8%) and Europe (+0.7%). Within EM, MSCI Asia outperformed with a total return of +1.8% in March. India returned +9.2%, followed by China (+2.4%). South Korea (-3%) and Malaysia (-2.8%) were the worst performers within the Asian region. MSCI Europe, Middle East & Africa (EMEA) and MSCI Latin America underperformed, posting total returns of -1.3% and -2.5% respectively. MSCI Turkey (-14.8%) was the worst performer within MSCI EMEA (and MSCI EM). MSCI South Africa shed -1.6% in March in US Dollar terms as the Rand weakened. Chile (-4.4%) and Brazil (-3.8%) were the worst performers within MSCI Latin America.In March, Real Estate was the top performing equity sector within both MSCI World and MSCI EM. This was followed by Consumer Staples and IT within MSCI World, and Communication Services and Consumer Discretionary within MSCI EM. Financials was the worst performing sector within MSCI World, while Industrials was the worst performer within MSCI EM in March.

Within MSCI SA, Energy (Exxaro), Consumer Discretionary (Naspers) and Communication Services (MC Group, MTN) posted solid US Dollar total returns. Health Care (Aspen, Netcare) and Industrials (Bidvest) were the worst performing sectors in March.

Year to date, MSCI World has provided a US Dollar total return of +12.6%, as the S&P 500 Index posted its best quarterly return in a decade, and the Russell 2000 Index its best quarter since 2011. All amid hopes of a trade deal between the US and China, an overly dovish Federal Reserve (Fed), which has changed its outlook to no more rate hikes this year (from the prior view of two), strong quarterly earnings results and buying momentum after the December stock swoon. Emerging markets returned +10% in US Dollars since the beginning of the year. The relative underperformance of EM comes as money continues to leave emerging markets and go back to developed markets, as the Dollar refuses to weaken. Emerging markets have been unchanged since the beginning of February and has now underperformed the S&P 500 by 3.5% since the start of the year. Year to date, EM Asia returned +11.1%, boosted by the strong performance from China (+17.7%), while Latin America returned +7.9%, boosted by Brazil (+8.2%). Within EMEA (+5.6%), the best country performance has come from Egypt (+15.9%), Greece (+12.8%) and Russia (+12.2%) while MSCI South Africa returned +4.6%. Turkey (-3%) is one of only three emerging market countries to post negative total returns in the year to date.



The Rand had another volatile month, ending March -3.1% lower against the US Dollar. Across asset classes, the Citigroup Investment-Grade Bond Index yielded a total return of +1.3%, as the Fed announced a pause in its hiking cycle. Meanwhile, South African bonds lost ground on an absolute and a relative basis: in US Dollar terms with SA 10-year bonds falling -1.2%. Commodity correlations moved away from their long-term norms over the past month, ith metals in particular shrugging off lacklustre underlying demand. Bulk and base metals strengthened, with iron ore prices closing in on US$100/ton, boosted by supply disruptions in Brazil and Australia. Within precious metals, palladium saw a stellar rise to close to US$1 600/oz before spectacularly collapsing by about 20% just before the month end. Oil prices also continued to firm, jumping over 30% the first three months of the year, posting the best return in a decade.
In South Africa, March 2019 was a particularly eventful month: Eskom implemented load shedding stage 4 for nine days in a row, severely hampering economic growth, while the SA Reserve Bank (SARB) left interest rates unchanged as expected, and the anxiously awaited Moody's announcement at the end of the month ended with a positive 'no-change' message to the market, preserving South Africa's investment-grade rating. In Rand terms, the South African equity market as represented by the FTSE/JSE Shareholder Weighted Index (SWIX) continued to show positive performance for the fourth consecutive month in March of +1.2%. This gain was driven by the +2.3% total return from the Large Cap stocks. Mid-Caps and Small Caps shed -1.8% and -2.7% respectively. Bonds as represented by the FTSE/JSE All Bond Index (ALBI) underperformed versus equities, with a total return of +1.3%. The FTSE/JSE SA Listed Property Index (SAPY) showed the largest underperformance, shedding -1.5% in March.

In South Africa, March 2019 was a particularly eventful month: Eskom implemented load shedding stage 4 for nine days in a row, severely hampering economic growth, while the SA Reserve Bank (SARB) left interest rates unchanged as expected, and the anxiously awaited Moody's announcement at the end of the month ended with a positive 'no-change' message to the market, preserving South Africa's investment-grade rating.

