Global Markets

The S&P 500 Index delivered a total return of 7.7% over the last three months, 10.6% year to date and 14.4% since its February lows. Unfortunately, this strength is not shared broadly, with European, Australasian, Far Eastern (EAFE) and emerging markets (EMs) returning (in US Dollar terms) 1.4% and -0.9% for the quarter and -1.0% and -7.4% year to date.

A spate of newsflows from across the globe is currently driving markets. America’s trade war against what seems to be the rest of the entire world remains an ongoing concern for investors. This has led to some participants betting that China will increase their current stimulus programme in the coming months. Trump also made another enemy in the Organisation of Petroleum Exporting Countries (OPEC), publicly calling them out to reduce oil prices by increasing supply. At the same time, focus was on the Federal Open Market Committee, which raised rates again - the third this year - and reaffirmed a hawkish outlook going into 2019 and beyond. It would seem as if another hike in December is almost assured.

Additional to this, the laundry list of potential market headwinds is quite long, with the yield curve that is flattening; disruptive mid-term elections; peak margins; increasing corporate leverage; problems in EMs; and a stock market trading at record price-to-sales ratios. Despite this litany of concerns, we think none will cause the transition from market risk to a market problem.

Despite the best efforts by bears, international equities are so far rather resilient. The MSCI World Index is up 5.9% year to date, outperforming bonds by 700 basis points, on a total return basis. The performance, however, is quite US-centric, but it is notable that even accounting for the latest Italy setback, Eurozone equities are also holding up relative to fixed -income this year, with the MSCI Eurozone at 0.7% against bonds at - 0.7%. The general market expectation is that there would be further gains into year-end, as the US Dollar is potentially peaking, the US business cycle remains well supported, and there is some stabilisation in EM/Eurozone activity evident. Fundamentally, growth drivers are also far from exhausted. Although the yield curve has flattened, stocks have never peaked before the yield curve inverted. The current yield curve shape is consistent with double-digit S&P 500 returns over the next 12 months.

EM equities have performed poorly in 2018, and at the recent low point were down as much as 20% from January highs. Our best view is that EMs are flattening out as they tend to have a strong inverse correlation to the US Dollar, which could be peaking out.

Prospects for the Rand and other EM currencies have swung as they have moved from being some of the most promising asset classes this year to becoming the worst-performing asset classes in the first half of the year, largely due to tailwinds from the global economy turning into headwinds.

South Africa

After a dismal first-quarter growth print of -2.2%, the second-quarter GDP print was again negative at -0.7%, plunging the economy into a technical recession. Domestic demand remains weak, down almost 4%, with some rebound in exports by 14% helping. Companies continue to run down inventories, detracting from GDP.

In the third quarter of 2018 the FTSE/JSE All Share Index (ALSI) posted a Rand total return of -2.17%. The last three months were anything but easy, especially with the quantum of the downward moves of some of the equity prices. It is also extraordinary how intraday volatility has picked up, and the fact that more than 60% of the ALSI constituents saw a more than 5% intraday move during this period. SA Resources and SA Financials outperformed in the third quarter with total returns of 5.2% and 2.8% respectively, while SA Industrials were the drag on the index, shedding 7.8% over the same period. The FTSE/JSE All Bond Index (ALBI) was virtually flat with a total return of 0.8%, while the FTSE/JSE SA Listed Property Index (SAPY) returned -1% over the same period.

Year to date, the ALSI has posted a total return of -3.8% versus the ALBI’s 4.8% and -22.2% for the SAPY. SA Resources (+21%) have severely outperformed SA Financials (-6.8%) and Industrials (-11.8%) since January 2018.

South Africa remains on a low growth path. The aftershocks of State Capture and policy uncertainty persist, constraining confidence and investment. Structural economic reforms remain slow in coming, though the finalisation of the Mining Charter before the end of the year marks an important milestone.

South Africa needs growth in order to arrest further fiscal, socio-economic and credit ratings decline. Moody’s review of the sovereign’s ratings around middle October is unlikely to deliver any surprises (no change to its stable outlook or its Baa3 rating), though we think there is a chance the review could be delayed until after the 24 October medium-term budget.

The economy should drag higher in the second half of the year as we shake off the worst impact of agriculture after good rains and companies re-stocking ahead of the Christmas season. We remain on track for 1.3% economic growth in 2018, which would be a sub-par outcome, but the second-half growth numbers should look more decent, up 3% off a low base. Consumer confidence is holding up after reaching record highs at the beginning of the year, but business confidence remains in the doldrums.

