Macro review

In the US, the third quarter saw increased political uncertainty amid rising tensions between the US and North Korea and the ongoing failure of the Trump administration to implement its policy goals. These tensions were a key factor behind the temporary rotation into lower-risk assets in August. In the wake of hurricanes Harvey and Irma, economic data and activity indicators deteriorated towards the period end. However, capital markets discounted the potential negative impact on growth as minimal, as did the US Federal Reserve (Fed) in its statement following the latest Federal Open Market Committee meeting. At this meeting, the Fed kept interest rates steady but confirmed that measures to reduce its balance sheet would begin in October, despite persistently weak inflation.

In the Eurozone region, economic data remained robust over the prior three months. GDP growth was confirmed at 0.6% in the second quarter, up from 0.5% in the first quarter. Economic sentiment rose to its highest level since July 2007, while unemployment in the Eurozone remained at 9.1% in August, which was stable compared to July, and the lowest rate since February 2009. The possibility that the European Central Bank could reduce its stimulus measures continued to be a focus for the market, as the committee kept policy rates unchanged in September. Also noteworthy was Angela Merkel winning a fourth term as the Chancellor of Germany in September. For the UK, the economy showed clear signs of slowing down, while inflation picked up, reaching 2.9% in August. During the quarter the Bank of England struck a more hawkish note with Governor Carney and a number of members of the Monetary Policy Committee openly discussing rate rises.

Emerging markets saw a positive economic backdrop of steady global growth, modest inflation, US dollar weakness and a continued momentum in the Chinese economy through a pickup in commodity prices. In China, Industrial profits rose 20% year-on-year in August vs. 16.5% year-on-year in July, driven by a rebound in industrial prices. In South Africa, the South African Reserve Bank (SARB) lowered the repo rate by 25 basis points (bps) in July, yet surprised markets by keeping the policy rate steady at 6.75% in September. GDP growth momentum recovered in the second quarter to lift by 2.5% %q/q saar after a brief technical recession in the first quarter.

Global and local market review

Global equity markets advanced in the third quarter with the MSCI World Index returning 5.0% in US dollars, and 16.5% year to date (YTD). This advance was largely driven by stable economic growth, benign inflation and positive earnings releases. Emerging market equities, however, outperformed their developed world counterparts, returning 8.0% during the third quarter and 28.1% YTD, in dollars. This streak of outperformance ended in September after 8 months of positive relative performance. Top performers in emerging markets in the third quarter were Brazil (+23%), Russia (+18%) and Chile (+17%), while Pakistan (-16%), Greece (-12%) and Qatar (-7%) were the laggards. Brazil saw some reform progress and central bank easing, while Russian equities rallied as crude prices picked up and lower inflation opened the door for further interest rate cuts. In contrast, Pakistan’s market was weighed by their Supreme Court’s disqualification of the prime minister, while Greece declined amid a sell-off in banking stocks.

Bond yields oscillated over the quarter and, with the exception of the UK, which sold off sharply in September, were ultimately little changed against a largely unchangedglobal economic backdrop. While the late-June sell-off initially continued in July, it came to a halt as growing expectations of a hawkish shift among central banks were reined in. Yields moved lower in August, precipitated by safe-haven buying, before reversing course once more in September as risk appetite returned.

The Bloomberg Commodities Index rose in the third quarter. The energy component generated the strongest return, with Brent crude rallying 20.1% over the quarter. It was supported by a faster-than-expected fall in US crude inventories and increased expectation for an extension of production cuts amid rising global demand. Industrial metals also recorded a robust return as economic momentum in China remained firm. Iron ore was up 14.9% while zinc (+15.5%) and copper (+9.5%) both posted sizeable gains. In contrast, the agricultural component lost value. Wheat and corn prices fell sharply amid record global supplies. In precious metals, gold was up 3.2%, in part given an uptick in geopolitical concerns.

US 10-year yields began the period at 2.31% and finished at 2.33% with bund 10- year yields virtually unchanged from 0.47% to 0.46%. Ten-year UK gilt yields rose 10 bps to 1.36%. The move reflected higher inflation and more hawkish central bank rhetoric. Corporate bonds made positive returns, outperforming government bonds. Global investment grade (IG) 2 credit rose 1.14% and high yield (HY) by 2.16%. The US led the way with IG gaining 1.37% and HY 2.04%.

Year to date, South African equities (Swix) delivered a healthy 10.6%, underperforming bonds (+4.0%) and cash (+3.7%) as commodity prices rallied and rate expectations buoyed equity markets during the third quarter. Over the quarter, the Swix returned 7.0%, driven by Materials (+17.8%), while Industrials (+7.4%) and Financials (+5.1%) also rallied. Within Industrials, Naspers (15.0%) continued to outperform on the back of a strong performance in Tencent. Interest rate-sensitive sectors such as Retail and Banks also bounced early in the third quarter, around the first rate-cut in July, although the SARB surprised markets in September by keeping the policy rate steady at 6.75%. MTN (+11.2%) also drove the equity market as MTN’s new management conveyed its aspirational growth potential, while Aspen (+5.7%) rallied after announcing the AstraZeneca (AZN) deal.

