Market comments

In Quarter 3, the MSCI EMEA index (which includes South Africa) fell 7.02%, which was worse than the returns of that of the MSCI Emerging Markets (EM) at -4.25% and far behind the MSCI World’s 0.53%. Year to date, the picture does not change much with the MSCI EMEA at 5.13%, relative to the MSCI EM return of 5.89% and way behind the 17.61% for the MSCI World. The Federal Reserve and the European Central Bank both eased policies to offset signs of weaker global growth. The US economy has weakened but is not in a recession mainly due to fiscal support offsetting the adverse impact of the trade war. The inversion of the US yield curve is perceived as tolling the bell for a near-term global recession whilst Draghi also added to the call for fiscal easing.

Adding to that, commodity prices took a dive with key iron ore benchmark prices plunging some 20% in a matter of weeks and the key industrial metal, copper, hitting two-year lows. The key global manufacturing indices have also dived and are at fiveyear lows - but was at least stable over the last two months.

In the UK, Eurosceptic Boris Johnson has become the prime minister after being elected as leader of the Tories. There appears a greater likelihood of a no-deal Brexit or, at the very least, yet another postponement of the October decision deadline. The market has discounted this in large part with a weaker Sterling. As business decisions get postponed, the UK could dip into a technical recession.

In South Africa the SA Reserve Bank held the policy rate unchanged at 6.5% at its September meeting, but their statement was more dovish than in July when it did cut. For Quarter 2 of 2019, GDP was 3.1% quarter-on-quarter, above the consensus of 2.4% and reversing the first three months’ contraction. SA headline CPI accelerated from 4.0% in January to 4.5% in March and then settled around 4.3% in August 2019. Forward rate agreements are now pricing in a 25bp rate cut in the next six months.

From an SA asset allocation perspective, cash (STEFI: +1.8%) outperformed SA bonds (ALBI: +0.8%) and the FTSE/JSE All Share Index returned -4.2% (Capped SWIX: -5.1%) in the third quarter of 2019. In Dollars, the MSCI SA (-12.60%) continued to underperform the MSCI EM (-4.25%) mainly due to a weak Rand (- 6.9%). SA equities and SA bonds saw outflows of $5.7bn and $2.4bn respectively year-to-date. Properties, after stabilising somewhat over the first half of 2019, experienced a tough three months, losing about -4.4%.
On the corporate side the most important news was the Naspers spin-off of Prosus, which listed on 11 September 2019. Prosus is now the largest listed EU consumer internet company.

Portfolio performance, attribution and strategy

Globally, factor performance has continued the general trend for the year with Low Volatility and Momentum outperforming and Value underperforming up to the end of August. In September there was a significant rotation from Momentum, Quality and Low Volatility into Value, but this was short-lived and it does not seem like a structural shift in trends has occurred. It is interesting to note that historically there has been no structural relationship between Value and Low Volatility, but in 2019 these two factors behaved like polar opposites, which was especially true from May onward, where Low Volatility generated strongly positive returns and Value significantly negative returns.

Domestically, the Momentum signal continues to perform very well over the quarter and the past year even though the market has de-trended with the last quarter’s negative performance. Price Momentum is now the strongest performing factor over the quarter as well as a 12-month period. Earnings revisions, however, failed to follow in the footsteps of Price Momentum and underperformed over the quarter as well as the past 12 months, but is well positioned within the broader Momentum strategy to provide diversified Momentum exposure when Price Momentum suffers drawdowns at inception points in the market.

The portfolio strategy has delivered excess returns of 2.1% over the Capped SWIX benchmark for the third quarter. The strategy’s positive contributions to performance was largely attributed to high scoring momentum stocks such as Anglo Platinum, Bidvest, Impala Platinum and Harmony Gold as well as an underweight position in Sasol. In terms of underperformance, detractors included overweights in African Rainbow Minerals, Telkom and Woolworths.

At the last rebalance date at the end of September, we transitioned the portfolio based on the evaluation of new factor signals and the risk levels in the portfolio. Based on these signals, exposure to Anglogold and Wolworths was increased and Northam was added to the portfolio, and this was funded by reducing the position in Harmony and Implats and dropping Exxaro. We remain convinced of the factor’s medium- to long-term significance and the premium it offers in the South African capital market and remain disciplined in our implementation and extraction of the factor.

Market comments

Global equities rebounded in June as the US-China trade war ebbed and Trump backed off on some of his threats. Global growth data remained negative with further declines in PMIs. Although the 19 June Federal Open Market Committee meeting saw no rate change, it delivered a strong statement virtually promising a rate cut at the 31 July meeting.

During the second quarter of 2019, the MSCI World Index realised a gross return of just more than 4%, outperforming the MSCI Emerging Markets Index, which managed a very modest return of 0.6% over the same period. Global bond yields continued to rally with US 10-year yields down to 2.01% and trading sub-2% for the first time since late 2016. US 10-year yields are down more than 125 basis points since November 2018.

