The Sanlam Select Defensive Balanced Fund changed it's name to Amplify SCI Defensive Balanced 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 domestic bonds (0.3% contribution), foreign equity (0.2%), domestic cash (0.2%) and domestic property (0.1%). Domestic equity and offshore cash were broadly neutral in the attribution. Given the attractive valuations in fixed income and curtailed return distribution, we increased our duration position from on-weight 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 (1.6%) was driven largely by domestic equity (0.9% contribution), followed by domestic bonds (0.6%), domestic cash (0.3%) and foreign equity (0.2%). 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 (1.7%) was driven largely by domestic equity (0.5% contribution), foreign cash (0.4%) and foreign equity (0.3%) due to the depreciation in the currency during the month. These were followed by contributions from domestic bonds (0.3%) and domestic cash (0.2%), while local property (-0.02%) detracted only marginally from the fund’s performance in March.

Our asset allocation was unchanged during the month. We maintained a relatively light allocation to domestic equities (24%) and foreign equities (8%), while retaining an underweight-duration position in domestic bonds (40%). We still favour a slightly larger exposure to offshore cash (14%) versus domestic cash (10%), with a moderate exposure 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.

Market stress eased over the course of September as the Dollar retreated and risk aversion subsided. Yet this attempt for emerging market (EM) assets to stabilise belies persistent underlying risks relating largely to the impact on growth and inflation from the ongoing trade battles. While the latest round of tariffs (10% on US$200 billion) had little market impact, participants may be ignoring the mediumterm risks from shifting supply chains and higher US consumer prices on incomes.

The US Federal Reserve (Fed) remains steadfast in its gradual normalisation. Chairman Jerome Powell omitted the reference to ‘accommodative’ and the Fed still sees the peak at 3.5%. For the Fed to continue tightening growth will need to hold up. Tax cuts and fiscal stimulus limit the near-term risks to US growth. But the combination of weaker EM growth and a strong US Dollar will at some point hurt US corporates and so, too, the equity market. This will probably be the signal to the Fed to stall.

So far policy makers have not responded to slowing Chinese growth with significant easing, evident in the stabilisation in the Yuan and limited liquidity injections. Further weakness will very likely prompt more aggressive stimulus from China, which could perversely bail out other EMs.

Locally, policy uncertainty persists with the Constitutional Review Committee asking for yet another extension of its deadline, this time to November. The Zondo Commission on State Capture and the SARS enquiry continue to elucidate the extent of work needed to undo the systematic weakening of various SA institutions. Yet institutional strength remains a positive pillar for SA’s credit rating, with Moody’s commentary pointing to a stable rating for the next 12 months at least. Hence, the review on 12 October is set to be a non-event. The Medium Term Budget Policy Statement should be more exciting as it will show how government will incorporate President Ramaphosa’s stimulus packages in a deficit-neutral manner. We think the market is being too negative on the budget update, yet a credible story from Treasury will only buy time given the steady increase in debt to GDP and the risk of larger weekly bond auctions somewhere down the line. President Ramaphosa will host the long-awaited jobs and investment summits in October.

Inflation is back in focus given the downside surprise in the August release, which, coupled with the technical recession, tipped the odds in favour of a pause at the September Monetary Policy Committee (MPC) meeting. With Brian Kahn having retired, the composition of the MPC tilts towards the hawkish side. Hence, it is easy to see the 4:3 vote for no change in September ending up as a 3:3 vote in favour of a hike in November if the Rand is still perceived as a risk. On this score the domestic uncertainties will be compounded by global events, in particular the Brazilian election (7 and 28 October), the Iran sanctions (4 November) and the US mid-term elections (6 November).

Market developments

Fixed income delivered positive total returns in September with fixed- and floatingrate credit each delivering 0.8%, while cash (0.5%), inflation-linked bonds (0.4%) and nominal bonds (0.2%) also posted modest returns. The laggards were listed property (-2.6%) and equities (-4.2%). For 3Q18, only fixed-rate credit (1.9%) managed to beat cash (1.7%), with floating-rate credit (1.4%), nominal bonds (0.8%) and inflation-linked bonds (0.5%) lagging the other fixed-income sectors. Listed property lost 1% during the quarter, while equities were 2.2% lower.

The recovery in EM assets and portfolio flows has been muted. The gyrations in the Dollar and the contagion from Argentina and Turkey left EM FX down 4% versus the Dollar for 3Q18. The Rand was hit by the market turmoil – while the unit gained 4% in September, it was still down 3% for the quarter. The Rand’s status as high vol/high beta was confirmed with the USD/ZAR trading below 13.50 in July and above 15.50 mid-August and early-September. The Rand has, for now, settled in line with our updated fair-value estimate around 14.00 -14.50.

After trading in a core 2.80% to 3% range, the US 10-year yield has again breached 3% amid a shift in the supply/demand balance. Issuance has been rising while the Fed has continued to shrink its balance sheet. Moreover, the increase in bund yields (from 30 bps to 55 bps) has at-the-margin reduced demand from offshore given higher hedging costs resulting from Fed hikes. The rise in US yields has so far not had an adverse impact on local currency bond yields, with most markets posting modest gains towards the end of September. Higher US yields will be a risk to EM rates only if they are followed by further Dollar strength. The SA 10-year yield traded between 8.75% and 9.50% during the quarter – at 9.20% the market is only moderately cheap compared to our fair-value range of 8.80% to 9%.

Global equities posted wide-ranging returns in September, with the Nikkei up by 5.5% and the Shanghai Composite up by 3.5%. The FTSE 100 rose by 1.1%, while the S&P 500 managed a 0.5% increase. The MSCI World Index rose by 0.4%, while the MSCI EM Index declined by 0.8%. The MSCI SA Index was a laggard, losing 6% during the month versus -5.3% for the FTSE/JSE All Share Index (ALSI) and -4.6% for the FTSE/JSE Shareholder Weighted Index (SWIX). Losses in pharmaceuticals (-40%), household goods (-18%), automobiles & parts (-15%), healthcare (-14%), beverages (-13%), and personal goods (-11%), were only partly offset by gains in industrial metals and mining (+20%). Despite the recovery in the exchange rate, resources (-0.3%) outperformed financials (-3.1%) and industrials (-7.0%). The latter was plagued by company-specific weakness, for example concerns about Aspen’s debt and asset sales, a weaker outlook from Netcare, and ongoing strain with Nigerian regulators.

Portfolio performance and positioning
The fund’s performance (-0.6%) was driven largely by domestic equity (-0.7% contribution), offshore equity (-0.3%), and domestic property (-0.1%). There was a modest offset from the positive performance in domestic bonds (0.3%) and domestic cash (0.2%).

The fund is conservatively positioned for risk, as reflected by our domestic cash position (25%), overweight duration position in bonds (44%) via investments in high-yielding low-duration credit instruments and government bonds, and defensive local equity allocation (17%). During the month we moved to a moderate overweight duration position in bonds. We have a small holding in foreign equity (8%), with a higher weighting in Europe where we believe the earnings growth prospects are more favourable than the rest of the developed markets given the stronger GDP recovery. We have maintained a low US Dollar exposure of 3% and our local property exposure at around 4%.
We remain defensively positioned with a focus on absolute returns and, as a result, prefer the real return available from government bonds, supplemented by highyielding low-duration credit instruments. Disappointing real activity data has supported our view that domestic retail and select industrial stocks ran too far in anticipation of a strong GDP rebound. We remain cautious on the extent of the growth recovery in the short term and we still prefer banks, resources, and global defensive stocks.