SA bonds (+3.7%) outperformed cash (+1.8%), yet underperformed SA equities (Capped Swix Index +5.9%) in the third quarter. The benchmark SA 10-year bond yield declined from 8.77% at the end of June 2017 to 8.55% at the end of September this year, supported by SA's high real yields, expectations of deceleration in inflation into year-end, and the global backdrop.

The FTSE/JSE SA Listed Property Index (SAPY) returned a total of 5.7% in the third quarter and 8.2% YTD. From January 2017 the SAPY has outperformed bonds and cash, but it has meaningfully underperformed the FTSE/JSE All Share Index (Alsi) (12.5%). The best performing shares in the SAPY for the quarter included shares with a high foreign exposure such as MAS Real Estate, NEPI Rockcastle as well as Greenbay Properties, which only recently entered the SAPY Index. This was driven by good fundamental earnings growth, which was partly driven by rand weakness. Conversely, shares with more pure-play SA exposure were some of the underperformers, such as Hyprop Investments, which derated substantially from well under a 6% dividend yield (DY) to over a 6.5% DY in the course of the quarter.

The year ahead

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.global economic backdrop. While the late-June sell-off initially continued in July, it
came to a halt as growing expectations of a hawkish shift among central banks were
reined in. Yields moved lower in August, precipitated by safe-haven buying, before
reversing course once more in September as risk appetite returned.
The Bloomberg Commodities Index rose in the third quarter. The energy component
generated the strongest return, with Brent crude rallying 20.1% over the quarter. It
was supported by a faster-than-expected fall in US crude inventories and increased
expectation for an extension of production cuts amid rising global demand. Industrial
metals also recorded a robust return as economic momentum in China remained
firm. Iron ore was up 14.9% while zinc (+15.5%) and copper (+9.5%) both posted
sizeable gains. In contrast, the agricultural component lost value. Wheat and corn
prices fell sharply amid record global supplies. In precious metals, gold was up
3.2%, in part given an uptick in geopolitical concerns.
US 10-year yields began the period at 2.31% and finished at 2.33% with bund 10-
year yields virtually unchanged from 0.47% to 0.46%. Ten-year UK gilt yields rose
10 bps to 1.36%. The move reflected higher inflation and more hawkish central bank
rhetoric. Corporate bonds made positive returns, outperforming government bonds.
Global investment grade (IG) 2 credit rose 1.14% and high yield (HY) by 2.16%. The
US led the way with IG gaining 1.37% and HY 2.04%.
Year to date, South African equities (Swix) delivered a healthy 10.6%,
underperforming bonds (+4.0%) and cash (+3.7%) as commodity prices rallied and
rate expectations buoyed equity markets during the third quarter. Over the quarter,
the Swix returned 7.0%, driven by Materials (+17.8%), while Industrials (+7.4%) and
Financials (+5.1%) also rallied. Within Industrials, Naspers (15.0%) continued to
outperform on the back of a strong performance in Tencent. Interest rate-sensitive
sectors such as Retail and Banks also bounced early in the third quarter, around the
first rate-cut in July, although the SARB surprised markets in September by keeping
the policy rate steady at 6.75%. MTN (+11.2%) also drove the equity market as
MTN’s new management conveyed its aspirational growth potential, while Aspen
(+5.7%) rallied after announcing the AstraZeneca (AZN) deal.
SA bonds (+3.7%) outperformed cash (+1.8%), yet underperformed SA equities
(Capped Swix Index +5.9%) in the third quarter. The benchmark SA 10-year bond
yield declined from 8.77% at the end of June 2017 to 8.55% at the end of September
this year, supported by SA's high real yields, expectations of deceleration in inflation
into year-end, and the global backdrop.
The FTSE/JSE SA Listed Property Index (SAPY) returned a total of 5.7% in the third
quarter and 8.2% YTD. From January 2017 the SAPY has outperformed bonds and
cash, but it has meaningfully underperformed the FTSE/JSE All Share Index (Alsi)
(12.5%). The best performing shares in the SAPY for the quarter included shares
with a high foreign exposure such as MAS Real Estate, NEPI Rockcastle as well as
Greenbay Properties, which only recently entered the SAPY Index. This was driven
by good fundamental earnings growth, which was partly driven by rand weakness.
Conversely, shares with more pure-play SA exposure were some of the
underperformers, such as Hyprop Investments, which derated substantially from well
under a 6% dividend yield (DY) to over a 6.5% DY in the course of the quarter.

The year ahead
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.