In the first half of 2019, the MSCI World Index delivered a total return of 17.4%, outperforming Emerging Markets (+10.8%). Within the 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 South Africa weak economic data dominated the post-election headlines with firstquarter GDP falling 3.2% quarter on quarter, worse than the -1.6% Bloomberg consensus. The President’s State of the Nation Address promised little more than further Eskom bailouts and progress on spectrum auctions with few details/deadlines.

During the second quarter of 2019, the FTSE/JSE All Share Index (ALSI) posted a total return of 3.9% versus the 8% for the first three months of 2019. SA Financials was the best performer, returning 5.4%, followed by SA Industrials with a total return of 4%. SA Resources only managed a gain of 2.4% in the second quarter after the large 17.8% total return in the previous quarter. The FTSE/JSE All Bond Index (ALBI) returned 3.7% after posting a similar return of 3.8% in the first quarter. SA Property managed to outperform bonds, posting a total return of 4.5%. Among the other important indices the FTSE/JSE Shareholder Weighted Index (SWIX) (+2.86%) performed in line with the FTSE/JSE Capped Shareholder Weighted All Share Index (Capped SWIX) (+2.90%).

In the first half of 2019, SA Equities was the best performing asset class, with the ALSI delivering a total return of 12.2%. SA Bonds gained 7.7%, whilst SA Property was the worst performing asset class with a total return of 6%. Cash posted a total return of 3.6%.

Portfolio performance, attribution and strategy

Globally, factor performance has reflected investor risk aversion but not in such a clear way that sectors have, as style volatility has increased masking trends in performance. Putting aside Growth, which has clearly been a consistent performer across markets, the poor performance year to date of both Value and Low Risk has been curious. Value is typically seen as the pro-risk/cyclical style, while Low Risk is the opposite and indeed, over the past six months, they have been negatively correlated. However, what we have seen is more rotation in these two styles as investor risk aversion has changed, but they have both been trending down. On a short-term basis, exposure in both styles has provided diversification but over the longer term this has been more problematic. The negative performance trend in these styles mirrors the general risk-on positioning of markets of the past six months.

Domestically, the Momentum signal continues to show a strong recovery since December 2018 along with general market sentiment, which has begun to entrench a trend after a period of rotating market leadership. As such, Price Momentum is now positive over a 12-month period for the first time since the second quarter of last year, illustrating the aggregative nature of its recovery. Earnings Revisions has shown more cyclicality than expected, however, over the prior quarter its behaviour is more in line with its traditional defensive role within the broad Momentum strategy - offering a more scaled-back cyclical exposure than its Price Momentum cousin. Over 12 months, however, the strategy is still underperforming due to the significant underperformance over the fourth quarter of 2018.

The portfolio strategy has similarly added positive excess returns over the quarter to the tune of c3.2% over the Capped SWIX benchmark. The strategy’s positive contributions to performance was largely attributed to high-scoring momentum stocks such as Sasol (SOL), Telkom (TKG), Sibayne Gold (SGL), Impala Platinum (IMP) and Anglo American Platinum (AMS). In terms of underperformance contributors, these included overweight positions in AngloGold (ANG), PSG Group (PSG) and Capitec (CPI) and underweight positions in ABSA (ABG) and Gold Fields (GFI).

At the last rebalance date (mid-June), we transitioned the portfolio based on the evaluation of new factor signals and the risk levels in the portfolio. Based on these signals, exposure to Naspers (NPN) was increased and MMI (MMI) and Quilter (QLT) were added to the portfolio, and this was funded by dropping PSG Konsult (KST), Netcare (NTC) and Reunert (RLO). We remain convinced of the factor’s medium- to long-term significance and the premium it offers in the South African capital market, and remain disciplined in our implementation and extraction of the factor.

Global Markets

MSCI developed markets experienced an exceptional quarter with a US Dollar return of 12.5%, outperforming emerging markets, which in turn also realised good absolute numbers of 9.9% year to date. After experiencing their worst December since 1931, global stocks posted their best January since 1987 and global equities had their second-best quarter on record. But the rally wasnft plain sailing with economic data releases surprising on the downside. Global growth is trending around the 3% mark, but the key question remains whether global growth has indeed bottomed at around trend levels.

The temporary ceasefire in the trade war and the postponement of the 25% tariff rate have provided the markets with some relief. The US Federal Reserve (Fed) joined the party with some dovish comments and markets now expect the Fed to cut rates both this year and the next, with only a modest rise in the US 10-year bond rate being anticipated. Finally, lower volatility provided a more favourable environment for risky assets.

Despite the S&P 500 Index posting its best start of the year in a decade, the inversion of the US yield curve at the end of the quarter put a damper on the initial bullish mood with concerns of a recession looming. The Fed will be using interest rates to target inflation, but Fed Chair Jerome Powell mentioned that the US was not at the neutral rate providing optimism that future hikes will be delayed. The Fed has effectively paused the federal funds rate at 2.5%, which is below the neutral level of 3%. This provided a boost to risk assets and weakened the greenback temporarily.

