PPS Defensive Fund - Sep 19 - Fund Manager Comment13 Dec 2019
The Minister of Finance is scheduled to present National Treasury’s Medium-Term Budget Review (MTBR) on 30 October 2019. Global growth forecasts are being lowered and the South African Reserve Bank’s (SARB’s) latest domestic economic forecasts are way below those budgeted by National Treasury in February 2019. The main budget data for the five months to August 2019 show tax revenue growth of 3.7% YoY against budgeted growth of 10.3% for fiscal 2020. The shortfall is broad-based with personal tax revenues up 5.2% against budgeted growth of 11.0%, company tax revenue growth down 1.2% against budgeted growth of 7.0% and net VAT revenue down 2.3% against budgeted growth of 11.0%. Against main budget tax revenue growth of 3.7%, total expenditure was up 12.6% YoY for the five months to August 2019, with the State debt cost up 15.5% YoY. Main budget real expenditure growth was up 7.1% YoY for the first five months of fiscal 2020, which does not signal fiscal consolidation. With expenditure exceeding revenue, the budget deficit was R189.4bn up 44.1% for the first five months of fiscal 2020. The outlook for the rest of fiscal 2020 does not look bright given slowing global growth, delays in crucial domestic reforms and SA’s leading indicator which has been declining for the past 10 months. National Treasury’s budget is also facing an escalating crisis from underperforming State-owned Companies. Eskom has required massive escalating bailouts to remain a going concern and so too has SAA, SABC, and Denel. Government’s debt levels are rising faster than budgeted and the rising State debt cost is increasingly crowding out non-interest expenditure. Government is facing a growing debt financing crisis and will have to resort to new measures of funding. The tax base is likely to be expanded further with higher marginal taxes for the wealthy, expanded indirect company taxes such as carbon and sugar taxes, and expansion of the international tax base for South Africans working outside SA. The reintroduction of prescribed assets is also being considered by government. Prescribed assets will force SA asset managers and pension funds to invest in the country’s bonds and State-owned Companies. Other sources of new debt could be from the New Development Bank or from Asian Development Banks. Government, re-empowered by its 6th National Election win, is focusing on its social and economic reform agenda which includes tighter racial empowerment regime, National Health Insurance, Land reform and industry empowerment charters. Consequently, no material improvement in the fiscal debt/GDP trajectory is expected in the short term.
The path to monetary policy normalisation among developed economies was reversed at the start of 2019. The reversal was in response to headwinds to global growth from the escalating trade war between the US and China and rising geopolitical risks. Both the World Bank and OECD have sharply lowered their global growth forecasts for 2019. Developed economy Central Banks are now lowering their policy rates and looking at expanding their balance sheets again. The main issue is that there is not enough policy rate room for a sufficient rate adjustment to counter a sharper than expected economic downturn. It is becoming increasingly clear that more Quantitative Easing (QE) will only serve to dent market confidence, discourage investment, hurt the banking system further. Central Banks’ demand for bonds have lowered yields curves, a trend compounded by greater income needs from an aging population and intensified hunt for yield from investors, especially pension funds and insurers. While the political economy is increasingly driven by inequality, developed economy governments are becoming more divided. These trends work against developing pro-growth policies. It appears that monetary policy will again have to do the “heavy lifting” to prevent a major global slowdown. Without enough downside room in policy rates and ineffectiveness of QE, new pro-growth policies are being discussed. The essence of these pro-growth policies is that money is created by the Central Bank, but the way the money is distributed and to whom is the main difference. Two such policies under discussion are the People QE (PQE) and Economic Rebalancing. In PQE, the Central Bank creates money and gives it directly to the citizens of the country and so doing generates consumption demand without involving government. In Economic Rebalancing, the assumption is the Central Bank can backstop fiscal expansion in order to rebalance the economy over the long term. Government can either borrow directly from the Central Bank, as in the case of Modern Monetary Theory (MMT) or issue bonds which the Central Bank can buy. Political and economic developments are driving an inevitable shift towards MMT. This development would represent the third phase of monetary policy development which would require greater interdependence between fiscal and monetary policy.
For the period since inception of the Fund until the end of September, the return of the Fund was 6.3%, compared to the benchmark inflation rate of 3.9%. The Fund continued to earn inflation plus returns from its core low risk, interest bearing investments, while the exposure to equities added to returns.
PPS Defensive comment - Mar 19 - Fund Manager Comment28 May 2019
Quarterly Commentary
Domestic macroeconomic themes
Slowing household disposable income growth
A major trend in South Africa in the last five years has been the slowdown in the growth of household disposable income, which has impacted the rate of household consumption expenditure, credit extension and is restraining South Africa’s Gross Domestic Expenditure growth and Gross Domestic Product growth.
In 2018, household disposable income rose 5.6% to R3.2 trillion of which 71.9% came from higher compensation to employees. This growth was boosted by higher growth in net social benefits, the net effect of which was partially eroded by a tax rate increase. In 2018, SA households spent all their net disposable income.
Stable monetary policy
In South Africa, domestic credit demand was up 6.8% year on year (YoY)for the three months to February 2019, boosted by government credit demand. Household credit growth, although low, has been slowly accelerating across all categories, namely mortgage credit (the largest component), instalment sales and unsecured growth. The BA900 bank returns show unsecured household credit growth was up 9.4% YoY in February 2019, driven by personal loans, which expanded 11.0% YoY. The high growth in personal loans contrasts with the low job and low wage growth suggesting increased financial stress.
Weak growth, declining inflation expectations and the deferral of credit rating agency Moody’s credit rating assessment until after the National Election in May 2019, give the SARB room to keep monetary policy stable. No policy rate change is expected until Q4:2019 at the earliest.
International Macroeconomic Themes
Falling global yields
Advanced economy bond yields have fallen during the first quarter of 2019, especially in March, with the US yield curve inverting at the short end of the curve between the three month and 10 year yield. This has raised concerns among investors about a possible sharper than expected global economic growth slowdown.
The sharp fall in bond yields in March 2019 was in response to a change in the Federal Reserve (Fed) and European Central Bank’s (ECB’s) assessment of financial conditions. In January 2019, the Fed indicated it would pause its rate policy rate normalisation and in March it indicated it would keep its Fed Fund rate on hold for the rest of 2019 and slow the pace of asset reduction in its balance sheet. This change lowered expectations of the Fed Fund rate trajectory.
This expected resurgence in the global hunt for yield has positive implications for increasing demand for Emerging Market assets, particularly for commodities ahead of an expected US-China trade deal. This new trend could lower SA bond yields and strengthen the ZAR. The degree to which this will occur will depend on the market’s view of Moody’s assessment of SA after the National Election in May this year.
Fund Commentary
For the period since inception of the Fund until the end of March, the return of the Fund was 3.4%, compared to the benchmark inflation rate of 1.6%.
The Fund continued to earn inflation plus returns from its core low risk, interest bearing investments, while the exposure to equities added to returns. We are surprised by the strength in SA Equities, given the headwinds of Eskom rolling load shedding, which will have an adverse affect on the economy. The expropriation without compensation debate also still must conclude.
Factors which could affect the market and returns this year include the outcome of the South African General Elections, resolution of the financing problems facing the SOE’s (particularly Eskom). BREXIT, negotiations on international trade barriers as well as the path of normalization of global interest rates.