The Sanlam Select Absolute Fund changed it's name to Amplify Sanlam Collective Investments Absolute Fund, effective from 01 December 2019.

Global policy discord was the main theme in 3Q19 as political decisions hurt growth, leading to demands from politicians for monetary policy to do more.

US President Donald Trump expanded tariffs on Chinese imports, although implementation will be staggered. The decline in the equity market stoked recession fears, with the US 2-10-year part of the yield curve inverting. The US Federal Reserve (Fed) cut rates twice since mid-2019, but the statements, minutes and dot plots have revealed a less dovish tone. Yet the Fed funds futures are pricing in one more cut for 2019 and two more for 2020.

It is a case of the Fed following the market, albeit reluctantly, given that falling rates, a 50-year low in unemployment, and trend GDP growth are offsetting fiscal tightening and trade wars. The slump in the ISM manufacturing index may be an overreaction to data and politics, but the fact that the oil price has not rallied despite attacks on Saudi Arabia production facilities suggests that global growth is faltering.

The European Central Bank has already embarked on the next round of quantitative easing with president Mario Draghi’s swansong delivering deeper negative rates and asset purchases of €20 billion per month. Negative yields across Europe and Japan are spilling over to the US and, from there, pushing investors further out the risk frontier. This search for yield has helped mask South Africa’s deteriorating fiscal position, as local bond yields have risen only modestly in the face of higher issuance.

The government announced a second large bailout for Eskom, which will have to be funded by higher taxes or expenditure reprioritisation. Both will be a net drain on the economy, as the cash injection will go towards debt redemptions rather than infrastructure.

While we all bemoan that the South African Reserve Bank (SARB) has not cut rates more aggressively, we must acknowledge that weak fiscal policy and lack of reform have hamstrung monetary policy. Cautious language accompanied the July Monetary Policy Committee repo rate cut, highlighting that the SARB is cognisant of the risks. Hence, the Medium-Term Budget Policy Statement will have to go beyond business-as-usual in laying out a clear and credible plan on how government will steer the fiscal ship on a more sustainable course.

Market developments
During September, SA floating rate credit (1%) was the only asset class to beat cash (0.6%). Nominal bonds (0.5%) marginally beat inflation-linked bonds (0.4%), fixed-rate credit (0.3%) and property (0.3%), while equities (0.2%) lagged in a narrow return distribution month. Similarly, for 3Q19, floating rate credit (3.1%) beat cash (1.8%), while fixed-income asset classes – fixed-rate credit (1.5%), nominal bonds (0.8%) and inflation-linked bonds (0.3%) – trumped property (-4.4%) and equities (-4.6%).

Relatively resilient US growth and sporadic safe-haven demand related to trade tensions, geopolitical risks, and impeachment uncertainty added impetus to the greenback. The Rand lost 7.2% against the Dollar, with some of the weakness reflecting hedging activity. The Rand is marginally cheap versus our 14.50-15.00 fair value range for the Rand against the US Dollar, but weak productivity growth and a substantial fiscal funding requirement are headwinds to major gains in the local currency.

Local bond yields rose only 20 basis points (bps) during 3Q19, but this belies the sharp increase in SA’s risk premium versus emerging markets. SA’s five-year credit default swap spread over its peer group widened from 60 bps to 90 bps, while the SA/ JPMorgan Government Bond Index-Emerging Markets Index spread rose from 280 bps to 340 bps. SA-specific factors account for the underperformance, as high real yields are required to entice foreign funding. At 8.80%, the SA 10-year yield is trading 720 bps above the US equivalent, but within our 8.60-9.10% fair-value range.

Central bank easing did not counter trade wars and Trump tweets in 3Q19, with the MSCI World Index flat for the quarter, while the MSCI EM Index lost 5.1% in Dollar terms. The MSCI SA Index lost 13.2%, with the Rand accounting for just over half the decline. Despite the September rebound, the FTSE/JSE Shareholder Weighted Index (SWIX) lost 4.3% (total return) in 3Q19, with broad-based underlying weakness: telecommunications (-7.8%), financials (-6.8%), basic materials (-6.4%), consumer services (-6.2%), industrials (-3.9%), health care (-2.5%), technology (-1.1%), and consumer goods (-0.8%). Stock-specific issues and policy uncertainty constrained the local market, with gold (12.3%) and platinum (25.8%) the standout sectors thanks to the higher Rand commodity prices.

