MARKET PERFORMANCE

The third quarter of 2018 marked the 11th anniversary of the Global Financial Crisis and, as liquidity dried up over the US summer holidays, markets once again experienced heightened volatility. Emerging market contagion was the main driver as concerns spread from Argentina’s fiscal problems and IMF bailout and Turkey’s twin deficits to Brazil’s contentious elections, Russia’s US sanctions and South Africa’s economic recession. Global traders came up with another acronym: BRATS. South Africa is the only country within BRATS that has not seen its credit rating downgraded to junk, albeit our markets are pricing in that downgrade. Beyond the idiosyncratic risks of the BRATS, the strong US dollar and rising US interest rates continue to lead to outflows from emerging markets, weakening their currencies and forcing them to hike interest rates once again to anchor inflation, a vicious cycle that puts further strain on their economies.

According to Bank of America Merrill Lynch, the number of global rate hikes is now at levels last seen before the Global Financial Crisis. Turkey, in a sign of capitulation, raised interest rates from 17.8% to 24%, while Russia increased rates for the first time in four years. The only positive is that this has been perceived as confirmation that the central banks of both countries remain relatively independent. At the same time, Argentina and Kenya implemented austerity measures to appease the IMF. Together with weaker than expected US consumer price inflation, these policy adjustments brought some calm to the emerging markets and their currencies by quarter end. Despite violent swings, the rand was only 2.9% weaker against the dollar over the quarter.

The US economy continued to strengthen, with equity markets hitting new highs, consumer confidence at its strongest levels in 18 years and jobless claims at 49-year lows. This has allowed the US Federal Reserve to increase interest rates for the third time this year and upgrade their growth expectations for 2019. Merrill Lynch’s survey of asset managers’ expectations reported the most favourable outlook for US earnings on record, reflected in the valuation of the S&P500 Index, which has outperformed the MSCI Emerging Market Index by 20% on a year-todate basis. US focus will move to the mid-term elections of 6 November, where polls suggest that the Democratic Party is likely to take the House of Representatives, while the Republicans will keep the Senate. This is not ideal, but is likely to paralyse President Donald Trump on the domestic policy front. Irrespective of the results, however, he will retain free reign on foreign policy issues.

The picture looks less rosy for the rest of the world, hit by a strengthening US dollar, oil prices at four-year highs and global trade wars. Oil remains a headwind to growth and rose to US$85/barrel as Trump announced sanctions on Iran’s energy industry and Venezuela’s supply decreased due to their economic crisis. The OECD has announced that global economic growth has peaked and lowered its growth forecasts for 2018, predominantly due to trade wars.

There seems to be no end to the US - China trade war, with both countries implementing second rounds of tariffs in September and China boycotting the annual UN Summit held in New York. The new tariffs bring the total value of Chinese goods levied with tariffs up to US$250bn, and Trump threatened to expand tariffs to include an additional US$267bn of Chinese imports, taking the total to over US$500bn, roughly the size of all Chinese imports. The yuan weakened to a 12-month low and the Shanghai Composite Index fell to a low 25% from its January highs. Chinese growth is slowing and the Chinese government is attempting to support growth with both fiscal and monetary support, but these have yet to make an impact.

In Europe, the ECB kept interest rates unchanged while lowering its growth forecasts. The ECB confirmed that it will end its €2.6 trillion stimulus programme by the end of 2018, with a first hike likely only in September 2019. The UK’s exit from the EU remains on the cards, but there is no deal in sight, as neither party is willing to compromise on the key issue of free movement of people. Further East, Russia held its biggest war games in four decades after Russian Prime Minister Dmitry Medvedev called US sanctions a declaration of economic war.

In Japan, Prime Minister Shenzo Abe was reelected to his post on the back of the strongest economic growth in two years, despite inflation remaining close to zero and the Bank of Japan retaining stimulus measures. In Central and Latin America, Venezuela sold more oil assets to China in exchange for its badly needed financial support, a move that led Trump to threaten military action against the country. Sentiment remains unsettled by politics, with 41% of economic output from the G20 now governed by populists, up from about 4% in 2007. Brazil heads for key elections on 7 October. Italian Prime Minister Giuseppe Conte says his government can’t adhere to EU budget rules, which sent Italian bond yields skyrocketing.

