Global Markets

The S&P 500 delivered a total return of 7.7% over the last three months, 10.6% year to date and 14.4% since its February lows. Unfortunately, this strength is not shared broadly, with European, Australasian, Far Eastern (EAFE) and Emerging markets (EM) returning in US dollar 1.4% and -0.9% for the quarter and -1.0% and -7.4% year to date.

A spate of news flows from across the globe is currently driving markets. America’s trade war against what seems to be the rest of the entire world remains an ongoing concern for investors. This has led to some participants betting that China will increase their current stimulus programme in the coming months. Trump also made another enemy in Opec, publicly calling them out to reduce oil prices by increasing supply. At the same time, focus was on the Federal Open Market Committee, which raised rates again - the third this year - and reaffirmed a hawkish outlook going into 2019 and beyond. It would seem as if another hike in December is almost assured.

Additional to this, the laundry list of potential market headwinds is quite long: with the yield curve that is flattening; disruptive mid-term elections; peak margins; increasing corporate leverage; problems in emerging markets; and a stock market trading at record price-to-sales. Despite this litany of concerns, we think none will cause the transition from market risk to a market problem.

Despite the best efforts by bears, international equities are so far rather resilient. MSCI World is up 5.9% year to date, outperforming bonds by 700bp, on a total return basis. The performance, however, is quite US centric, but it is notable that even accounting for the latest Italy setback, Eurozone equities are also holding up relative to fixed income this year, with the MSCI Eurozone at 0.7% against bonds at -0.7%. The general market expectation is that there would be further gains into yearend, as the US dollar is potentially peaking, the US business cycle remains well supported, and there is some stabilisation in emerging markets/Eurozone activity evident. Fundamentally, growth drivers are also far from exhausted. Although the yield curve has flattened, stocks have never peaked before the yield curve inverted. The current yield curve shape is consistent with double-digit S&P500 returns over the next 12 months.

Emerging market (EM) equities have performed poorly in 2018 and were at the recent low point down as much as 20% from January highs. Our best view is that EMs are flattening out as they tend to have a strong inverse correlation to the US dollar, which could be peaking out.

Prospects for the rand and other EM currencies have swung as they have moved from being some of the most promising asset classes this year to becoming the worst-performing asset classes in the first half of the year, largely due to tailwinds from the global economy turning into headwinds.

Performance

The MSCI World Index (developed markets) realised a net return of about 5 % in US dollar terms for the third quarter of 2018, which was better than that of the MSCI Emerging Markets of -1.1%. 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 1600 shares included in the index. We do the tracking of this index through a process of optimisation with an ex-ante tracking error varying between 15 and 18 basis points.

The MSCI World Index (in rand terms) managed a return of about 8.4% (5% in US dollar) over the last three months. This difference in return was mainly due to the rand depreciating by about 3% against the US dollar over this period.

For the year to date 2018 the rand return for this index was more than 28%.

Market overview

What a volatile start for global markets during the first three months of 2018!

A pullback in technology-driven shares, rising trade tensions and fears over higher rates and inflation led to a volatile first quarter of 2018 for the S&P 500 Index. Following a 10% correction from its January highs and rallying back 8% by early March, the index suffered another 5% pullback in the last few weeks, ending the month of March down 2.5% on a total return basis and losing 0.8% over the last three months (first negative quarter since the third quarter of 2015). The S&P 500’s correction of just over 5% in the first week of February was a reminder that rising bond yields are likely to cause much anxiety on the path to normalisation.

While stocks were the worst-performing asset class in March, they finished the first quarter in the middle of the pack, beating both long-term Treasuries (-3.2%) and investment-grade corporate bonds (-2.2%) but lagging cash (+0.4%), gold (+2.5%), WTI oil (+5.3%) and the US Dollar Index (-0.7%).

Forgotten was the fact that the US implemented the biggest tax reform in three decades to drive the corporate income tax rate down from 35% to 21% and boost investment spending and productivity. The US is also encouraging corporates to repatriate some $2.5 trillion held offshore - but the impact on the US dollar should be limited as it is over 10 years and already held in dollars. The market, however, reminisced that the 1986 tax reform programme led to the considerable weakening of the greenback.

While recent data globally are mixed, credit impulse numbers and various leading indicators do suggest that growth expectations may still have room to drift lower. This could mean that downside risks for equities, yields and broader commodity prices are increasing, but in general the market positioning is much cleaner now and has probably priced in this ‘news’, leaving scope for a bounce.

While February and March are historically weak, April is a seasonally strong month (+1.2% average total return since 1928, the third-best month of the year).

Portfolio and performance review

The MSCI World Index (developed markets) realised a net return of -1.28% in US dollar terms for the first quarter of 2018, which was worse than that of the MSCI Emerging Markets Index of 1.5%.

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 18 basis points.

The MSCI World Index (in rand terms) managed a return of about -5.5% (-1.28% in US dollar) over the last three months - this difference in return was mainly due to the rand appreciating by more than 4% against the dollar over this period.

Conclusion

Volatility has once again become the dominant factor in financial markets globally, Volatility has once again become the dominant factor in financial markets globally, exemplified by the VIX fear index experiencing its biggest daily spike in history during the quarter. There are growing concerns that global businesses may be subject to new regulation and be the target of tariffs if a US-China trade war escalates. Political risk is dominating fundamentals and we now have progressed into a new era where central banks are not the backstop supporting financial markets.