Market overview

As we move into the final quarter of 2019 concerns around the macro environment continue to heighten. Not only is U.S economic growth showing cracks but Europe, Asia and LATAM remain mired in a lackluster growth dynamic with little pointing towards sustainable uptick in the environment. The economic data has deteriorated quickly, especially through the back end of the 3rd quarter. The U.S. consumer appears to be holding up well amidst a backdrop of full employment and gently rising wages but the high frequency data points to trouble ahead and the weakness in the manufacturing and now service sectors could feed into employment and then consumption.

In the shorter term, the pivot from “Liquidity Drain” to “pause” and now into a full-blown rate cutting cycle and potentially a resumption in balance sheet expansion by the Fed, the ECB, Japan (who never stopped) and the Chinese fiscal action should provide sufficient liquidity to allow for a muddle along scenario for global markets. Regrettably, in our scenario work this environment is largely unexciting from a return perspective given the slowing global growth dynamics but is our highest probability scenario. Globally, we see muted returns in the short to medium term across the broad opportunity set. Growth assets likely face some headwinds and a little margin pressure but that is likely already in the price in many markets. As mentioned previously, the low rate environment continues, across the curve. We believe equity markets will continue to benefit from negative real rates and even in absolute terms are fair value but are broadly cheap relative to bonds. We see credit as largely having done as well as it could from a spread perspective. We remain less constructive on our domestic market. We have not been excited around SA equities for some time but our orientation toward the ZAR and SA bonds was positive and represented our predominant expression of risk taking over the last few years until two quarters ago, when we began moderating our positioning.
We see little indication of any real action from Ramaphosa’s economics team and the lack of policy response from the Government in SA is hugely worrying. There is now simply not enough money. The declining tax revenue picture, poor employment figures and business confidence highlights SA’s lack of growth, Lack of competitiveness and its poor investment environment. The risk, amidst this policy paralysis, is that the lack of growth due to poor confidence becomes slightly more entrenched amidst the slower global backdrop and South Africa’s increasing fiscal fragility ultimately gives rise to spillover effects in credit, rates, the currency and equities. While our Government bonds look appealing from a valuation perspective, South Africa’s debt to GDP ratio is worrying. We believe the country is running out of room to maneuver as the debt burden ratchets quickly higher. The government is seemingly not prepared to either prioritize specific institutions, put forward clarity on stake sales or take some hard decisions around areas of expenditure. As a result, we feel the need to moderate our view around our favoured asset class (bonds) for a broader mix of exposures given the risk of a “negative watch” which would be customary, although not a requirement, ahead of a potential rating downgrade for our country by Moodys.

The commentary gives the views of the portfolio manager at the time of writing. Any forecasts or commentary included in this document are not guaranteed to occur.

STANLIB Inflation Plus 5% Fund has closed and merged into STANLIB Absolute Plus Fund.

Market overview

The first quarter of 2019 was one of the strongest quarters in history for risk assets around the world. This followed what could only be described as an anaemic 2018 return profile and a horrid final quarter of 2018. Policymakers united in their response to ever-increasing risks and the observable market impacts that tighter liquidity conditions, higher interest rates and continued trade war rhetoric was having on global markets. The US Federal Reserve reviewed its "autopilot" balance sheet guidance and rate hiking trajectory, evoking criticisms it had lost credibility. We believe the Fed, European Central Bank and the Bank of China (directed by the Politburo), may have provided a lifeline for global markets, avoiding the knock-on effects that falling markets and widening credit spreads would have had on growth that was already slowing. The liquidity taps are back on - in various ways - around the world and, while risk assets have some work to do to justify current valuations, concerns should ebb from here. US rate markets have repriced very strongly and are now anticipating interest rate cuts through 2020, as the bond market thinks the Fed is "boxed in". The Fed controls the global cost of capital and this easing at the margin allowed markets to find their feet. It gave other central banks the green light to begin responding to slowing economic conditions without trying to navigate the impact of a stronger dollar.

The "stay-of-execution" did not only come from central banks but also from Moody’s, whose long-awaited and widely-expected announcement of a change in SA’s credit rating outlook to negative did not take place at all. South African assets all rallied as the long-anticipated event came to naught. Like the central banks’ responses to slowing global growth, this non-event allows the proverbial can to be kicked ever further down the road.

This did not provide any comfort to SA investors, who have had to cope with the impact of load shedding and multiple commissions of enquiry painting a dire picture of political and corporate greed and ineptness. These impacts are likely to be felt for some time in the high-street economy at a critical juncture which is proving difficult for South African consumers and businesses alike. We expect some of the "black-out" impact will be felt in SA’s GDP growth data over the next quarter or two. Considerable hope rests on an electoral outcome which provides a clear leadership mandate for President Cyril Ramaphosa to begin making observable changes that would allow SA to exit the past decade of mismanagement and provide businesses with the confidence to help the ailing economy find a firmer footing.

The commentary gives the views of the portfolio manager at the time of writing. Any forecasts or commentary included in this document are not guaranteed to occur.

Market overview

The dramatic change in the investment backdrop seen in the first quarter was confirmed in Q2. Locally, the Ramaphoria rally evaporated as S.A. economic and survey data disappointed, and global investor appetite for EM assets soured. At the same time, inflation bottomed a touch below 4% end-March, and is projected to rise back to the 5-6% range as VAT hikes coincide with a weaker Rand and stronger oil prices. The Reserve Bank, whilst on hold, is clearly nervous about further adverse currency moves and has a bias to hike if necessary to contain inflationary pressures.

Global developed equities held up fairly well in Q2, with MSCI World up 2% in US Dollars. This figure however masks a material rise in day-to-day equity volatility, and ignores sharp falls in Emerging Markets equities which ended down 8%. Flows out of Emerging assets (equities, bonds and FX) became significant from mid-April, coinciding with the broad rally in the US Dollar. If anything, outflows are accelerating as EM stress spread from Turkey and Argentina through Brazil, South Africa, Asia and Eastern Europe. EM central banks have responded by moving to tighten monetary policy, but it is unclear as yet whether this has arrested the outflows. Dollar strength gained impetus from rising global trade tensions and also a weakening Chinese Renminbi as the quarter drew to a close. So long as the Dollar continues to rally, expect Emerging stresses to intensify. The Federal Reserve continues to hike interest rates at a pace of 25 basis points per quarter in response to a US economy running at full-speed, and Chairman Powell made it clear that global (ex-US) financial stresses were far down his list of concerns.

Along with turmoil in Emerging assets, trade tensions preoccupied financial markets for most of Q2, with Trump making good on his promise to wage a trade war with both China and traditional Western allies alike. Although the impact of tariffs enacted so far is only a marginal drag on growth / push on inflation, the threats of much bigger salvos to come has caused business and investor sentiment to sour rapidly. Trump’s unpredictable nature has injected a geo-political risk premium into risk asset prices which will be hard to reverse.

Against this worrying backdrop, it is important to remember that global growth remains strong, economic fundamentals in Emerging Markets are sound, the real global risk-free rate is still negative and no indicators are suggesting a recession is imminent. In many ways the abnormally low volatility / high return environment of 2017 to January 2018 was anomalous, and a more realistic perception of risk is healthy over the medium-term. We recognise that much of what we are seeing at present is typical of late-cycle environments, and we reduced our risk appetite in Q2 to reflect this. We are watching closely to see whether the global Dollar liquidity drain intensifies or not, with great attention to be paid to the US Dollar, credit spreads and stress levels in the fragile Emerging areas such as Turkey and Brazil.

The commentary gives the views of the portfolio manager at the time of writing. Any forecasts or commentary included in this document are not guaranteed to occur.