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.

The SA Listed Property Index (SAPY) realised a return of -4.4% during the third quarter of 2019. The best performing shares in the SAPY for the last quarter included Sirius (19%), Resilient (9%), Investec Australia (8%) and Liberty 2 Degrees (3%). By contrast, the worst performers were Hospitality B (-16%), Fortress B (- 15%), Redefine (-13%) and Mas Plc (-13%)
During the September index rebalance there was one constituent deletion, namely Accelerate Property Fund (APF), and one addition, which was Stor-age Property (SSS) in the SA Listed Property Index (SAPY). The one-way turnover (2.5%) was somewhat higher than the recent past.

Developed market bond yields continued to trend lower. Yields on the benchmark US 10-year bond declined 34 basis points from 2.0% at the end of June to 1.66%. In Europe, the yield on the 10-year German Bund touched a new all-time low of - 0.716%.

The All Bond Index returned 0.78% for the quarter, underperforming the SteFI cash index return of 1.83%. The 3- to 7-year sector delivered the best return (1.29%). The yield on the benchmark R186 rose 0.235% to 8.32% while the R2035 (16-year bond) yield rose 0.17% to 9.61%.

With inflation remaining relatively subdued, demand for inflation protection has been week. The inflation-linked index returned just 0.25% for the quarter. Yields on the week. The inflation-linked index returned just 0.25% for the quarter. Yields on the I2029 (10-year) rose 0.24% from 3.17% to 3.41%. The yield on the ultra-long I2050 reached a new high of 3.65% in September before ending the quarter at 3.63%.

Equity portfolio performance and attribution

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, value signals like Price to Cash Flow and Price to Book have delivered strong performance over the past year, but the Dividend Yield and Earnings Yield factors continued to underperform in the third quarter. Momentum as measured by Price Momentum continued to outperform in the third quarter while the more defensive Earnings Revision signal marginally underperformed. Locally, quality signals of Profitability and Growth continued to underperform in 2019 after experiencing strong outperformance in 2018.

The multi-factor approach of the fund, where stocks are selected based on their combined Value, Momentum and Quality signal, added value over and above the single factors but still underperformed the benchmark FTSE/JSE Capped Shareholder Weighted All Share Index over the third quarter.

From an attribution perspective, overweights in Anglo Platinum, Harmony Gold and Clicks and an underweight position in Sasol added value to the strategy over the quarter. Counters that detracted value from the strategy included an overweight in Kumba Iron Ore, Telkom and Truworths while an underweight in Naspers also detracted from performance.

In terms of constituent changes to the Satrix SmartcoreTM index, we added Spar Group while deletions were Sibanye Gold and Tsogo Sun Hotels.

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 (FOMC) 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 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%.

Yields on the benchmark US 10-year bond declined 47 basis points during the quarter from 2.479% to 2.005%. In its June statement the FOMC acknowledged that economic growth was slowing somewhat and in describing future interest rate changes the statement said the FOMC will ‘closely monitor/will act as appropriate’.

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.

The front and intermediate bonds rallied along with developed market bonds but the back-end bonds did not follow, resulting in a sharply steeper curve. The yield on the R2023 (5-year) bond rallied 41 basis points, while the yield on the R2048 (30-year) bond rose 9 basis points. The FTSE/JSE All Bond Index (ALBI) returned 3.7% for the quarter, with the ‘belly’ of the curve delivering the best performance. The 7-12- year sector delivered a return of 4.61%.

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. SA Bonds (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 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%. return of 3.6%.

The FTSE/JSE SA Listed Property Index (SAPY) returned a total of 4.5% during the second quarter of 2019 against the 1.5% in the first three months of 2019. This was better than the ALSI return of 3.9%, cash at 1.8% and bonds, which returned a credible 3.8%. For the last six months the SAPY is still lagging most other major domestic asset classes, returning 6% versus 12.2% for equities, 7.7% for bonds, but still outperforming cash at 3.6%.

Equity portfolio performance, attribution and strategy

After Value signals domestically delivered an overall strong 2018 and first-quarter 2019 performance, the factor saw some profit-taking and rotation into Momentum strategies. Once again, a sector effect cannot be ignored as the positive market sentiment largely focused on Financial and Industrials counters (less value exposure) rather than Resources (more value exposure).

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.

In a reversal of fortunes, Quality continues to experience profit-taking as the equity market turnaround has shown a preference to cyclical shares. This after an extended period of a risk-off environment which provided a fertile ground for Quality factors, in particular profitability factors such as Return on Equity. Investors have been favouring stocks with high profits in order to mitigate macro challenges, and even though economic sentiment has recently been soft domestically, global sentiment has buoyed cyclical stocks and ignored stocks that have durable competitive advantages. As an aggregate signal, the combination of Momentum, Value and Quality provided a powerful signal to the portfolio, allowing the strategy to extract strong positive excess returns relative to the Capped SWIX.

From an attribution perspective, overweight positions in Telkom (TKG), Kumba Iron Ore (KIO), Anglo American Platinum (AMS), FirstRand (FSR) and Clicks (CLS) added value to the strategy over the quarter, while an underweight position in Sasol (SOL) also contributed to the outperformance over the prior quarter. Counters that detracted value from the strategy included underweight positions in MTN (MTN), AngloGold (ANG) and Standard Bank (SBK) while an overweight position in Netcare (NTC) also hurt the relative performance.

In terms of constituent changes to the Satrix SmartcoreTM Index, we added Quilter (QLT) and Harmony (HAR), while deletions were Sappi (SAP) and Sasol (SOL).

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.
In February and March South Africa experienced stage four load shedding, which is expected to have a negative impact on the first-quarter growth rate. Yields on South African bonds underperformed the rally in developed markets partly because of the increased risk of a credit downgrade from Moody’s, which would have resulted in South Africa losing its investment-grade status and falling out of the World Government Bond Index (WGBI).

With inflation printing at 4% and 4.1% in January and February respectively, demand on inflation protection has been low. Inflation-linked bonds (ILBs) have continued to underperform nominal bonds. The Government Issued Bonds Index (IGOV) returned just 0.5% for the quarter compared to the FTSE/JSE All Bond Index (ALBI) return of 3.76%. Yields on the 15-year ILB (R202) traded at 3.32%, their highest level since June 2009, and the long-dated I2025 touched a new high of 3.42%.

The domestic commercial property market continues to trade in a weak macroeconomic environment with low investor confidence. The FTSE/JSE SA Listed Property Index (SAPY) returned a total of 1.45% during the first quarter of 2019 against the -4% in the last quarter of 2019. This was still much worse than the FTSE/JSE All Share Index (ALSI) return of 8% and below that of cash (1.8%) and bonds, which returned a credible 3.8%. For the last 12 months, the SAPY materially underperformed all other major domestic asset classes, returning -5.7% versus 5% for equities, 3.5% for bonds, and about 7.3% for cash.

Equity 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.