Performance

The ALSI delivered a return of -2.17% during the last three months, which was better than that of the FTSE/JSE Shareholder Weighted Index (SWIX), which realised -3.34%. Your fund managed to outperform the ALSI marginally.

Our overweight position in certain resource stocks drove our performance, especially our overweight position in Anglo American Platinum, which performed well. Given the weaker Rand, the platinum group metals (PGM) basket has improved by 8% quarter-on-quarter and the company should move into a free cash flow positive position following its planned restructuring. Sasol (overweight) also performed well, up over 10%, with Brent oil up 7% this quarter in Rand terms. The oil price is at four-year highs with supply concerns augmented by the US threatening to boycott Iranian exports.

On the Financial side, the fund benefited from the overweight position in Old Mutual, which unbundled its stake in UK wealth manager Quilter and came back home for a primary listing on the JSE. Old Mutual was up 14% in the quarter, outperforming the ALSI. On the downside, the underweight position in Discovery detracted from performance after the insurer delivered results which beat expectations as their UK business appeared to turn the corner. The stock was up 15% in the quarter but trades at a hefty premium to embedded value.

The Industrial sector suffered the sharpest downdraft with some heavyweights being subject to some panic selling. MTN, a stock where we have a marginal overweight position, sold off 17% this quarter with yet another unexpected move by the Nigerian government. The Nigerian Central Bank demanded the return of US$8 billion of dividends which had been paid out over the past decade. The stock was sold off so sharply that the market implied a zero value for the Nigerian business ? MTN’s most profitable operation. While the government’s actions ahead of forthcoming elections remain unpredictable, our estimate is that the risk is now more than discounted in the share price and that a lengthy legal battle is likely to mean that some level of sanity will prevail.

Conclusion

In South Africa, the sentiment pendulum has swung from optimism, with the new political administration driving business and consumer confidence higher, to disappointment about the latest macro-economic drivers (GDP), which has dampened expectations of a solid economic recovery. Either way, economic mood swings tend to be exaggerated. Also, the expectation that President Ramaphosa will, in one fell swoop, reverse years of neglect and maladministration is unrealistic.

The JSE trades on a forward P/E of just around 13x, which, relative to its long-term history, is not expensive.

Market overview
What a volatile start for global markets during the first three months of 2018!

A pullback in technology-driven shares, rising trade tensions and fears over higher rates and inflation led to a volatile first quarter of 2018 for the S&P 500 Index. Following a 10% correction from its January highs and rallying back 8% by early March, the index suffered another 5% pullback in the last few weeks, ending the month of March down 2.5% on a total return basis and losing 0.8% over the last three months (first negative quarter since the third quarter of 2015). The S&P 500’s correction of just over 5% in the first week of February was a reminder that rising bond yields are likely to cause much anxiety on the path to normalisation.

While stocks were the worst-performing asset class in March, they finished the first quarter in the middle of the pack, beating both long-term Treasuries (-3.2%) and investment-grade corporate bonds (-2.2%) but lagging cash (+0.4%), gold (+2.5%), WTI oil (+5.3%) and the US Dollar Index (-0.7%).

Forgotten was the fact that the US implemented the biggest tax reform in three decades to drive the corporate income tax rate down from 35% to 21% and boost investment spending and productivity. The US is also encouraging corporates to repatriate some $2.5 trillion held offshore - but the impact on the US dollar should be limited as it is over 10 years and already held in dollars. The market, however, reminisced that the 1986 tax reform programme led to the considerable weakening of the greenback.

While recent data globally are mixed, credit impulse numbers and various leading indicators do suggest that growth expectations may still have room to drift lower. This could mean that downside risks for equities, yields and broader commodity prices are increasing, but in general the market positioning is much cleaner now and has probably priced in this ‘news’, leaving scope for a bounce.

While February and March are historically weak, April is a seasonally strong month (+1.2% average total return since 1928, the third-best month of the year).