In Rand terms, the South African equity market as represented by the FTSE/JSE Shareholder Weighted Index (SWIX) continued to show positive performance for the fourth consecutive month in March of +1.2%. This gain was driven by the +2.3% total return from the Large Cap stocks. Mid-Caps and Small Caps shed -1.8% and -2.7% respectively. Bonds as represented by the FTSE/JSE All Bond Index (ALBI) underperformed versus equities, with a total return of +1.3%. The FTSE/JSE SA Listed Property Index (SAPY) showed the largest underperformance, shedding -1.5% in March.

SA Resources again posted the best performance in March with a total return of +4.4%. This was on the back of a solid performance by Industrial Metals (+19.2%). General Mining returned +7.5%, and Chemicals returned +5.3% in March. Following three months of solid total return performance, Gold Mining shed -4.5%, while Forestry & Paper lost -4% over the month. SA Industrials posted a total return of +2.9% in March. Of the industry groups, Technology was the best performer with a total return of +9.3% (note that as of 1 March, Naspers was reclassified from Media to Software & Computers). Telecommunications returned +5%, with MTN posting a total return of +10% and Telkom a total return of +4.1%. Consumer Goods gained +1.8% in March with Tobacco returning (+18.7%) and Beverages (+10%). Health Care (-14.1%) was the worst performing industry group as Aspen lost -33.3% following their results. Industrials showed a loss of -5.3% in March with General Industrials shedding -5.9% and Construction & Materials shedding -5.7%. General Retailers were -5.3% lower while Media (MC Group, which was unbundled from Naspers during the month) gained +14.9%.

SA Financials lost -4% in March as negative sentiment around the Eskom load shedding and preceding the Moody's announcement at the end of the month led to a sell-off in the Rand and bond market. The worst performance in Financials came from Banks (-6%) and Life Insurance (-4.9%).

Year to date, the FTSE/JSE All Share Index (ALSI) has posted a total return of +8% versus total returns of +3.8% for the ALBI and +1.5% for the SAPY. SA Resources and SA Industrials have gained 17.8% and 7.4% respectively. SA Financials have been flat (-0.4%).Of the industry groups, the largest year-to-date outperformance versus the ALSI has come from Basic Materials (+18%) (Industrial Metals +54.9%, Platinum +49.7%, General Mining +22.4%) and Consumer Goods (+12.4%) (Tobacco +29.5%, Beverages +24.8%). The largest underperformance has come from Health Care (-12.7%) and Industrials (-3.9%).

The Optimised Equity Fund outperformed strongly during the month, with top positive contributions coming from overweight positions in British American Tobacco, BHP, Anglo American, AB InBev and the fund's offshore exposure, while substantial underweight positions in Aspen, Nedbank, Remgro and Discovery also added strongly. Detractors included the structural underweight holding in Naspers given the risk of its outsized weighting in the index, the fund's exposure to financials and mid-caps, as well as the underweight positions in Sasol, whose rise on the back of a stronger oil price was captured through exposure to BHP in particular.

What to expect going forward? Globally, it seems that the outlook for economic growth, while slowing, is not precarious as yet, while pockets of weakness, such as Europe, or concerns, such as China, need to be watched. Much will depend on the conclusion of a US?China trade deal and it looks likely that some form of deal will be announced, not the least because both parties need a deal: China needs to stem a structural slowdown, while the US will be heading into elections, with the Trump administration eager to use a deal in electioneering. While a US?China trade deal will be a relief for markets globally, it is worth pointing out that the ramifications for global trade are still murky: the potential deal being a bilateral agreement between the two largest economies globally, implications for third-party suppliers or marketshare losses in other large economies like Europe (Germany) or developed Asia (South Korea, Japan), are not easy to forecast, and could provide ample reason for further volatility.