Portfolio performance and positioning

The fund’s performance (0.7%) during September was driven by foreign equity (0.2% contribution), domestic bonds (0.2%), domestic property (0.1%), domestic equity (0.1%) and domestic cash (0.1%). Given the attractive valuations in fixed income and curtailed return distribution, we increased our duration position from onweight to overweight during the month.

Notwithstanding the 3.1% rebound in GDP in 2Q19, output in the first half of 2019 was still 0.5% below that of the second half of 2018. Moreover, the SARB’s leading indicator has trended downwards, third-quarter business confidence slumped to 21, and the manufacturing PMI has dropped to a post-crisis low of 41.6. While the market welcomed Treasury’s growth plan as being more private sector-friendly, policy uncertainty continues, particularly in the electricity sector. SOE bailouts have gathered pace, while revenues are running well short of budget estimates. SA credit and local currency risk premia are already reflecting the SA-specific weakness. The benign inflation outlook results in a real yield of over 4% in local fixed income. This is competitively priced versus local and peer group asset classes. Our equity positions still reflect a somewhat cautious view on global and local growth, being overweight resources and global diversified counters. With cheaper valuations in recent months, we have reduced our underweight allocations to various SA Inc sectors, including retailers.

It has been an erratic three months for equity markets. The S&P 500 Index was Goldilocks in April (+3.9%), but lost it all and then some in May (-6.8%) due to Trump's tariff tweets, only to rebound strongly in June (+7.2%) on the expectation of US Federal Reserve (Fed) easing, and to make a record high in the first week of July on a renewed trade truce. Notwithstanding the ongoing damage to the global economy from existing trade tariffs and persistent uncertainty, the equity market is signalling strong growth ahead. Admittedly, the sharp fall in bond yields has assisted valuations.

The slump in developed market bond yields is telling a different story - it signals concern about growth, evident in lower real yields, as well as deflation fears. The first half of 2019 repricing in monetary policy expectations has seen a scramble by some analysts to revise forecasts to Fed cuts. While few are projecting a US recession, some expect insurance cuts to offset the impact from trade wars and the waning impact of prior fiscal stimulus.

It is not obvious that the Fed should be cutting rates based on the performance in equities and US GDP. Yet the expectation of Fed stimulus has contributed to the easing in financial conditions, with the market pricing in at least 25 basis points for the July meeting. Hence, the Fed would have to explain a pause carefully to prevent a sharp sell-off in rates and risk assets.

The Fed's dovish pivot has given emerging market central banks room to manoeuvre. The SA market reflects this, with the forward rate agreement curve fully priced for a 25-basis point rate cut in July. SA is a more obvious candidate for substantial central bank easing, but fiscal risks and capital flow volatility have so far prevented an easing cycle. With only five Monetary Policy Committee members contributing to the July meeting, the divisions within the committee make the repo rate outcome a much closer call than what the market is reflecting.

Market developments

A more dovish Fed and hopes of a trade truce left local equities (4.8%) in the lead for June. Bonds (2.2%), listed property (2.2%) and fixed-rate credit (2%) beat cash (0.6%), while floating-rate credit (0.5%) and inflation-linked bonds (0.3%) underperformed. For 2Q19 all the asset categories beat cash (1.8%), with listed property taking a surprising lead (4.5%), followed by fixed-rate credit (4.2%), equities (3.9%), bonds (3.7%), inflation-linked bonds (2.8%) and floating-rate credit (2.6%).

The lower Fed dot plot and US yields left the Dollar 1.6% weaker in June and emerging market FX 2.5% stronger. The Rand rallied 3.5%, taking the USD/ZAR to the low 14.00s. At 14.10, the Rand is neutral on our short-term 14.00-14.50 fairvalue range, but potentially expensive on a medium-term view given the weak growth trajectory and potential for credit rating downgrades.