In South Africa, President Cyril Ramaphosa called for the constitution to be changed to allow land expropriation without compensation, causing massive investor anxiety. Economic data remained weak and inflation subdued as SA entered recession. In response, Ramaphosa presented a viable economic plan based on refocussing R50bn of expenditure towards stimulating economic growth. The plan includes the introduction of more competition in the telecommunications sector to bring down data costs, relaxation of visa requirements for foreigners to stimulate tourism, easing of immigration restrictions to bring in badly needed skills, finalisation of the Mining Charter, a R400bn infrastructure fund designed to create jobs, more private/public partnerships and some clarity on the land appropriation issue. However, there are no short-term solutions to the problems.

The quarter ended with the FTSE/JSE SWIX Index down 3.3%, the JSE All Bond Index up 0.8% and the rand 2.9% weaker relative to the US dollar.

FUND PERFORMANCE

The Sygnia Skeleton Balanced 40 Fund returned 1.2% for the quarter, in line with its strategic benchmark, which also returned 1.2%. The Fund benefitted from its large offshore position, which protected it from the emerging market selloff during the quarter, while the Fund’s mix of domestic risk assets over the quarter ultimately detracted from performance.
During the quarter we continued to downweight our emerging market exposure, particularly domestic equity and domestic bonds, which face both global and local headwinds. We continue to maintain a large offshore exposure, and the money we have taken offshore over the year remains in low-risk, liquid assets; we firmly believe that the increase in volatility will bring about buying opportunities. We are also looking at various protection strategies that will allow us to take on market exposure in a low-risk manner. The changes made to the Fund’s positioning are in line with its investment objective of maximising long-term returns, with a strong focus on managing the risk of short-term capital losses.

MARKET PERFORMANCE

Market sentiment in the second quarter of 2018 was largely driven by the erratic behaviour of US President Donald Trump, starting with his withdrawal from the nuclear treaty with Iran and followed by the imposition of further sanctions against Russia, an aggressive stance at the G7 meeting and all-consuming tit-for-tat trade battles with China and other allies. The US Federal Reserve added to the toxic investment environment by raising interest rates and signalling two more increases in 2018 and three in 2019, while the ECB indicated that it would wind down its €30 billion-a-month bond-buying program by December as inflation rose to meet the ECB’s 2% target in June. This translated into a massive sell-off of emerging markets. A number of countries, such as India, Turkey, Indonesia and Argentina, increased interest rates to protect their currencies. The stock market oscillated between optimistic belief that Trump was merely posturing to a growing fear that he is single-handedly disturbing the world order and destroying the prospects of synchronised global growth. Other geopolitical tensions added to the noise. The historic summit between the US and North Korea yielded little. In Europe, Italy’s new coalition government confirmed that although it had no intention of leaving the euro, it wanted a revision of budgetary constraints. And in Turkey, Recep Tayyip Erdogan was re-elected president, leading to concerns that he would exert more control over the country’s monetary policy.

South Africa and other emerging markets reeled from a sharp sell-off with currencies near multiyear lows. The countries most at risk are those with large US dollar-denominated debt levels, such as Argentina, Turkey and Brazil. Adding to the problem is that lack of liquidity in the bond markets places additional pressure on the currencies, which can be used quickly to hedge against a broader deterioration by selling them short.

Unfortunately, stability is not on the horizon as Trump continues his quest to get China to reduce its US$375 billion trade deficit with the US by US$200 billion. Trump ordered the identification of US$200 billion in Chinese imports for additional tariffs of 10%, with yet another US$200 billion in the offing if Beijing retaliates. While the US$50 billion in tariffs announced in April were mainly on industrial goods, the new move is broader. It was followed by an announcement that the US plans to halt Chinese investment in US technology. China promised to retaliate. It could do so by imposing higher tariffs, making life harder for US companies such as Ford, General Motors and Apple, which generate significant revenues in China, or simply by devaluing its currency and negating the effect of Trump’s tariffs on the economy. The latter move risks triggering capital outflows, however. In the meantime, China’s central bank cut the amount of reserves the country’s banks are required to keep on deposit, freeing up more than US$100 billion to help cushion the impact.

The US followed through on its decision to impose tariffs on steel and aluminium imports from the EU, Canada and Mexico. The EU, in turn, proposed levies worth US$3.3 billion on US exports. Trump responded with a threat of 20% to 25% tariffs on European car imports. The last couple of days of the quarter brought some market stability as Trump seemingly softened his stance on China’s technology-investment restrictions in the face of growing political and business backlash. At the same time, softer US GDP growth of an annualised 2% in the first quarter calmed concerns about a hawkish US Fed. And finally, the EU Summit migration agreement reduced the political risk of Germany’s coalition government collapsing.