However, the possibility of a no-deal Brexit is also in the balance with another extension expected beyond the crucial 2 April vote. There is an increasing possibility that Britain will go for the customs union route (a so-called esoftf Brexit), but there remains the possibility of a referendum and an early election.

The Chinese economy continues to experience a soft landing with growth expected to be in the 6.0-6.5% p.a. range in the year to come, the slowest growth rate in three decades. The Chinese are stimulating their economy further with tax cuts . the latest measure to be implemented . and at the end of March the manufacturing PMI surprised on the upside with the biggest month-on-month increase since 2012.

Local Markets

In the past decade economic growth has been hampered structurally by poor productivity. The SA Reserve Bank (SARB) leading indicator has started pointing downwards due to low manufacturing confidence and orders. Manufacturing confidence and orders have remained low for 10 years with the latest data showing a deepening contraction. We expect, nonetheless, a mild recovery from the GDP shock suffered in the first half of 2018, which is partly linked to weakening terms of trade and a weaker exchange rate (PPP Rand/Dollar being closer to 13) to shift our growth rate back towards a tepid 1.4% run rate (structurally we remain stuck below 2%).

South Africa is experiencing a steep yield curve, which would suggest that the economy should be improving. But the poor fiscal position has meant that the government has crowded out the private sector. This, in part, explains the low rate of credit growth at a sub-par 6% p.a. South Africa needs the private sector to invest but the return on investment remains too low. We do, however, expect a rebound in agricultural production to boost growth.

A key risk remains Eskom with the electricity availability factor dropping to 65% at the beginning of the year, leading to stage four load shedding. This has already negatively impacted manufacturing output. In the National Budget government committed to provide some R69 billion of support to Eskom over the next three years, partly allaying short-term fears given its balance sheet hole of some R200 billion.

At the end of the quarter, Moody’s also gave us a stay of execution postponing the release of its credit review until after the elections.

The JSE had a solid quarter with the FTSE/JSE Capped Shareholder Weighted Index (Capped SWIX) posting a return of about 3.85% for the quarter, but is still staying in negative territory for the past 12 months. The market has rewarded businesses that have been stable and focused on organic growth while businesses that have been acquisitive and laden with debt have been punished. We are in an environment where there is a serious risk that liquidity will be withdrawn by central banks. Businesses which were very acquisitive and funded these acquisitions with debt have been at the mercy of the economic slowdown, which contributed to poor returns.

On a sectoral basis resources stocks were the stars of the JSE once again, up close to 18% this quarter. Platinum stocks continued to shine bright, up close to 50% aided by rising basket prices and the benefit of good cost management over the past few years. Financial stocks were flat this quarter with credit growth being very weak and corporate credit growth dipping below household credit growth for the first time in almost a decade. Industrial stocks posted solid returns, up close to 9% this quarter, a welcome difference to the recent past.

Portfolio performance, attribution and strategy

On the factor front globally, the year-to-date numbers are mixed. Quality, Low Volatility and Growth were the big winners with both Momentum and Value underperforming. The least surprising of these was Momentum, which tends to lag during major market reversals like the one we saw in the first quarter. The performance pattern of Value versus everything else has re-emerged and one that has been present more often than not since the Global Financial Crisis. This implies that investors globally are cautious on the economic outlook and will continue to tilt towards defensive styles, or putting it another way, there are significant headwinds for Value performance. The troubles with Value have flummoxed quant managers in general, most of whom try to exploit the Value anomaly in some capacity despite the belief that the factor should provide positive returns over the long run.

Domestically, the Momentum factor has seen a strong recovery since December 2018 along with general market sentiment, which has begun to entrench a trend after a year of gyrations and rotating market leadership. The portfolio strategy has similarly added positive excess returns over the quarter to the tune of about 3% over the Capped SWIX benchmark. The strategy’s positive contributions to performance were largely attributed to high-scoring momentum stocks such as Anglo American Platinum (AMS), Impala Platinum (IMP), Capitec (CPI), African Rainbow Minerals (ARI) and Exxaro (EXX). In terms of underperformance contributors, these included overweight positions in Mr Price (MPC), Discovery (DSY) and AVI (AVI) and underweight positions in Naspers (NPN) and Anglo American plc (AGL).

At the last rebalance date (mid-March), we transitioned the portfolio based on the evaluation of new factor signals and the risk levels in the portfolio. Based on these signals, exposure to MTN (MTN) was increased and Kumba Iron Ore (KIO) was added to the portfolio, and this was funded by reductions in AVI (AVI), Exxaro (EXX) and Discovery (DSY). We remain convinced of the factor’s medium- to long-term significance and the premium it offers in the South African capital market and remain disciplined in our implementation and extraction of the factor.