MARKET PERFORMANCE

The rallies in US stocks and the US dollar sparked by the election of President Donald Trump started to look stretched amid doubts about Trump’s ability to deliver on promises of tax cuts, infrastructure spend and loosening of regulation. Emerging markets have been the biggest beneficiaries of the new _search-for-yield_ trade, which led to most currencies strengthening beyond what the economic and political fundamentals seemed to warrant.
Geopolitical risks featured high on the radar, with a potential US vs North Korea stand-off, the French presidential elections and the use of force by the US in Syria, which brought the country into direct conflict with Russia. Brazil’s new president, Michel Temer, faced unexpected bribery allegations, while in South Africa, the fractures within the ANC started to threaten economic stability. In the UK, Prime Minister Theresa May cost the Conservative Party a parliamentary majority in a snap election, and in the US, Trump has been implicated in trying to influence an investigation into the ties between his campaign and Russia. The G7 meeting in April was dominated by tensions over trade, Russia and climate change, with Trump withdrawing the US from the 2015 Paris climate agreement. And in the Middle East, Qatar came under military blockade by four other states emboldened by good relations with the US, for its ties to terrorism.

In the US, the Federal Reserve raised interest rates by 0.25% to between 1% and 1.25%, with one more increase planned for this year, and outlined plans to start shrinking its US$4.5 trillion balance sheet, despite mixed signals on unemployment and inflation. Although the unemployment rate fell to a 16-year low of 4.4% in June, inflation continued to slow down to 1.7%, well below the US Fed’s 2% target, and wage growth remained tepid. On a positive note, US economic growth in the first quarter was revised upwards to an annual rate of 1.4%. The recent pick-up in consumer spending is expected to have generated strong growth during the second quarter.

The Eurozone’s economy grew at 1.9% in the first quarter with growth being more wide-spread. Even the weaker economies such as Greece, Finland, Portugal and Italy experienced pick-ups. Despite that, the ECB reiterated that monthly bond purchases of €60 billion would continue into 2018 if required. Surveys of manufacturing and services activity reached a six-year high, while business and consumer confidence hit its highest level since August 2007. Politically things are also looking more stable after a pro-EU independent, Emmanuel Macron, won the French presidential elections. The EU raised its economic growth forecasts to 1.9% for both 2017 and 2018.

China also posted its strongest quarterly growth in a year and a half, with its GDP expanding at 6.9% year-on-year in the first quarter driven by continuing infrastructure spending. Second quarter data was more mixed, with easing retail sales, slower industrial production and weaker surveys of manufacturing and services sector activity.

The MSCI included China in its emerging markets index, but the stock and bond markets fell on the news that the bank regulator ordered an audit of the borrowing by some of the country’s largest companies. Chinese companies have issued more than US$90.5 billion in dollar-denominated bonds this year after issuing US$102.8 billion worth of bonds in 2016. The country also introduced a host of other measures to curb runaway debt, which stands at 300% of GDP. The uncertainty weighed on metals and commodity prices. And in a shock move, Moody’s cut China’s credit rating over growth concerns for the first time since November 1989.

The IMF increased its global growth forecast for 2017 from 3.4% to 3.5%, but warned that the threat of protectionist policies and structural problems, such as low productivity and high income inequality, meant the balance of risks remains tilted to the downside.

Markets were mostly positive, encouraged by the French elections and the removal of some uncertainty hanging over the Italian banking system after the European Commission allowed the Italian government to bail-out two regional banks. The final days of June brought back volatility on the back of the ECB, with the Bank of Canada and the Bank of England adopting more hawkish stances. This triggered a sharp sell-off in sovereign bonds. And finally, oil prices continued to fall below US$48 a barrel on widespread evidence of a fuel glut despite OPEC and other oil producers agreeing to extend supply curbs for another nine months to fight the rise of the US shale industry.

In South Africa, the political uncertainty created by the changes at National Treasury was buffered by a firmer Rand, which benefitted from strong investment inflows into emerging markets. S&P, Fitch and Moody’s cut South Africa’s credit rating to junk status, citing a weakening of institutional strength and rising political risks. One more "notch" cut at one agency would mean that South Africa would fall out of all major global bond indices, including the World Government Bond Index, and could see as much as R190 billion flowing out of its bond market. May brought more drama to an already weary South Africa as leaked emails detailing the alleged corrupt relationship between the Gupta family and many ministers and state officials entertained the nation.