On the economic front, according to the IMF the US remained on course for 2.9% GDP growth this year and 2.7% in 2019, thanks to US$1.5 trillion in tax cuts and US$300 billion in federal spending increases. However, the IMF also warned that growth is likely to drop to 1.9% in 2020 and 1.7% in 2021 based on the US’s unsustainable rising public debt load and the shift towards greater protectionism. US inflation came in slightly higher than expected at 2.8% in May, on the back of higher petrol prices. It is the highest number since February 2012. The unemployment rate fell to an 18-year low of 3.8%. China’s economy expanded at a faster-thanexpected 6.8% in the first quarter, though flagging exports and factory output may prove a drag in the coming months. The eurozone economy entered 2018 on a high, having recorded its fastest expansion in a decade during 2017, as it outpaced the US for the second straight year. However, the economic indicators for the first three months of 2018 recorded a sharp slowdown, which continued into the second quarter. The eurozone’s GDP grew by an annualised 1.7% in the first quarter, down from 2.7% in the fourth quarter of last year. Despite this, most economists still expect the year as a whole to register growth close to last year’s 2.4%, with unemployment of 8.5% at its lowest level since December 2008 and consumer inflation in June at 2% year-on-year. Core inflation, which excludes volatile items such as energy and food, fell to 1% in June from 1.1% in May.

The ECB announced it will end its government bond purchases in December 2019 but extended the life of negative interest rates past the summer of 2019. The central bank has bought €2.4 trillion of bonds over three years. The ECB lowered its forecast for 2018 GDP growth to 2.1% but raised its inflation projections for this year and next to 1.7%. In South Africa, the rand came within a hair’s breadth of the R14/US$ level, while yields on benchmark 10-year government bonds spiked above 9% for the first time since December 2017. The rand has lost about 17% against the US dollar in the current quarter alone, as foreign investors sold R34.7 billion worth of South African bonds between January and June, the highest sell-off on record. Last year, the first six months of the year recorded an inflow of R45.7 billion. In another shock, the economy shrank by 2.2% in the first quarter of 2018 compared with the final quarter of last year, with the agricultural sector plunging by 24.2%. This is the largest quarterly fall since the second quarter of 2009. The IMF forecasts growth of 1.5% in 2018 and 1.7% in 2019. And the current account deficit widened more than expected, to 4.8% of GDP, from 2.9% in the previous quarter and 2% the year before. Consumer inflation fell to 4.4% in May despite a 1% VAT rate hike in April, mainly due to lower food prices. The Reserve Bank kept interest rates on hold at 6.5%, citing upside risks to the inflation outlook from US dollar strength and the surge in oil prices. The sell-off in emerging markets comes at a time when South Africa is desperately trying to attract foreign investment. President Cyril Ramaphosa led a delegation to the G7 Summit in Canada, South Africa’s first invitation in seven years.

On a positive note, the new version of the Mining Charter recognised the key principle of “once empowered, always empowered”, although ownership targets have been raised from 26% to 30%. Ramaphosa also gave an indication of what land redistribution would look like at the Drakensberg Inclusive Growth Forum. Measures proposed included giving arable land and agricultural support to emerging black farmers, providing labour tenants with security of tenure, housing poor families in well-located urban areas and ensuring that communal land is used for the benefit of communities. The quarter ended with the FTSE/JSE SWIX Index up 2.7%, the JSE All Bond Index down 1.2% and the rand 8.1% weaker relative to the US dollar.

FUND PERFORMANCE

The Sygnia Skeleton Balanced 40 Fund returned 3.5% for the quarter, outperforming its strategic benchmark, which returned 2.1%. Outperformance was driven by the Fund’s large offshore position, which protected the portfolio from the Emerging market sell-off during the quarter. The Fund’s low exposure to domestic risk assets, particularly SA bonds, benefitted performance as well. We made very few changes during the quarter: we increased our offshore exposure quite early in the quarter and continued our downweighting of emerging markets. The money we have taken offshore remains in low-risk, liquid assets, as we firmly believe that the increase in volatility will bring about buying opportunities. We are also looking at various protection strategies that will allow us to take on market exposure in a low-risk manner. The changes made to the Fund’s positioning are in line with its investment objective of maximising long-term returns combined with a strong focus on managing the risk of short-term capital losses.