The fourth quarter of 2019 dramatically reversed the trend of the previous quarter, with strong equity advances to record highs. The US maintained strong positive momentum while emerging market equities led global markets, buoyed by the strength of EM currencies relative to the US dollar.

Increasing risk-appetite fuelled a sustained rally across most asset classes, as market participants responded to narratives of de-escalating trade tensions and continued stimulus.
The US Fed has continued to act in line with a reversal in policy stance and obliged the market with aggressive repo operations since September. The Fed’s pivot in January ushered in a ‘risk-on’ rally and the fourth quarter was the culmination of an exceptional year for risk-taking. Central banks across the world are responding aggressively to stave off an economic slowdown. Market participants are positioned for a melt-up and they have not been disappointed.

The CBOE Volatility Index (VIX) spiked in May and has stabilised since then. For the moment, the market appears willing to disregard macro headwinds and extreme valuations. Central bank support remains the overriding narrative and US equities remain close to all-time highs.

An additional feature of the quarter was the marginal rise in developed market bond yields. Global Bonds declined by 0.50% as market participants started to price in a Fed stalemate and a resumption in synchronised global growth. Emerging market bonds advanced in line with the rally in emerging currencies and a renewed search for yield. The signal from the bond market remains unclear and the weakness in trend suggests a low level of conviction.
For the quarter, most major asset classes advanced, with relatively few losers. Gold surged by 3.04%, in line with US Dollar weakness and despite rising yields. Gold appears to be trading in line with real yields and the increasing demand for safe havens, in an environment of rising uncertainty. It is rare for Gold to be correlated with risk assets and time will tell which asset class is providing the correct signal.

The MSCI World Index surged by 8.7%. MSCI Emerging Market Index advanced by 11.9% over the quarter, aided by an explosive rally of EM currencies relative to the dollar.

Global property, as measured by the iShares Developed Market Property Yield ETF which tracks the FTSE EPRA / NAREIT Developed Index advanced by 1.96% over the quarter. Global Property was relatively resilient during the market drawdown in late 2018 and displayed the same resilience in 2019.

On the domestic front, global market action had a positive knock-on effect on SA Bonds. Political and economic issues remain but this was crowded out by the positivity in global risk assets.

Domestic fixed income securities had another positive quarter. The All Bond Index managed a positive return of 1.70% while inflation-linked bonds, as measured by the JSE CILI Index struggled with a 1.10% decline. Cash, as measured by the STeFI index, returned a steady 1.70%. The JSE Preference Share Index had another exceptional quarter with a positive return of 2,97%. SA Listed Property had another lagging quarter, despite managing a meagre advance of 0.60%. The listed property sector is struggling to sustain a recovery and has yet to reach the January 2019 peak.

The All Share Index advanced by 4.60%, which reversed the decline in the previous quarter and provided a welcome return to the positive momentum of the first half of 2019. The advance was broad based and in terms of sectors, SA Industrials lagged with a flat performance for the quarter. Mid-Caps surged, with a 12.4% advance, while Small-Caps continued to lag with a 0.7% return. Small-Caps are down by 4.1% for the year. In terms of Equity sectors, the top performers were Platinum +47.0%, Pharmaceuticals +30.9%, Gold +26.1% and Chemicals +19.6%. The worst performers were Fixed Line Telecoms -49.9%, Beverages -15.0% and Household Goods -14.3%.

In Q4, SA Equities advanced by more than other Emerging Markets. The quarter was less volatile than the previous quarter but was dominated by increasing positive sentiment towards risk assets in general and equities more specifically. Domestically oriented equities, most notably Small-Caps, have not participated in the recent advance and valuations are very cheap relative to history. The decline in domestic equity valuations now discount very low expectations and represents a multi-decade opportunity for investors to participate in the recovery on a more rational basis. Current valuations are reminiscent of the early 2000’s, when negative sentiment towards domestic small and mid-caps provided a platform for high prospective returns in the ensuing years. Domestic Policymakers and leadership have demonstrated a resolve to address the structural impediments in the fiscus and critical institutions. The process is underway and is taking time. For the moment, Moody’s seem patient and willing to grant additional time for policymakers to set the country on the road to fiscal recovery.

Domestic Equity valuations remain attractive relative to long term growth prospects. The Rand is likely to remain range bound and could even remain strong, as US dollar weakness persists, and the US Fed continues the current monetary policy path. SA Inc equities are undoubtedly cheap and discounting very weak prospects. We continue to believe that we are entering a prolonged period that will suit stock-pickers and active managers.

The probability is high that equities, as an asset class, could continue to muddle through. Risk assets are hovering close to all-time highs but remain extremely vulnerable to either a recession or a sudden increase in risk aversion

For that reason, we continue to advocate caution and conservatism, with adequate diversification across portfolios.

Portfolio overview

The Fund advanced by 0.77%, which lagged the average fund. Performance was mixed, in a quarter when most asset classes advanced and our fund positioning remained inherently conservative.

Our defensive positioning enabled the fund to navigate 2019 very well but in the fourth quarter it was a significant detractor. Asset allocation was the biggest detractor, while domestic equity selection was really good. Our intentional bias towards diversification and conservatism continued as preference shares and nominal bonds generated surprisingly strong positive returns and cushioned volatility in other risk assets. Lack of exposure to risk was the over-riding reason for the lag in relative return.

The net result was below-average performance for the quarter. More importantly, the excellent relative performance of the Fund since the middle of 2017 remains intact. In particular, the Fund has generated first quartile performance over 2 years and since mid-2017.

On the domestic front, our stock selection discipline and asset allocation experience enabled us to maintain our trend of avoiding or averting the worst performing securities and sectors. In equities, our very low exposure to Telecoms and the domestic consumer stocks added significant value. Individual stocks contributed significantly, led by our high exposure to Implats, Remgro, Goldfields, Mediclinic, Bat Plc and Sasol. Excellent stock selection was however dampened by our overall lower allocation to domestic equities, which detracted at the asset allocation level.

Detractors were few but had some impact on relative returns. Our fledgling position in Woolworths and declining exposure to Reinet were the biggest detractors.

In a rare reversal of the trend since early 2018, our high allocation to Global Equities was unable to compensate for a lower domestic equity weighting, as currency strength and global stock selection significantly lagged the domestic equity market.

In addition, our long held commitment to having above-average cash in the fund, was a significant detractor over the quarter, as virtually every asset class advanced strongly.

Portfolio positioning

The fund positioning and strategy remains virtually unchanged.

We remain marginally under-weight equities and within equities, we favour strong balance sheets, cheaper valuations and global. Our foreign exposure remains high, despite having correctly reduced foreign exposure in anticipation of less currency tailwinds and in response to attractive valuations on the domestic front.

We re-configured our domestic equity exposure during the quarter as value re-emerged after an extended sell-off. We are steadily increasing exposure to domestically oriented stocks.

Our Fixed Income exposure is inherently conservative, lower duration and adequately diversified. Our increase in government bond exposure during the previous quarter added immediate value. We remain underweight relative to the average fund, based on fiscal considerations. We have no parastatal or SOE debt exposure.

Cash is a residual outcome of our investment process. Cash balances increased marginally over the quarter as we rebalanced the currency and sector exposure after significant advances.