News on the economic front was equally sombre as South Africa officially entered a recession. Despite growing by 1% year-on-year, the first quarter growth came in at -0.7%, following a 0.3% contraction in the final quarter of 2016. Unemployment hit a 13-year high in the first quarter, coming in at 27.7%, with little hope of improvement as heightened policy uncertainty continued to undermine business confidence. Consumer inflation came in at 5.4% year-on-year in May on the back of a stronger Rand. Despite this, the Reserve Bank kept the repo rate unchanged at 7%, quoting a deterioration in the economic growth outlook following the downgrades as a reason. All major banks cut their growth forecasts for South Africa, ranging from 0.7% to 1.1%, while the IMF projects the country’s growth for 2017 at 0.8%.

In two "black swan" events, the Minister of Mineral Resources Mosebenzi Zwane gazetted the Mining Charter with scant consultation with industry, wiping billions from the value of resource companies. And the Public Protector Busisiwe Mkhwebane attacked the independence and role of the Reserve Bank, although she subsequently withdrew her recommendations. Both moves had a negative effect on investment sentiment.

FUND PERFORMANCE

During a volatile quarter, the Sygnia Skeleton Worldwide Flexible Fund returned 0.9% compared to its long-term target, CPI + 5% per annum, which was 2.2%. Underperformance was primarily driven by poor market conditions with no asset class delivering returns in excess of the target. The Fund’s domestic fixed interest and property exposure, and offshore equity exposure, benefitted performance.

Throughout the quarter we reduced the Fund’s exposure to domestic risk assets, opting for money market, which is generally seen as a safe haven asset class. We maintained a chunky off-shore exposure to hedge against political risk, potential credit downgrades and declining investor sentiment, which we do not feel is being priced in. In the offshore component of the Fund, we exited a position in high dividend-paying equities, took some profits on our US equity overweight position and up-weighted our exposure to emerging market bonds.

These positions were taken in line with the Fund’s investment objective of providing superior long-term returns while protecting capital over the medium- to long-term.

MARKET PERFORMANCE

2017 started on a nervous note, with newsflow dominated by the actions of the newly-minted US President, Donald Trump. From the White House's embrace of 'alternative facts' to Trump's Twitter feed, a new crop of risks had investors on edge. On the other hand, Trump's agenda of infrastructure spend, tax cuts and looser regulation has spurred expectations of stronger US growth and lit a fire under the US stock markets, pulling up global sentiment. The market remained choppy in February, oscillating on the one hand between strong upturns on good global economic data and Trump's promises of cutting taxes and relaxing regulation, and on the other, concerns about political risks in Europe with looming elections in the Netherlands and France, and weakness in commodity prices. March brought more sobriety to the table as uncertainty about whether Trump would be able to implement his policies surfaced after he failed to get the Affordable Care Act, a key campaign promise, repealed. However, the stock markets held up relatively well, with levels of volatility at record lows.

The biggest risk in the US is the country's increasingly protectionist stance on trade, including withdrawal from the TPP trade deal and the announcement of plans to renegotiate trade agreements with Canada and Mexico. The biggest risk in the eurozone is the resurgence of right-wing politics after the UK officially triggered Article 50, formalising its exit from the European Union.

On the economic front, despite recording its slowest growth in five years in 2016 at 1.6%, the US's economic expansion is now officially the third longest on record and shows no signs of abating, with robust hiring, falling unemployment and firmer wage growth. The unemployment rate fell to 4.7%, while inflation rose to 1.9% in January from a year earlier, close to the central bank's 2.0% objective.

As expected, the US Federal Reserve increased the target range for the federal funds rate from 0.75% to 1.0% and signalled two more increases this year, albeit gradually paced. The US Fed's forecasts for growth and inflation remained unchanged at 2.1% and 1.9% respectively.

The eurozone also looked healthier, with business sentiment, growth rates and unemployment all surprising on the upside. The economy has now posted 14 consecutive quarters of growth, the unemployment rate has returned to single digits and consumer confidence has reached its highest level in six years. February's year-on-year inflation came in at 2.0%, the highest level since January 2013, putting pressure on the ECB to limit quantitative easing.

Economic data from China pointed to sustained growth momentum in the first two months of the year, after growth for 2016 came in at 6.7%. China's central bank lifted interest rates for the second time this year, hours after the US Fed, and continued to prop up the yuan and stem capital outflows.

Emerging markets continued to benefit from the unpredictability of Trump's policies as investors looked for higher returns elsewhere. Economic fundamentals in developing markets are expected to improve in 2017, leading to the highest inflows into emerging markets' bonds in any one quarter on record.

In South Africa, despite weak economic fundamentals and political risk, the rand enjoyed a period of unusual strength relative to the US dollar, a function of strong emerging markets' inflows. The Reserve Bank left the repo rate unchanged at 7.0%, raised its inflation expectation for 2017 to 6.2% and kept its 2017 growth forecast unchanged at 0.4%. The unemployment rate dropped to 26.5% in the fourth quarter, while inflation fell to 6.3% in February from 6.6% in January.

