In sharp contrast to the conclusion of 2018, 2019 ended on a strong note with equity markets surging, EM spreads compressing, and EM FX rebounding. Yield curve inversion, moderating earnings momentum, trade wars, global manufacturing slowdown, and stronger US dollar should have been a toxic mix for equity markets. Yet, the Fed’s dovish pivot and renewed QE was enough to save the year – who said central banking is boring! T

he challenge from here is that valuations require strong earnings growth at a time when geopolitical concerns are intensifying, the oil price is higher, and populism is percolating. Moreover, improving growth, tightening labour markets, and de-globalisation could lead to long overdue inflationary pressures. This would be a headwind not only to bonds, but also to equities via the threat of central banks turning hawkish again.

A more challenging global backdrop in 2020 would exacerbate domestic hurdles, which currently seem insurmountable. The fiscus is a mess, Stage 6 load shedding remains a threat, and policy uncertainty continues in the form of the Expropriation Bill, the Section 25 amendment, and the NHI Bill. Limited reforms and stagnation could lead to rating downgrades and attendant capital outflows. Given these prospects, the SARB surely wishes that monetary policy were a little more boring. With the MPC short on doves and long on hawks, notably weaker growth, sustained low inflation, and falling inflation expectations will be required to pull the SARB over the line on rate cuts. In the meantime, the focus falls on Eskom, Minister Mboweni’s February Budget, and Moody’s review.

Market developments

Equities (4.6%) took pole position for 4Q19, followed by fixed-rate credit (3.0%), and floating-rate credit (2.9%). Bonds (1.7%) performed in line with cash (1.7%), but property (0.6%) and inflation-linked bonds (-0.9%) underperformed.

The US dollar lost 3% in 4Q19 as risk appetite improved due to easier monetary policy, strengthening EM data, and the pending “phase one” US/China trade deal. The rand was the best performer within the EM FX majors for Q4, appreciating by 8.6%. USD/ZAR dipped below 14.00 on the last day of 2019, but has since risen to 14.30, which is marginally overvalued compared to our 14.50 – 15.00 fair-value range.

DM bond yields were flat to moderately higher during 4Q19 as easier monetary policy supported risk assets and real activity indicators suggested a stabilisation in growth momentum. The 20bp rally in SA yields in December was not enough to offset the impact of the MTBPS, leaving yields unchanged for the quarter. While the 5-year CDS compressed by 40bp, the local 10-year yield still reflects fiscal risk – at 9.00% it is at the upper end of our 8.60% - 9.10% fair-value range.

Risk-on spread from DM to EM equities with the MSCI EM (up 11.4%) outperforming the MSCI World (up 8.2%) during Q4 amid the promise of a trade deal, the convincing conservative victory in the UK, and the weaker US dollar. Having lagged for most of the year, the MSCI SA ended strongly, printing a total return of 10% for December and 13% for 4Q19 in dollar terms. The SWIX gained 4.8% and 3.7% for Q4 and December, respectively. Platinum mining (47%), gold mining (26%) and health care (21%) were the most notably performers in Q4, while consumer services (2.9%), financials (2.8%), industrials (0.7%), and consumer goods (0.5%) posted more pedestrian returns. Technology (-0.9%) and telecommunications (-13%) were at the other end of the return scale.

Portfolio performance and positioning

The fund’s performance (2.4%) during 4Q19 was driven by domestic equity (2.5% contribution), followed by domestic cash (0.4%), domestic bonds (0.2%), domestic property (0.1%) and offshore equity (0.1%). Offshore cash (-0.9%) detracted from performance due to the stronger rand. During the quarter, we trimmed our offshore equity and offshore cash exposures in favour of domestic cash given the rally in global markets and preference for relatively attractive domestic carry opportunities.

The domestic growth outlook remains lacklustre as business and consumer confidence are dampened by policy uncertainty and severe electricity constraints. The downward trend in the leading indicator and confirmation of yet another quarterly contraction in GDP in Q3 reflect constrained domestic demand amid weak employment growth and relatively tight credit conditions. While the nascent stabilisation in high-frequency global activity indicators suggests that the cycle will be prolonged, political uncertainty is set to escalate as we move through 2020. The pending trade deal and monetary policy easing supported US equities, but renewed risks come from US/Iran/Iraq tensions and the higher oil price. A global rebound would assist SA exports, but a durable upswing depends on domestic fixed investment and attendant job creation. Given the subdued growth outlook, we remain cautious on domestic equity prospects and still prefer resources and global diversifieds as well as greater exposure to domestic financials than to the retail sector. We think elevated fiscal risks are priced, with real bond yields above 4.0% attractive.