Global markets, up 5% in US dollars this quarter, have remained buoyed
by the $1.7 billion central bank injection this year and 13% increase in
earnings growth. Global growth is strong at 3.5%, accompanied by low
unemployment and improved consumer and business confidence. The
current bull run in global equities is near the strongest in history, yet
global valuations are only near the trough levels of 2003. Moreover,
prospects for earnings are the most positive in nearly five years. On the
face of it, the outlook appears serene, but on most historical measures
the US seems to be on the expensive side while other regions prove to be
cheaper.
History has shown us that the toughest month in the calendar year for the
Dow Jones is October, which has coincided with emerging market (EM)
currency sell-off since early September. The question is whether this
should be a cause for concern, as in the grander scheme of things these
are small moves as EM currencies are still up 5% vs the US dollar year to
date (YTD). Most importantly for SA investors, the rand has declined
versus the greenback and has wiped out most of this year’s currency
gains. There have been four main drivers for the rebounding of the dollar:
1) mainly that US inflation is likely to move higher over the coming
months, suggesting a December hike by the Fed; 2) reversing
quantitative easing from October; 3) President Trump’s overhauled plans
on tax reform, including cutting the corporate tax rate to 20%; and 4)
Chancellor Merkel’s reduced majority in the German elections.
We believe that right now we are in ‘EM giving back some of the strong
gains of 2017’ territory. But moves in the dollar are something to watch in
the immediate future.
In South Africa, apart from the ongoing movie between the US and North
Korea, there isn’t much that moved the SA market in September. This
could change as the ANC presidential race heats up into December.
We are seeing some recovery in real economy data, with the increase in
electricity demand and positive vehicle sales growth being good
examples; there are nonetheless signs of slightly positive GDP growth
after negative growth in Q1. South Africa has never been in recession
when global growth has been in excess of 2.5%. We continue to see GDP
growth averaging below 1.0% in 2017 and between 1% and 1.5% in
2018, with downside risk particularly next year, should the political
environment sour further. Nevertheless, the fact that the economy has
managed to climb out of recession in Q2 is likely to allay some fears and,
in our view, should bode in favour of the currency (at least in the short
term). That said, South Africa has fared well bearing in mind that 60% of
the JP Morgan Global Bond Index is now un-investable. The term
premium in SA bonds is the highest among emerging markets, showing
that the pricing of our bonds is at extremes now. The risk of S&P
downgrading our local bonds to junk is high but it could take a while
before South Africa gets removed from the World Government Bond
Index
In Q3 2017, the FTSE/JSE All Share Index (Alsi) posted a rand total
return of +8.9% versus -0.4% for Q2 and +3.8% for the first three months
of the year. This has been the best quarterly performance since Q3 2013
(+12.5%). This performance was boosted by the +17.8% total return from
SA Resources (-7% in Q2). SA Industrials and SA Financials showed
similar improvements in performance in Q3 of about 5%. The FTSE/JSE
All Bond Index (Albi) underperformed equities, returning +3.7% (+1.5% in
Q2).
The Alsi’s YTD total return of +12.6% has outperformed all other asset
classes (SAPY +8.2%, Albi +7.8%, Cash +5.6%). SA Industrials (+17%)
outperformed SA Resources (+12.4%) and Financials (+4%). Although
this appears to be good absolute returns, the South African market
underperformed that of its emerging market peers. A large contributing
factor was the net outflows in local equities of US$5.6 billion against the
Sanlam Namibia General Equity Fund
October 2017
factor was the net outflows in local equities of US$5.6 billion against the
inflows into emerging markets of US$63 billion YTD.
The Alsi’s forward price/earnings (P/E) ratio rerated by about 3.5% during
the last three months as the metals rally and rate cut expectations
boosted equities earlier in the quarter.
Performance and portfolio actions
The positive global backdrop helped spur the JSE strongly higher this
quarter with the FTSE/JSE Shareholder Weighted All Share Index (Swix)
up 7%, driven by a sharp rebound in Resources stocks, up close to 18%
in rands. Industrial stocks also delivered a decent performance, up by
over 7%, while Financial stocks lagged, up only 5% in the quarter. The
Sanlam Namibia General Equity portfolio delivered returns below its
benchmark in difficult market conditions.
The General Miners were up 29% during the quarter, driven by positive
data from China and a rebound in commodity prices, with oil notably up at
20% and the palladium price up 5% - now higher than the platinum price
for the first time since 2001. This drove Anglo American up 42% after
delivering strong half-year numbers while Glencore was up 27%. With
billionaire Anil Agarwal boosting his stake in Anglo American by US$2
billion and BHP Billiton the subject of corporate activists, there is
increasing pressure on mining houses to deliver value to shareholders.
There were, however, contrasting fortunes for the precious metal
producers. Gold was up a measly 1% this quarter with the new buzzword
among our clients being bitcoin and its role as an alternative currency - in
other words as an alternative for gold! On the downside, there were
disappointing results from Implats, which saw its share price drop once
again by 16%.
Our largest holding, Naspers, performed well this quarter (up 15%) after
delivering solid numbers. Globally, there is positive sentiment towards IT
stocks and Naspers’ investment in Tencent, the Chinese Internet
company, continues to drive the share price, up 20% this quarter. It is
worth noting that the Chinese stock market had its best quarter since
2009, up 15%. On the downside, Steinhoff was down over 10%, once
again afflicted by unsubstantiated accusation of malpractice in Europe.
The market shrugged off the successful listing of its African retail
businesses, STAR, at the end of September, which added R16 billion to
its coffers and should have resulted in a rerating of the rest of the group,
which operates mainly in developed markets.
Financial stocks delivered lacklustre interim numbers. Standard Bank
stood out with solid top-line growth driven by its African operations and
the share was up 12% this quarter. FirstRand also delivered dividend
growth ahead of earnings growth and the share was up by over 10%. Old
Mutual, one of our largest positions in the financial sector, was up a
pleasing 10%. The group is focusing on a separate listing of its UK wealth
business, which would help rerate the counter. On the downside, MMI
Holdings was down 10% after reporting disappointing results with weak
performance in group risk and poor persistency in the retail business
resulting in very weak sales. This has led to question marks as to the
sustainability of the group’s high dividend yield.
Conclusion
The main question facing investors, as in Q3, is whether valuations and
positioning point to a tactical pullback from risk. We think 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