Developed market bond yields plummeted in June with the German 10-year Bund falling deeper into negative territory (-0.4%) and the US 10-year bond moving sub-2% for the first time since the 2016 US elections. Expectations of Fed rate cuts and European Central Bank President Draghi's 'whatever it takes 2.0' boosted global bond markets. SA lagged the global rally due to the negative impact of the first-quarter GDP data, political news flow, and fiscal fears. Even so, the 10-year yield fell by 30 basis points in June, to 8.70%, which is at the lower end of our 8.60- 9.10% fair-value range.

Falling yields contributed to the surge in equities in June, with the S&P 500 Index rebounding by 6.9%. The MSCI World Index gained 6.5%, marginally beating the MSCI Emerging Markets Index's 5.7% gain. SA was a relative outperformer, in part due to FX appreciation, with the MSCI SA Index up by 6.2%. The FTSE/JSE All Share Index gained 4.8% and the FTSE/JSE Shareholder Weighted All Share Index 3.1%. The underlying performances were wide-ranging: resources outperformed (8.9%), in particular gold mining (+24.5%) stood out, followed closely by consumer goods (8.4%), while industrials (-4.1%) and health care (-0.5%) declined outright. Financials (1.3%) and consumer services (0.6%) underperformed, while technology (4.4%) and telecommunications (4.1%) outperformed modestly. The rally brought valuations closer to fair value with the market now trading on a forward price-toearnings ratio of 13.5.

Portfolio performance and positioning The fund's performance (2%) was driven largely by domestic equity (1.4% contribution), followed by domestic bonds (0.4%), foreign equity (0.2%), and domestic cash (0.1%). These were partly countered by the negative performance from foreign cash (-0.3%), which was due to the appreciation in the Rand. Domestic property was neutral for the portfolio's performance. The rebound in developed market equity assets amid a more dovish Fed and the expectation of a trade truce at the G20 spilled over to emerging market assets. Our allocation to domestic cash declined in June in favour of offshore cash, which partly reflects the expiry of an FX derivatives position. We maintained a moderate underweight-duration position in domestic bonds.

Domestic activity, confidence, and consumer metrics remain disappointing. Escalating trade tensions in May have given way to a renewed truce in June, with US-Sino trade talks set to resume. However, a deal is unlikely to transpire, leaving uncertainty elevated. South African asset valuations are no longer attractive, justifying a cautious stance as weak growth will lead to slowing earnings momentum, while also weighing on the fiscal position. President Ramaphosa's State of the Nation Address was promising, but the pace of political and economic reform remains pedestrian and, therefore, underwhelming. As such, we remain cautious and still prefer global defensive stocks and resources, and a moderate underweight allocation to duration

South Africa’s own goals continued in March as power rationing intensified, macro data weakened further, President Ramaphosa committed to nationalising the South African Reserve Bank (SARB), and the ANC submitted a less-than-wholesome party list for the 8 May general elections.

Operational challenges, diesel shortages, and lower power imports due to Cyclone Idai in Mozambique triggered Stage 4 load shedding mid-month. This, in turn, dampened confidence, evident in the BER Business Confidence Index falling further. Our GDP tracker points to a contraction in 1Q19, which could weigh on SA asset prices given concern about implications for tax revenues. SARS has already confirmed a R14.6 billion tax revenue shortfall for FY19.

Inflation remains contained, printing at 4.1% in February, with a notable moderation in inflation expectations – five-year expectations fell to 5.1% in 1Q19. This, alongside a less hawkish US Federal Reserve (Fed), allowed the SARB to move to a neutral stance in its March meeting, which resulted in a unanimous decision to keep the repo rate unchanged at 6.75%.

