The third quarter of 2017 marked the ten-year anniversary of the start of the global financial crisis, generally agreed to have started during August 2007 with a series of credit shocks and leading to an international banking crisis. The economic downturn that followed was one of the worst recessions in decades in many global economies.

Reflecting back on the last decade, we have seen unprecedented economic policies being implemented. Expansionary fiscal policies were implemented in an effort to avert a repeat of the prolonged deep recessions and high unemployment rates which were seen in the 1930s. The increased levels of spending combined with lower economic growth levels have led to higher government debt levels worldwide. On the other hand we have also seen the use of unconventional monetary policy measures, with exceptionally low and even negative interest rates in some developed markets as well as quantitative easing policies implemented by a number of major economies, including in the United States, United Kingdom, Europe and Japan. Global trade and global growth levels retreated sharply during the 2007 to 2008 global financial crisis. Since then, global growth levels have recovered to historical norms albeit below trend growth levels, while global trade has remained below pre-crisis levels. The higher growth rates have not been accompanied by higher inflation despite the expansionary monetary policy measures being implemented as wage growth has remained sluggish while corporate profits continued to rise. This has helped fuel political instability in many major economies worldwide. Global financial markets have performed well with global equity markets posting new all-time highs on a frequent basis. The financial and banking sectors have been left behind and underperformed equity markets in general while a number of technology stocks delivered phenomenal returns to those investors who were willing to hold on. Global bond markets have also delivered stellar performance over the last decade as the sustained downward trend in interest rates have resulted in healthy total returns. The world economy and financial markets have grown accustomed to the support of central banks’ accommodative policies and we are still to see the impact if they are adjusted or normalised going forward. The question remains to what extent these lower interest rates and accommodative monetary policies have resulted in inflated asset prices elsewhere in the financial system.

Taking a look at the third quarter of 2017, it was marked by strong performance and new all-time highs in global equity markets, with volatility measures still at all-time lows despite geopolitical tensions and the threat of central bank normalisation looming. One of the central themes in financial markets towards the end of the third quarter was the potential unwinding of monetary stimulus in the United States and Europe going forward. Global and local 10-year government bond yields started the quarter at elevated levels, following hawkish comments from the Fed in the United States and the European Central Bank in Europe. We subsequently saw yields trend lower during July and August until they gave back their gains and global bond yields moved upwards again during September, with local yields following suit.

Namibian CPI was reported at 5.4% year-on-year for August and thus unchanged from the July year-on-year number. Of the four major components, food and non-alcoholic beverages increased by 4.6% yearon-year in August and thus unchanged from July. Inflation in the transport sector decreased to 2.0% year-on-year in August and is easing back from the 2.4% year-on-year for July. The pullback was fuelled by a decrease in vehicle purchase prices. Alcoholic beverages and tobacco increased by vehicle purchase prices. Alcoholic beverages and tobacco increased by 4.8% year-on-year in August, which is higher than the 3.6% year-on-year increase for July. This was in large part on the back of higher alcoholic beverage prices. The housing, utilities and fuels sector increased by 8.3% year-on-year in August, which is lower than the 9.1% year-on-year for July.

The Namibia Statistics Agency (NSA) released the final 2016 Annual National Accounts during August. The final figures reported some key revisions, including an upward revision of the 2016 GDP growth figure from 0.2% to 1.1%. Namibian economic growth continues to face some headwinds and the upwardly adjusted growth rate is still significantly below historic levels. The growth figures for the second quarter confirmed this when they were released during September and showed that the Namibian economy remained in a recession: the NSA reported that real GDP contracted by 1.7% year-on-year in the second quarter. The growth outlook remains weak with risks skewed to the downside. Given the close links between Namibia and South Africa, if the low growth environment in South Africa persists it would have negative repercussions for Namibia and put economic activity and cross-border trade under strain. This could be exasperated by the potential for further sovereign credit rating downgrades that South Africa may face and the negative repercussions it would have in South Africa and, by extension, Namibia.

