Market review

Global markets

Global equity markets experienced another relatively good quarter, albeit with more modest performance than in the first quarter (Q1). Looking at the indices in US dollars – on a total return basis the S&P 500 Index gained 4.3%, the MSCI World Index gained 4.2% and the MSCI Emerging Markets Index, lagged again, closing 0.7% higher this quarter. The surprising decline in long dated developed market government bond yields, which started in Q1, did not subside. Yield on US 10 year maturity bonds declined from 2.4% at the end of Q1 to 2.0% at the end of Q2 and the yield on 10 year German bonds declined from -0.1% to -0.3%.

In late June, the Federal Reserve (the Fed) indicated that it might cut interest rates sooner than previously thought by cutting the word ‘patient’ out of its policy statement. It added that it would ‘act as appropriate’ to sustain economic expansion. President Trump has often taken to Twitter to share his exasperation with the Fed’s previous rate increases. Prime Minister Theresa May announced that she would step down as leader of the ruling Conservative Party in the United Kingdom after successive failures to deliver an acceptable Brexit deal. Boris Johnson and Jeremy Hunt are in the race to replace May as leader. Both Johnson and Hunt have claimed that they can renegotiate the withdrawal deal with the European Union and get it through Parliament before the expiry date of 31 October 2019.

South African markets

South African markets outperformed their emerging market peers. The FTSE/JSE Capped Swix gained 2.9% in rand. The US dollar investor benefited from rand strength, as the rand gained against the US dollar from R14.48 at the end of Q1 to R14.07 at the end of Q2. South African bonds delivered strong performance again this quarter, closing 3.8% higher at the end of June.

South Africans went to the polling booth in May. The ANC secured 57.5% of the vote, which was the worst performance for the party in a national election). The DA and EFF, in second and third place respectively, received 20.8% and 10.8% of the vote. The ANC secured outright majorities in all regions except the Western Cape, where the DA maintained its majority.

In June Stats SA published its estimates of gross domestic product (GDP). The economy contracted by 3.2% in Q1 – recording the largest quarterly drop in output since the financial crisis.

Performance

The continued positive returns from both global and local equities has been fueled by the prospect of ‘lower for longer’ global interest rates and higher commodity prices, the latter supporting a 10.2% return in June for the resources sector (driven mainly by gold and platinum).

South African market returns in the second quarter were driven by financials returning 5.4%, followed by industrials returning 4.0% and resources returning 2.4%.

For the quarter, our portfolio has outperformed its benchmark. A number of our small cap holdings have contributed significantly to the performance in the quarter – these include Altron (+37.3%), Libstar (+24%) and Adcorp (+22%). Other holdings that added to returns are Absa (+20.3%), MTN (+20.5%) and Investec (+8.9%).

Finally, as mentioned in the past, investing is in many respects a negative art. Avoiding losses is as important as the desire to make a profit. In this regard, many of our best decisions were to avoid poor investments which have come under significant scrutiny the past quarter. These include Redefine (-30%), Omnia (-31%), Robosis (-65%), and Tongaat (-39%).

Portfolio review

This has undoubtedly been one of the more anxious periods for South Africans. In addition to having to deal with electricity outages and a general rise in the cost of business in South Africa, corporates are under pressure to cut costs in order to protect profits and returns. Consumers are having to deal with higher VAT, fuel and administered prices (such as electricity) and this is impacting on discretionary spend. Consumer and business confidence remain low. We remain cautious on domestic South Africa and do not see a dramatic improvement in economic growth in the shorter term. Although there are uncertainties surrounding Brexit risks as well as the United States–China trade related issues, global growth could well be supported in the short term by lower interest rates.

Despite macro concerns, we should not lose sight of the fact that great long-term opportunities often emerge in tough environments. In this environment we continue to seek out mispriced opportunities where we have above average conviction. Our objectives are to ensure we focus on constantly improving the quality of the portfolio while reducing the role of chance which unknown macroeconomic events may have. In a tough environment it does not pay to invest in poor quality, highly geared businesses. We remained focused on sticking to our strengths, such as stock picking in an uncertain environment.

In this regard, the heightened uncertainty has created some good opportunities. New positions in the portfolio include AVI, ABInbev and Dis-Chem.