The recent inversion of the US yield curve provided further reason for market nervousness, as an inversion usually heralds a recession following 12 to18 months later. While markets usually still rise strongly during that period, concerns about stock valuations and earnings delivery in the US in particular, keeps investors sceptical and hesitant to commit funds at this stage of the cycle. This keeps the current environment volatile as investors reluctantly 'climb the wall of worry' and put more money to work. Here in South Africa, following the positive Moody's decision, we see two key risk events until the end of the year: first will obviously be the parliamentary elections on 8 May and, until then, much electioneering-related news might keep markets relatively thinly traded and volatile. As mentioned before, while the market seems to have priced in an ANC victory of at least 55% ? with a lower number possibly leading to a selloff - most election outcomes should lead to some form of certainty and stability, something craved by consumers and businesses alike, in order to commit to investments and growth. A recent statistic showed that household deposits at banks are close to all-time highs as a percentage of GDP at 23% at the end of 2018, highlighting the potential for consumer spending, which in turn could lead to heightened business activity, as inventories and capex are at multiyear lows. The second risk is less precise around a date, but rather lies around the steps taken to solve the Eskom crisis. The challenges to prevent further load shedding and optimise the current assets operationally have to be seen in conjunction with the large potential fiscal and credit implications from financing the improvements at the SOE. A large part of creating sustainable economic growth going forward will depend on how this challenge is going to be tackled and markets will be watching closely.

Our view of the above is that we are likely to see some form of a US?China trade deal announced soon, and that markets are likely to squeeze higher on the back of positioning and improving earnings revision ratios again. We also believe that any recession fears at this stage are overdone and priced in too quickly as well, since equity markets typically lead recessions by between six to 12 months, and there is no sign of that as yet. Other indicators such as high-yield corporate spreads, PMIs, wage growth, unemployment, volatility and house prices are not yet moving into worrisome territory. A slowdown in global growth will likely occur into 2019 but recession fears may be pre-emptive for now.

In addition, central banks have turned distinctly dovish, which will probably support a growth rebound in the second half of 2019, which will also support equity markets. In South Africa, the potential is for an upside surprise in markets, given overall negative sentiment, growth expectations and positioning. With all of that, the fund remains constructively positioned, as we continue to believe that the latecycle bull market is still intact, while a balance remains to cater for expected higher volatility levels globally, and here in SA, particularly driven by currency movements.