South Africa

The JSE battled two opposing forces this quarter. On the one hand the ‘Ramaphosa effect’ drove some SA Inc. stocks to new highs, while the ‘Viceroy effect’ led to a slew of rumours impacting a number of companies. The recall of the former president attracted elusive foreign flows to the JSE, which flowed mainly into local retailers and banks, up 22%, a very narrow part of the market viewed as representative of the SA economy. The Budget also served to quell investor concerns. Fiscal consolidation is back on track with government debt now peaking at 55% of GDP - better than the mid-term budget scenario where debt was forecast to balloon. The GDP outlook has improved slightly from 1.1% to 1.8% and prospective revenue has improved thanks to a 1% increase in the VAT rate and enforcement of a strict expenditure ceiling.

Over the last three months the FTSE/JSE All Share Index (ALSI) posted a total return of -6.0%. This has been its worst quarterly performance in Sanlam Namibia General Equity Fund April 2018 total return of -6.0%. This has been its worst quarterly performance in eight years (Q2 2010: -8.2%). SA Industrials were the worst performer, returning -8.0% (Naspers and British American Tobacco, which were both down more than 15%). SA Resources lost 3.8% (rising global uncertainty) and SA Financials lost 3.6%. The FTSE/JSE All Bond Index (ALBI) outperformed with a total return of 8.1% (helped by Moody’s keeping SA’s sovereign credit rating unchanged), while the FTSE/JSE SA Listed Property Index (SAPY) has shown the largest underperformance, -19.6% (negative press on Resilient group of companies).

Of the equity sectors, the top first-quarter performance came from Nonlife Insurance (+24.4%), Fixed Line Telecoms (+10.0%) and General Retailers (+9.2%). The worst performance came from Real Estate Development and Services (-31.2%), Software (-30.5%) and Household Goods (-29.0%).

The ALSI has derated year to date and is now trading at a forward priceto-earnings (P/E) ratio of between 14.5 times and 15 times (16.8 times historic) versus the long-term average of 12.6 times. But ex Naspers we are at 13.5 times versus the long-term average of 12.3 times.

Portfolio and performance review

Your fund managed to outperform its benchmark - the ALSI (-5.97%) - comfortably. The main reasons for this were the relative underweight positions in property shares such as Resilient and Fortress and also in Naspers, which was down over 15% during this period. Overweight exposures in Namibian Breweries and Old Mutual further enhanced this performance. Overweight positions in poor-performing shares such as Curro and British American Tobacco negated some of this performance.

The negative returns for the first quarter were mainly due to industrial stocks, down 8%, as the strong rand and choppy global markets weighed on stocks with global footprints. British American Tobacco and Naspers were both down over 15%. The Ramaphosa effect was noticeable with banks, up 24%, apparel retailers, up 9%, and small cap stocks, down slightly. Resources stocks were down around 4% with heavyweight Anglo American up 10%, while the platinum index came under pressure, down some 27%, with Impala Platinum falling out of the FTSE/JSE Top 40 Index after retreating 27% on the back of poor results.

Conclusion

Volatility has once again become the dominant factor in financial markets globally, exemplified by the VIX fear index experiencing its biggest daily spike in history during the quarter. There are growing concerns that global businesses may be subject to new regulation and be the target of tariffs if a US-China trade war escalates. Political risk is dominating fundamentals and we now have progressed into a new era where central banks are not the backstop supporting financial markets.

In South Africa, the sentiment pendulum has swung from pessimism to optimism with the new political administration driving business and consumer confidence higher with expectations of a solid economic recovery being discounted. Either way, economic mood swings tend to be exaggerated. Also, the expectation that President Ramaphosa will, in one fell swoop, reverse years of maladministration and corruption are unrealistic.

Market review

For the first time on record, global equity markets rallied in all 12 months of a year. The MSCI ACWI rallied 21.6% in 2017, which is one of the strongest years since 2009. Consistent with previous economic upturns, the US lagged the global index somewhat while Emerging Markets (EM) (+34.3%) and Asia Pacific ex-Japan (+33.5%) led the pack. At the beginning of 2017, global macro and earnings were improving and the policy was accommodative and, analysing the current environment, it seems as if the same attractive set-up for equities exists at the start of 2018.

While tax reforms in the US should provide a big boost to 2018 earnings growth, there are several reasons to expect it to be a headwind in subsequent years, due to the fact that higher returns should incentivise additional competition, which then should have a negative impact on margins over time. The stronger growth could also result in more aggressive Fed tightening, which could eventually weigh on overall economic growth.