Turkey once again showed itself as the lightning rod in emerging markets with the Lira suffering another bout of volatility as falling reserves and more evidence of domestic Dollar-hoarding spooked investors. While the Rand temporarily suffered from Turkey contagion, the weakness was short-lived as the currency and bonds benefited from Moody’s decision not to review the credit rating (Baa3/stable outlook). While this ‘skip’ has not quelled ratings fears, it has bought SA assets more time to benefit from the recovery in risk appetite.

The Fed’s dot plot almost flatlined in March as the median shifted to only one hike, in 2020. Moreover, quantitative tightening will end in September, and there is a high probability that substantial Treasury purchases will resume from 1Q20. Data out of Germany remain disappointing, but China is turning a corner. However, downside risks remain elevated with the delay in Brexit and the US/China trade deal. The US 10-year/three-month yield spread inverted briefly in March, with many believing this is confirmation of the coming recession.

While the end may be near, this is probably only the beginning of the end of the US expansion. For SA, this is but only the end of the beginning of the leadership transition. All eyes will be on the 8 May elections as a gauge of structural reform, even if we know that reform is tough to implement, particularly with low growth and a divided party.

Market developments

Strong global risk appetite kept local equities (1.6%) in the lead for March’s asset class performance. Bonds (1.3%), fixed-rate credit (1.2%), and floating-rate credit (0.9%) outperformed cash (0.6%), while inflation-linked bonds (-0.8%) and listed property (-1.5%) were relative laggards.

The Dollar’s resilience continued, gaining 1.2% versus developed market majors and 2% against emerging market currencies. The Rand was a slight underperformer, losing 3% against the Dollar due to load shedding and ratings risk. Even so, the Rand/Dollar exchange rate remains in line with our 14.00-14.50 fairvalue range.Confirmation of the end of quantitative tightening and the paring of growth expectations pushed the US 10-year yield to below 2.40%. Again, SA-specific issues – load shedding and the Moody’s review – ensured that local rates lagged the decline in global yields. Foreigners remained modest net sellers of SA bonds (R1.3 billion) in March. At 9%, bonds are fairly priced relative to our 8.60-9.10% fairvalue range.

The dovish Fed and signs of a nascent recovery in global trade activity boosted equity markets further in March. The S&P 500 Index gained 1.8%, the Eurostoxx 50 rose by 2.1%, and the Shanghai Composite jumped by 5.1%. The MSCI South Africa Index (USD) lost 2.1% in March, underperforming the modest gain in the MSCI World (1%) and MSCI Emerging Markets (0.7%) indices. The FTSE/JSE All Share Index (ALSI) rose by 0.8% in March, with varying underlying sector performances. The weaker Rand and higher industrial commodity prices supported resources (3.7%), while the surge in Naspers boosted the technology sector (9.3%). Consumer-related sectors were under pressure with consumer services (-3%) suffering from Rand weakness and SA pessimism, while financials (-4%) were impacted by the weaker Rand, ratings fears, and disappointing earnings announcements.

Portfolio performance and positioning

The fund’s performance (1.9%) was driven largely by domestic equity (0.8% contribution), foreign equity (0.5%) and foreign cash (0.3%) due to the depreciation in the currency during the month. These were followed by contributions from domestic bonds (0.2%) and domestic cash (0.2%), while local property (-0.04%) detracted only marginally from the fund’s performance in March.

Our asset allocation was broadly unchanged during the month. We maintained our allocation to domestic equities (40%) and offshore (11%) equities, while retaining an underweight-duration position in domestic bonds (32%). We kept our exposure broadly equal between domestic cash (1.4%) and offshore cash (11.4%), with a modest allocation to local property (4%).

Domestic real activity data, confidence indicators and consumer metrics remain disappointing, but have been countered by improving global risk appetite and the lower local repo rate expectations. South African asset valuations have moved towards neutral relative to the anticipated growth recovery, given elevated downside risks. Uncertainty persists, centred on political risks in an election year, fiscal pressures, Eskom’s liquidity position, and the risk of load shedding as we move into the high-demand winter period. As such, we remain cautious and still prefer global defensive stocks and resources, but have increased our allocations to domestic retail counters given recent underperformance.