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 its 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 a 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 and changes

The FTSE/JSE RAFI Top 40 Index returned -6.6% over the quarter, underperforming the FTSE/JSE Top 40 Index by 1.38%. On a 12-month rolling basis the FTSE/JSE RAFI Top 40 Index underperformed the FTSE/JSE Top 40 Index by 1.9%.

The relative underperformance for the quarter was mainly attributable to the large overweight position in Sasol, which declined a further 28% after being down 22% the previous quarter. Another detractor was the overweight position in Intu Properties, which continued its slide downwards, falling a further 39%.

The major contributors to relative outperformance were the fund’s overweight positions in Impala Platinum and Sibanye Gold, which returned 36.7% and 25.0% respectively.

The FTSE/JSE RAFI 40 Index is rebalanced once a year in March and is based on multiple fundamental factors in order to calculate the fundamental weights as per the ground rules. The data used to determine these factors are taken over the prior fiveyear period.

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 FTE/JSE All Bond Index (ALBI) returned 3.7% after posting a similar return of 3.8% in the first quarter. Property managed to outperform bonds, posting a total return of 4.5%. Among the other important indices the FTSE/JSE Shareholder Weighted All Share 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%.

Performance

The FTSE/JSE RAFI Top 40 Index returned 3.73% over the quarter, underperforming the FTSE/JSE Top 40 Index by 0.88%. On a 12-month rolling basis the RAFI Top 40 Index outperformed the Top 40 Index by 7.8%.

The relative underperformance for the quarter was mainly attributable to the large overweight position in Sasol, which declined 22%, as well as the overweight position in Intu Properties, which fell 33%.

The major contributors to relative outperformance were the fund’s overweight positions in ABSA Group and MTN, which returned 20.3% and 20.5% respectively.

The RAFI 40 Index is rebalanced once a year in March and is based on multiple fundamental factors in order to calculate the fundamental weights as per the ground rules. The data used to determine these factors are taken over the prior five-year period.

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.

Some key risk that remains for 2019 is that the tailwind of quantitative easing is turning into the headwind of quantitative tapering. Net purchases by central banks were running at $23 billion per month and could turn negative this year, especially in the case of the Fed. This is likely to add to the uncertainty and volatility during the course of the year. While inflation in the developed world remains contained with US inflation below 2.5% p.a., the pickup in wage growth is a concern (from 1.5% to 2.5% p.a.) in the US. But it is noteworthy that there is no inflation pressure in Europe and Japan.

The International Monetary Fund (IMF) is forecasting a slowdown in the US this year with the rest of world growth stabilising. The risk remains that the Fed may still tighten rates further. However, the risk of a recession remains low in our opinion.

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 showinga 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% (FTSE/JSE All Share Index (ALSI) return 7.97%) 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.


Fund performance

The FTSE/JSE RAFI Top 40 Index returned 7.38% over the quarter, underperforming the FTSE/JSE Top 40 Index by 1.08%. On a 12-month rolling basis the FTSE/JSE RAFI Top 40 Index managed to outperform the FTSE/JSE Top 40 Index by 0.22%.

The relative underperformance for the quarter was mainly attributable to the large underweight position in Naspers, which returned 21.3%, as well as the overweight position in Absa Group, which declined by 6%. The major contributors to relative performance were the fund’s overweight position in Impala Platinum and the underweight position in Mr Price, which returned +70% and -23% respectively. The fund was rebalanced in March to the new FTSE/JSE RAFI 40 Index, which is rebalanced once a year and is based on multiple fundamental factors in order to calculate the fundamental weights as per the ground rules. The data used to determine these factors are taken over the prior five-year period.
Conclusion

Despite a poor economic backdrop and populist rhetoric ahead of the elections, the JSE posted solid returns after a poor 2018. Patient investors will know that the best investments are made when sentiment is bearish. The JSE is trading on a forward P/E of 13x and an attractive forward dividend yield of close to 4%.