The yields on the US 10yr rose marginally from 2.33% to 2.40% over the quarter, but for a brief period when they touched 2.5%. However, the curve flattened aggressively as shorter maturities sold off in anticipation of the December rate hike and continued tightening of monetary policy by the Fed in 2018. Yields on German bonds rallied slightly from 0.46% to 0.42%.

The end of the quarter brought a number of unknowns in South Africa to the fore, leading to some sharp share price dislocations. We knew about the precarious financial position of state-owned enterprises, but did not know that it would be Steinhoff International that would make the headline as possibly one of the largest collapses in the history of corporate South Africa. We also knew that South Africa’s credit rating was on a knife-edge, but did not know that Moody’s would decide on a stay of execution. I think that we have now become accustomed to expect the unexpected when it comes to global political events.

In rands, SA Equities (All Share: +21%) outperformed SA Bonds (+10.2%) and cash (+7.5%). Property again had a good year with a total return of about 17.2%. The rand was also the sixth best performing EM currency against the dollar, appreciating by 10.9%. The local bond market endured a tumultuous ride and yields sold off more than 100bps as the market anticipated a bad mini-Budget and Finance Minister Gigaba revealed the extent of the fiscal deterioration in the Medium-Term Budget Policy Statement (MTBPS).

In terms of major contributions to the FTSE/JSE All Share Index’s return of 21% in 2017 in rands, Media (Naspers: +71.8%) contributed the major portion to this return. The Ramaphosa win at the ANC elective conference buoyed SA domestic-demand sectors, including Banks (+29.9%), Insurance (+37.5%), Diversified Financials (+16.2%) and Retail (+26%). The general underweight positioning in SA domestic-demand sectors also added to the domestic stock rally into year-end. Of the sectors that realised negative returns, Consumer Durables suffered the most, given accounting irregularities (Steinhoff), followed by Healthcare.

In 2017, SA equities recorded outflows of $2.5bn, significantly lagginginflows into EM equities of $77.2bn. However, dissecting the flows, it appears that, excluding the outflows from dual-listed stocks and the Barclays and Vodacom sell-down, SA equities saw inflows of just more than R60bn in 2017.

The FTSE/JSE All Share Index (ALSI) 12-month forward PE on market expectations re-rated by about 6% to 15.5 times in December 2017 (14.5 times in September 2017).

Market and portfolio review

The ALSI had a strong close to the year, up by some 7.4% in the final quarter to end the year up 21%, delivering exceptionally strong returns against a politically and economically challenging backdrop.

Our fund had a very tough quarter mainly due to our overweight position in Steinhoff (-92% in December), which was the main contributor to our underperformance of the benchmark. This performance was exacerbated by our underweight Naspers and overweight position in British American Tobacco. Steinhoff International is presently caught in an information vacuum. There have been no pronouncements as to what was inflated or omitted from the past financial statements and we will have to await the release of new information to know the full extent of over- or understatements of the accounts. In addition, the company is now caught up in a liquidity squeeze with funders unlikely to roll further funding and credit agencies having downgraded the company’s rating to subinvestment grade. Finally, various directors such as billionaire Christo Wiese and former CEO Markus Jooste had borrowed debt against the security of Steinhoff shares and the collapse of the share price has led to margin calls, which have triggered further selling as covenants were breached and lenders took hold of the collateral, exacerbating the share price decline.Our view is that the group will have to be restructured, broken up and its structure simplified. New management will have to be brought on board to regain investor confidence and those guilty of wrongdoing will have to be held responsible with the commensurate punishment. Until then, the stock is likely to remain highly speculative and a value trap.

On the positive side our overweight positions in mid-size companies such as Curro, Stadio and Foschini managed to soften the blow on the Steinhoff underperformance.

Conclusion

Last year, the risks linked to Fed tapering and a China hard landing informed a lot of the cautious views on global equities. Cheap money found its way into alternative assets with cryptocurrencies being all the rage. This year, the risk of a China hard landing appears to have abated but there are continued concerns about the path of the US economy and future Fed actions. Last year emerging markets benefited from a buoyant global growth environment but valuations have now normalised.

A year ago, there was general apathy towards SA equities and the focus on political and economic downside risks in South Africa meant that many investors sat on the side lines, which teed up the strong relief rally we witnessed at the end of the year. In South Africa, the danger is that too much, too soon may be expected from the new ANC leadership and alsoglobal risks from Fed tapering may now be underestimated.