Also in August, Moody’s downgraded Namibia’s foreign and local currency sovereign credit ratings from Baa3 to Ba1, thus now rated one notch below investment grade. The agency also maintained its negative outlook. They noted three key factors for the downgrade, being firstly the continued decrease in Namibia's fiscal strength on the back of significant fiscal imbalances combined with an increasing debt burden. Secondly, there is the limited institutional capacity to manage shocks and solve the longer-term structural fiscal rigidities. Thirdly, there is the risk of renewed government liquidity pressures in the coming years. This brings the Moody’s rating to one notch below the Fitch rating, which is at BBB-, also with a negative outlook.

Namibian and South African yields started the quarter at elevated levels with the yield on South African government bonds touching 9% at the beginning of the third quarter, and the Namibian 10-year government bond yield at 10.66%. Yields subsequently traded stronger during July, August and the first half of September before reversing the trend towards the end of September as local interest rates reacted to the hawkish comments from the United States Fed in addition to the South African Reserve Bank surprising the market by coming out with their own hawkish statement and keeping the repo rate unchanged, while the market was expecting a relatively strong probability of a policy rate cut. The Bank of Namibia cut the repo rate by 25 basis points during August bringing it to 6.75% and in line with the South African policy rate. One could have expected that positive bond market fundamentals would have been more supportive given the contained inflation and good trade numbers. However, local nominal yields traded significantly higher during the last two weeks of the month. Local nominal bonds still delivered good returns for the third quarter, outperforming inflation-linked bonds and cash with the longer end of the nominal yield curve being the best performing sector.

The year 2016 will remembered for a few big geopolitical surprises, namely Brexit and the election of Donald Trump as US president. Both of these events were largely driven by populism and protectionism. One could call it the ‘revenge of the middle class’. The election of Donald Trump led to a sharp increase in US treasury yields (and global yields) as markets priced in possible fiscal stimulus from the US, deregulation and a possible increase in trade barriers. We saw a global sell-off in previously loved asset classes like property and bonds, while value stocks started to outperform substantially in the aftermath of the US election results.

On the domestic front we had to deal with ongoing political infighting, which led to frequent bouts of currency volatility. We started 2016 dealing with the aftermath of the ‘Nenegate’ episode and a weak currency. Fortunately, South Africa managed to retain its investment grade rating for the time being. The rand recovered some lost ground over the course of the year and closed at R13.68/$ from R15.49/$ the previous year. This off course affected all portfolios with offshore exposure significantly and reminded investors that the rand is not always a one-way bet, unlike the previous couple of years. One could argue that stabilising growth in China and significant infrastructure spend from the US will support commodity prices and hence currencies like the rand; the counter argument could be that rising global yields might exert a bit more pressure on emerging market currencies as a whole.

We maintain that we are close to the top of the domestic tightening cycle with the repo rate at 7%. Hopefully we’ll also get some reprieve from a slowdown in especially food inflation during the course of the year. The 10-year RSA bond yield closed the year at 8.92%, down from 9.69% at the beginning of 2016. Nominal bonds had a fantastic year following the terrible 2015 and posted an annual return of 15.5%. Inflation-linked bonds returned +6.3% for the year, while cash delivered +7.4% for the year. Property posted a decent +10.2% for the year with most of it recorded during December (+4.3%).

What we did
Over the quarter the overall fund duration stayed fairly constant at about one year with little changes between the different fixed-income asset classes. We continued the process of yield enhancement although corporate credit looks expensive relative to bank credit spreads. Our clear preference for fixed-rate negotiable certificates of deposit (NCDs) and nominal bonds over inflation-linked bonds paid dividends over the calendar year, although, admittedly, we started 2016 at very attractive nominal yield levels. The fund comfortably exceeded the targeted return for the calendar year after a more testing 2015.

Our strategy
As stated last quarter, South African fixed-income assets remain attractive as an investment case, despite very good 2016 performances. Real yields of between 2% and 3% are still on offer in the fixed-income space with the yield of the fund comfortably approaching 9%. Although breakeven inflation levels have come down from the first quarter levels, we still prefer nominal bonds over inflation-linked bonds over the medium term. Some of the possible headwinds for the local fixed-income market could be rising global inflation expectations, rising global bond yields and currency weakness from unexpected political surprises. On balance, we prefer to add to the overall portfolio risk, given the general favourable valuations.