Market review

Global markets, up 5% in US dollars this quarter, have remained buoyed by the $1.7 billion central bank injection this year and 13% increase in earnings growth. Global growth is strong at 3.5%, accompanied by low unemployment and improved consumer and business confidence. The current bull run in global equities is near the strongest in history, yet global valuations are only near the trough levels of 2003. Moreover, prospects for earnings are the most positive in nearly five years. On the face of it, the outlook appears serene, but on most historical measures the US seems to be on the expensive side while other regions prove to be cheaper.

History has shown us that the toughest month in the calendar year for the Dow Jones is October, which has coincided with emerging market (EM) currency sell-off since early September. The question is whether this should be a cause for concern, as in the grander scheme of things these are small moves as EM currencies are still up 5% vs the US dollar year to date. Most importantly for SA investors, the rand has declined versus the greenback and has wiped out most of this year’s currency gains. There have been four main drivers for the rebounding of the dollar: 1) mainly that US inflation is likely to move higher over the coming months, suggesting a December hike by the Fed; 2) reversing quantitative easing from October; 3) President Trump’s overhauled plans on tax reform, including cutting the corporate tax rate to 20%; and 4) Chancellor Merkel’s reduced majority in the German elections.

The rebalancing of the Chinese economy continues with strong double-digit growth in retail spending while investment spending growth is slowing down into the single digits. The services economy is growing faster, attracting three quarters of fixed investment in the economy. The housing market remains resilient especially on the commercial side with a tapering off of residential sales due to restrictions to cool off activity. The cynics, however, always point out that Chinese data comes out 17 calendar days after the period end, but there is no doubt that the economy has showed some resilience this year.

We believe that right now we are in ‘EM giving back some of the strong gains of 2017’ territory. But moves in the dollar are something to watch in the immediate future.

Performance and portfolio actions

The MSCI World Index (developed markets) realised a net return of 4.8 % in US dollar terms for the third quarter of 2017, which was worse than that of the MSCI Emerging Markets Index (6.4%).

Our feeder fund buys and sells units in a ‘parent fund’ called the Satrix MSCI World Index fund, which tracks 23 developed countries with more than 1 600 shares included in the index. We do the tracking of this index through a process of optimisation with a tracking error varying between 15 and 20 basis points.

The MSCI World Index (in rand terms) managed a return of about 8% over the last three months. Over this period the rand depreciated by about 3.5% against the US dollar.

Conculsion

The main question facing investors, as in the third quarter of 2017, is whether valuations and positioning point to a tactical pullback from risk. We think that the general market view currently is that it would probably not. This year’s equity rally has been driven by earnings growth, not multiple expansion; while the pace of this growth might slow, stocks should still out-earn bonds. It is difficult to see a plausible catalyst that could upset valuations in risky assets for the rest of 2017. If we contrast the fortunes of overseas markets to our local one, it is clear that investor confidence is an important behavioural factor driving investment markets. Companies which have delivered results below expectation are being marked down heavily and a number of former darling stocks have suddenly been found wanting.