The budget largely balanced the books by increasing individual taxes and the dividend withholding tax, while avoiding touching the capital gains tax and VAT. The budget targets a deficit of 3.1% of GDP for 2017/18. GDP growth for 2017/18 has been projected at 1.3%, up from 0.5% in 2016/17.

Unfortunately there was a lull before a storm, as in March, in a shock move, President Jacob Zuma replaced Finance Minister Pravin Gordhan and Deputy Finance Minister Mcebisi Jonas with Malusi Gigaba and Sifiso Buthelezi. Equities and bonds dropped sharply, with banks bearing the brunt of the sell-off, while the rand depreciated. Credit rating agencies S&P and Fitch downgraded South Africa almost immediately. S&P cut the rating of foreign-denominated debt to below investment grade, or junk, while Fitch cut both local and foreign debt to junk. This has very serious implications for South Africa's ability to attract foreign inflows and investment, as well as the higher interest that the government will have to pay on future borrowings and roll-over debt, money that could be better used helping to lift South Africans out of poverty. The political instability is a bitter pill to swallow after the weak economic data of 2016. The GDP contracted by 0.3% quarter-on-quarter in the fourth quarter, bringing annual growth to just 0.3%. Mining and manufacturing were the main culprits.

Oil prices oscillated between US$51 and US$56 a barrel as output cuts by OPEC were counterbalanced by rising US shale oil production and the fact that non-OPEC members are only cutting production by 50.0% of what they pledged.

We expect a precarious quarter ahead as South African politics and economics become invariably interwoven. We expect a weakening of the fiscal framework, as well as of the regulatory banking framework, and hence negative economic sentiment towards South Africa will continue. The flow of money into emerging markets is softening the landing, but even over the short term volatility is likely to pick up in both equity and bond markets. The rand is also likely to weaken over the next quarter; this should help the resources sector. Sygnia has thus significantly reduced risk across all portfolios, with maximum exposure to offshore investments and a higher exposure to rand hedge counters.

The FTSE/JSE Capped SWIX Index ended the quarter 2.4% up, with the Resources sector up 1.9%, Industrials 7.1% up and Financials down 1.9%. The bond market delivered a return of 2.5%, while the rand depreciated by 2.0% relative to the US dollar.

FUND PERFORMANCE

During a difficult quarter the Sygnia Skeleton Worldwide Flexible Fund returned 3.0% compared to its long term target, CPI + 5% per annum, which was 3.3%. Underperformance was driven predominantly by a strong rand, which detracted from the Fund’s offshore performance, while the Fund’s equity and domestic bond exposure benefitted performance.
The rand strengthened for the quarter despite its sharp depreciation at the end of March.

At the beginning of the quarter we added to the Fund’s fixed-interest position as a hedge against a strengthening rand. Given the political risks we were facing, we did not feel it was prudent to reduce the Fund’s offshore exposure and therefore increased domestic bonds, which do well in a strong rand environment. We also increased the Fund’s exposure to domestic equity and domestic property early in the quarter. In the offshore component of
the Fund we reduced its bias to US equities, cut global property and developed-market bonds to zero and increased exposure to emerging markets.

These positions were taken in line with the Fund’s investment objective of providing superior longterm returns while protecting capital over the medium to long term.

MARKET PERFORMANCE

The start of 2016 was dominated by nervousness that the US economy's recovery had lost momentum, compounded by fears over China's economic growth. A sharp decline in the price of crude oil to just above US$26 a barrel and general volatility in Asian markets deepened concerns about global growth. Bond-buying programmes pushed government borrowing costs lower, with yields on nearly US$14 trillion of debt trading below zero at one point during the year. The second half of 2016 brought a complete turnaround despite Brexit. The eurozone started looking healthier, commodity prices rose as China continued its credit-fueled infrastructure spending spree and the US economic growth rate picked up to 3.2% in the third quarter, the strongest number since 2014. The election of Republican Donald Trump as the next US president served as a catalyst for a rally in US stocks amid speculation that his plans for a vast government spending programme, lower taxes and looser regulations will stoke higher economic growth, inflation and, potentially, corporate profits. This would allow the US Federal Reserve to continue normalising monetary policy at a fast pace. The US dollar ended the year at a 14-year high relative to its developed markets peers.

Energy shares made a stunning recovery as the price of crude oil rose from US$37.04 a barrel at the start of the year to US$56.82 a barrel at the end, after OPEC and other large exporters struck a deal aimed at reducing the glut of supply on global markets.

The three-decade bull market in bonds also seems to be over. Although bond yields rode economic anxiety all the way to record lows post-Brexit, that reversed on the expectations of US fiscal stimulus.

Finally, everyone's favorite crypto-currency, bitcoin, had a fantastic 2016, rising by 79%. Bitcoin has become very popular in China, which has introduced stringent capital controls.