Global markets started the month of September on a downward trend with the MSCI EM reaching an intra-month low on the 12th of September, but rebounding to end largely flat with a US dollar total return of -0.5%. MSCI Frontier Markets also ended the month unchanged, while MSCI World Markets managed to eke out a positive US dollar total return of 0.6%. Within MSCI World markets, the Pacific region posted a US Dollar total return of 1.9%, while the European and North American region each gained 0.4%.
Those market moves came about as the US imposed 10% tariffs on the roughly $200bn of Chinese imports and the retaliatory Chinese differential tariffs on $60bn of US products. At the same time, and after a very volatile negotiation period, the US agreed a new trade deal with Mexico and Canada, replacing the original NAFTA agreement. In Europe, concerns about the health of the EU/euro flared up again as the Italian government agreed on a 2.4% of GDP budget deficit target for the next three years, higher than the prudential limits agreed within the Euro area. September also saw continued tightening by central banks in the US and major emerging markets.
Among the commodity complex, oil was one of the best performers, as US sanctions on Iran took its toll, with supply side concerns driving crude prices higher. As a result of those macro headwinds, within emerging markets (EM) MSCI Asia (-1.7%) was the worst performing region, dragged down by losses from heavyweights India (-9.1%), Malaysia (-1.6%), Indonesia (-1.6%) and China (-1.4%). Thailand outperformed with a total return of 3.2%. MSCI LatAm (4.7%) was the best performing EM region in September, with heavyweight Brazil returning 7.0%. MSCI EMEA gained 1.9% in September. Turkey rebounded from the sharp losses in August, gaining 20.6%. Russia returned 9.9%. MSCI Greece and Egypt shed 8.2% and 6.3% respectively, while MSCI SA posted a loss of 1.9%. As a result of the sharp oil price move, Energy was the top performing equity sector within World and Emerging markets in September, while Real Estate was the worst performer in both.
In the third quarter of 2018, MSCI EM returned -0.9% vs -7.9% in the second quarter. The MSCI World index returned 5.1% over the third quarter vs 1.9% in the second quarter. Within MSCI EM, the best third quarter performance came from the LatAm region (4.9%). Heavyweights China (-7.4%) and South Africa (-7.2%) were a drag on their respective regions over the quarter, with Asia being 1.7% lower and EMEA 1.4% lower. Year-to-date, MSCI South Africa has lost around 21%, with the rand depreciating by 12.5% against the US dollar. Looking at September in rand terms, the South African equity market fell across the board, with the ALSI losing 4.2%. Large Cap and Mid Cap stocks shed 4.4% and 3.7% respectively, while the Small Caps shed 1.7%. Property was also under pressure, losing 2.6%. SA Bonds, however, managed to eke out a small positive total return of 0.3%.
On the macro front, President Ramaphosa outlined a stimulus package in September that aims to kick-start the economy by reprioritising the current expenditure mix to target growth- and employment-generating projects. The key aim of the package is to improve implementation using existing resources. It is deemed positive that the drive for successful implementation of all these goals is coming directly from the president. In terms of growth, however, the impact of this package might only be judged in hindsight, as a lot will depend on the speed and efficacy of implementing many of the promised projects in the plan. September’s release of SA’s CPI inflation eased to 4.9% year-on-year in August, from 5.1% in July, and was better than the consensus of 5.2%, contributing to the SA Reserve Bank keeping interest rates on hold, while the vote was close. After big losses in previous months, the USDZAR strengthened by almost 4% in September as risk sentiment improved and the US dollar weakened. However, the rand was quite volatile in the interim, weakening above R15.50/USD, but coming back sharply as risk sentiment towards emerging markets improved and volatility eased.
With all of the above, the largest negative equity performance came from SA Industrials (-7.7%), which posted its worst monthly performance since February 2009. The downturn was led by Pharmaceuticals (-39.7%), Personal Goods (-9.7%) and Food Producers (-8.0%), amongst others. SA Financials lost 2.0% in September, with the worst performance coming from Equity Investments (-6.6%), Banks (-3.4%) and REITs (-2.9%). Non-life and Life Insurance posted positive total returns of 9.8% and 1.1% respectively. SA Resources once again outperformed over the month, returning 1.0%, with Platinum returning 16.5%.
In the third quarter of 2018, the ALSI posted a rand total return of -2.2% vs 4.5% for the second quarter and -6.0% for the first quarter. SA Resources and SA Financials outperformed in the third quarter with total returns of 5.2% and 2.8% respectively, while SA Industrials was the drag on the index, shedding 7.8% over the quarter. The All Bond index was virtually flat with a total return of 0.8% in the third quarter vs -3.8% in the second quarter and 8.1% in the first quarter. The SAPY returned -1.0% in the third quarter vs -2.2% in the second quarter and -19.6% in the first quarter. The Optimised Equity Fund outperformed again during the month, with Aspen being the biggest positive contributor as our zero-weight position due to balance sheet concerns of the company played out and the stock dropped more than 40%. Our overweight position in select resources, namely Anglo American, BHP Billiton and Impala, as well as select offshore holdings, all contributed positively, despite the strengthening rand. Detractors included some select small- and midcaps, but here we are comfortable with our positioning due to a strong value underpin, in our view. One more word on avoiding Aspen: The fund has been able to generate significant alpha over the past 12 months by being able to avoid “stock bombs” like Steinhoff, EOH, Resilient, and most recently MTN and Aspen, all stocks where the fund had mostly zero holdings due to ESG or significant balance sheet concerns. While we also successfully avoided Lonmin and ABIL in the past for the same reasons, we are not claiming to be able to avoid stock bombs all the time, particularly if fraud by insiders is involved.
However, while we certainly sometimes make investments which don’t generate the desired returns, we do believe that our detailed and disciplined approach to investing in general, and ESG in particular, gives us the confidence to make sometimes contrarian decisions (often those “bombs” are particularly popular), to protect our clients’ assets and obtain the alpha we are mandated to generate. During September our investment team also attended a major investment conference with 12 keynote speakers and over 160 representatives from 65 JSElisted corporates. While the mood at the conference was still considerably subdued, given the current political and economic challenges here in South Africa and globally, the macro environment for SA listed stocks seems to have improved versus a year ago. Thus, our team noted opportunities in stocks where either the self-help element is strong, or where a strong business model and execution helped gain market share from weaker competitors, strengthening their overall positioning. Opportunities in the mining sector also started to show up, as a tough environment over the past few years forced companies to focus on cost efficiencies and repairing balance sheets.
Looking ahead, we believe that the outlook is far from smooth sailing, and while we continue to believe that we are in a late cycle bull market where some good returns and alpha can still be obtained, this comes at a cost: volatility. Sellside research shows that over the last quarter two-thirds of all ALSI constituents saw a 5% intraday move! As a reminder VIX is still at 12 vs an average of 17.07 post the financial crisis. If it normalises as central banks rein in liquidity, this is only the beginning.

Return and risk are two inseparable sides of the same coin. Therefore, we continue to advocate a disciplined and balanced portfolio construction approach, to protect the alpha which is the result of careful stock selection.