Global markets
The year 2016 was definitely full of surprises starting with the Bank of Japan stunning the market with a surprise move to negative interest rates, muted Chinese GDP growth and the Brexit vote that wiped out about $2 trillion of global stocks overnight and knocked the British pound to 31-year lows. This was followed by Trump winning the presidency in a historic election upset in the US, which led to the dollar reaching a 14- year high in November and also the long-awaited Fed interest rate hike in December, with probably more to come in 2017.

The standout event over the last quarter must be the spectacular sell-off in US long bonds following the election of Donald Trump as president. The yield of the 30-year bond increased from 2.3% in October to 3.2% in mid-December as markets priced in the likelihood of fiscal stimulus with the Republicans firmly in control. The Fed continued on a path of vigilance against inflation as leading indicators point to growth and the first signs of wage inflation become visible. Both these events are a harbinger for a process that is likely to lead to higher global bond yields in future.

The 2016 performance of global equity markets was reasonable at best. The US dollar return of the MSCI Developed Markets Index was 8.2% and that for the MSCI Emerging Markets Index (EM) was 11.6%. The MSCI World Value Index outperformed its Growth counterpart by 7.8% over the last six months, a level that only occurred for 6% of the time over the last 20 years. Despite the 2016 rally, the MSCI Value shares are still close to historic lows in terms of earnings, valuations and price levels relative to Growth shares. The underperformance of Value stocks has closely tracked bond yields and inflation expectations, both of which are in a bottoming process.

It is our view that global growth will be driven by an acceleration in the US with stable growth in the Eurozone. The Chinese economy will probably grow at a slightly lower rate as fiscal stimulus and the leveraging of the property sector slow down.

We also expect stable growth in emerging markets in general and South Africa recovering from a low base as commodity prices stabilise.

South Africa
The MSCI SA Index (+18.4%) outperformed the MSCI EM Index (+11.6%) in dollar terms in 2016, as the rand (+12.6%) recovered to end 2016 as the third-best performing EM currency, helped by the political landscape stabilising somewhat, SA avoiding the foreign currency ratings downgrade and an improvement in commodity prices and EM sentiment.

However, in local currency terms, the FTSE/JSE All Share Index (ALSI) (+2.6%) underperformed SA bonds (+15.5%) and cash (+7.4%) in 2016. From a sector perspective 2016 was a year for value cyclicals with General Mining (+61.6%), Platinum (+50.5%) and Banks (+33.6%) among the best performing sectors. The eventual appointment of Finance Minister Pravin Gordhan, who helped SA avoid the ratings downgrade in 2016, and an improvement in EM risk sentiment helped the rand to achieve its best year since 2009, appreciating by 12.6% in 2016.

Unsurprisingly, SA equities performed poorly, given the drag from randhedge sectors, especially those with a significant sterling component, which came under pressure as a result of the impact of Brexit - with the pound sterling being very weak on a relative basis.
The FTSE/JSE Shareholder Weighted All Share Index (SWIX) delivered a 4% total return in rand terms, which hides the massive outperformance of value shares vs growth shares over the year, breaking a 10-year trend of value underperforming. Resources stocks led the way and were up 29%, outperforming the financial and industrial stocks, which posted a small decline.

Portfolio performance and actions
During the last quarter of 2016 your portfolio managed to outperform the ALSI by a modest margin, but on a 12-month basis the outperformance was more meaningful (+3%).

This was mainly due to our funds’ relative underweight positions in shares like Naspers, AngloGold, and Impala Platinum, which all managed very poor returns over the last three months. The overweight exposure to one of the smaller-cap shares, namely Curro Holdings, enhanced this outperformance. The relative overweight exposures to Northam and British American Tobacco managed to negate this performance difference somewhat.

During the quarter we added to select resource shares, which, despite the recent rally, were not fully pricing in the cash flow benefits of very strong commodity prices. New positions were established in high-quality retailers such as Mr Price (offering value for the first time in years) and Dis-Chem (a new listing).

Conclusion
We don’t expect 2017 to be a calm year in financial markets. In Europe, German and French elections will bring with them the usual dose of political uncertainty and further west, chatter around Brexit is unlikely to die down with Article 50 likely to be invoked in the first half of 2017.

Similarly, locally, the succession debate within the ruling party is likely to intensify. In the US, the Trump presidency will be under pressure to deliver on the pro-growth promises, which has swept the Republicans to victory.

These events are likely to cause further market volatility.