In a snapshot summary, the S&P 500 Index ended 2016 up 9.5% in dollar terms, Japan's Nikkei 225 Index was up 0.4%, the FTSE 100 Index rose by 13.8% in pounds and the Europe Stoxx 600 Index declined by 1.7% in euro terms. The MSCI All Countries World Index returned 7.9%, with the MSCI Emerging Markets Index up 11.2%. The South African equity market was uninspiring with the JSE/FTSE All Share Index up 2.6% over 2016. The star performer was the resources sector, which ended the year 28.9% higher, with the gold price up 8.5% in USD. The fourth quarter started on a cautious note with concerns about the US elections, the oil price and the implications of the US Fed's potential interest rate increases. It ended with a risk-on investment sentiment triggered, perversely, by Trump's ascendancy to the US Presidency.

China declared an air pollution red alert, closing schools and factories in many cities. This is likely to affect economic growth in the fourth quarter just after the country posted more positive figures in October and November. Consumer price inflation rose to 2.3% in November, not far off the government's target of 3%. More significantly, China continued to spend its foreign exchange reserves in supporting the yuan and stemming capital outflows.

In Europe, the weaker euro brought about signs of a nascent recovery. Markit's manufacturing PMI for the eurozone came in at 53.8 in November, its highest reading since January 2014, while inflation rose to a 31-month high at 0.6% year-on-year. And although the ECB extended its bond-buying programme by nine months to December 2017, it slowed the pace of bond buying from €80 billion per month back to €60 billion.

The Bank of Japan kept its monetary policy steady, with overnight interest rates at minus 0.1% and a cap on 10-year bond yields "at around zero", while turning more positive in its growth outlook on the back of the sharp depreciation of the yen. Japan's third quarter growth figure came in at an annualised 1.3%.

In the US, the unemployment rate fell to 4.6% in November, while inflation rose to 1.7%, not far off the US Fed's 2% target. With the revised GDP growth rate at 3.5% in the third quarter, the US Fed raised short-term interest rates by a quarter-point from 0.5% to 0.75% in December and forecast three further increases for 2017.

On the political front, the UK announced that it will trigger Article 50, the official notification of exit from the EU, by March 2017.

In South Africa the rand enjoyed another see-saw quarter on political cat-and-mouse games played between the Presidency and Finance Minister Pravin Gordhan. Despite that, Gordhan delivered a prudent and well-received medium-term budget statement, with the key points being:
- GDP growth forecast has been revised down to 0.5% for 2016, 1.3% in 2017 and 2.0% in 2018.
- The budget deficit is projected at 3.4% of GDP in 2016/17, 2.7% in 2017/18 and 2.5% in 2018/19.
- Tax increases of R28 billion are planned for 2017/18, up from the R15 billion announced in February.
- Debt service costs will amount to R148 billion this fiscal year.

The most significant news for South Africa was that Gordhan almost single-handedly staved off the country's credit rating downgrades for at least six months. All three rating agencies - S&P, Fitch and Moody's - quoted heightened political uncertainty as a risk factor. Most meaningfully, the government pushed the nuclear procurement programme out by 15 years to 2037. Lower demand for electricity, as well as far lower prices than anticipated for renewable energy, have altered the base case, making renewable energy more attractive and nuclear energy less attractive.

South Africa's economic fundamentals remained feeble, however, with consumer inflation increasing to 6.4% year-on-year in November and the unemployment rate rising to 27.1%, the highest level in eight years. The third quarter GDP growth disappointed at an annualised 0.2% after a 3.3% acceleration in the second quarter and a 1.2% contraction in the first quarter. The Reserve Bank held the repo rate unchanged at 7.0%, while forecasting growth at 0.4% for 2016, 1.2% in 2017 and 1.6% in 2018.

FUND PERFORMANCE

During a difficult quarter the Sygnia Skeleton Worldwide Flexible Fund returned -0.3% compared to its long term target, CPI + 5% per annum, which was 2.2%. This underperformance was driven by poor market conditions with no asset class delivering returns in excess of the target. The Fund's low exposure to risk assets over the period benefited performance.

During the quarter, we continued to trim the Fund's exposure to risk assets while adding to positions in commodities and emerging markets. We replaced Global Bond manager Franklin Templeton with a combination of Developed and Emerging Market Government Bond index trackers and a basket of stable, high dividend-paying global companies. We also introduced the Sygnia 4th Industrial Revolution Global Equity Fund, which gives the Fund exposure to global tech companies that are optimally positioned to benefit from new technologies - including autonomous vehicles, clean tech, drones, 3D printing, robotics, nanotech, smart buildings, virtual reality, cyber-security, space, wearables and more.

These positions were taken in line with the Fund's investment objective of providing superior long-term returns while protecting capital over the medium to long term.