Market comments

In Quarter 3, the MSCI EMEA index (which includes South Africa) fell 7.02%, which was worse than the returns of that of the MSCI Emerging Markets (EM) at -4.25% and far behind the MSCI World’s 0.53%. Year to date, the picture does not change much with the MSCI EMEA at 5.13%, relative to the MSCI EM return of 5.89% and way behind the 17.61% for the MSCI World.

The Federal Reserve and the European Central Bank both eased policies to offset signs of weaker global growth. The US economy has weakened but is not in a recession mainly due to fiscal support offsetting the adverse impact of the trade war. The inversion of the US yield curve is perceived as tolling the bell for a near-term global recession whilst Draghi also added to the call for fiscal easing.

Adding to that, commodity prices took a dive with key iron ore benchmark prices plunging some 20% in a matter of weeks and the key industrial metal, copper, hitting two-year lows. The key global manufacturing indices have also dived and are at fiveyear lows - but was at least stable over the last two months.

In the UK, Eurosceptic Boris Johnson has become the prime minister after being elected as leader of the Tories. There appears a greater likelihood of a no-deal Brexit or, at the very least, yet another postponement of the October decision deadline. The market has discounted this in large part with a weaker Sterling. As business decisions get postponed, the UK could dip into a technical recession.

In South Africa the SA Reserve Bank held the policy rate unchanged at 6.5% at its September meeting, but its statement was more dovish than in July when it did cut. For Quarter 2 of 2019, GDP was 3.1% quarter-on-quarter, above the consensus of 2.4% and reversing the first three months’ contraction. SA headline CPI accelerated from 4.0% in January to 4.5% in March and then settled around 4.3% in August 2019. Forward rate agreements are now pricing in a 25bp rate cut in the next six months.

From a SA asset allocation perspective, cash (STEFI: +1.8%) outperformed SA Bonds (ALBI: +0.8%) and the FTSE/JSE All Share Index returned -4.2% (Capped SWIX: -5.1%) in the third quarter of 2019. In Dollars, the MSCI SA (-12.60%) continued to underperform the MSCI EM (-4.25%) mainly due to a weak Rand (- 6.9%). SA equities and SA bonds saw outflows of $5.7bn and $2.4bn respectively year-to-date. Properties, after stabilising somewhat over the first half of 2019, experienced a tough three months, losing about -4.4%.

On the corporate side the most important news was the Naspers spin-off of Prosus, which listed on 11 September 2019. Prosus is now the largest listed EU consumer internet company.

Fund performance

After a reasonable first half of the year equity markets experienced a tough third quarter. The FTSE/JSE Capped Shareholder Weighted All Share Index (CAPSWIX) was one of the worst performing general all share equity indices for the third quarter of 2019, down 5.11%, which was in line with that of the FTSE/JSE Capped All Share index (CAPALSI), which realised a return of -5.14%. Both these indices are still in positive territory for the year to date with the CAPALSI about 4% above that of the CAPSWIX.

The decline in the performance of the Capped SWIX index during the past three months was led by earnings downgrades. Brexit uncertainty and a decline in rental income weighed on Intu (-38.6%). Sappi (-31.6%) ended lower with no signs of recovery in dissolving wood pulp (DWP) prices, currently trading at their lowest levels in 30 years. Sasol (-27.7%) sold off on increased uncertainty, as Sasol delayed results due to suspected control weaknesses. Massmart (-29.7%) fell, as it reported its first interim loss in over a decade. Discovery fell by 23.5% given concerns that NHI could be disruptive for medical schemes. However, SA precious metals, particularly Northam (+40.9%), Impala (+36.6%), Harmony (+36.4%), Sibanye (+25.2%) and AngloGold (+11.8%), partially offset the decline in the indices, underpinned by higher gold and PGM basket prices and a weaker Rand.

Your portfolio performed in line with its benchmark despite very regular and larger flows into your fund. This was mainly due to our optimised model portfolio outperforming the Capped SWIX Index. One of the main reasons for this was the fact that our model avoided the significantly underperforming Arrowhead properties. Our optimised portfolio hold between 135 and 140 shares out of a possible 160 plus shares at an ex-ante active risk of between 6 and 8 basis points.

The unbundling of Prosus from Naspers went smoothly just before the major quarterly rebalance The effect of this unbundling was that the combined weight of the unbundled entities were higher (closer to 15%) than the about 10% in Naspers before the unbundling. During the September 2019 FTSE/JSE index review there were no constituent changes implemented on the index. Weight changes happened on Anglo American and Naspers. The one-way turnover was about 2%.

Our strategy

After four mediocre years, the market is starting to move closer to our estimate of value. In addition, there has been uncharacteristic macro volatility and many corporates have scored own goals through ill-timed acquisitions and venturing beyond our shores into areas where they do not enjoy a similar dominant industry position. Regulation has also proven more severe in a number of sectors and this has forced incumbents to operate under stricter scrutiny and with limited operational freedom. However, most of these issues have been discounted in current stock prices, and we back the strong management teams to guide their companies out of their current mire.

After a difficult period for the JSE, the market is trading on a forward P/E of 13x and an attractive forward dividend yield of close to 4%.

Market comments

Global equities rebounded in June as the US-China trade war ebbed and Trump backed off on some of his threats. Global growth data remained negative with further declines in PMIs. Although the 19 June Federal Open market Committee meeting saw no rate change, it delivered a strong statement, virtually promising a rate cut at the 31 July meeting.

During the second quarter of 2019, the MSCI World Index realised a gross return of just more than 4%, outperforming the MSCI Emerging Markets Index, which managed a very modest return of 0.6% over the same period. Global bond yields continued to rally with US 10-year yields down to 2.01% and trading sub-2% for the first time since late 2016. US 10-year yields are down more than 125 basis points since November 2018.

In the first half of 2019, the MSCI World Index delivered a total return of 17.4%, outperforming Emerging Markets (+10.8%). Within the MSCI World, North America was the best performing region with a return of 18.9%, followed by Europe’s 16.5% and the Pacific region’s 11.3%.

In South Africa weak economic data dominated the post-election headlines with first-quarter GDP falling 3.2% quarter-on-quarter, worse than the -1.6% Bloomberg consensus. The President’s State of the Nation Address promised little more than further Eskom bailouts and progress on spectrum auctions with few details/deadlines.

During the second quarter of 2019, the FTSE/JSE All Share Index (ALSI) posted a total return of 3.9% versus the 8% for the first three months of 2019. SA Financials was the best performer, returning 5.4%, followed by SA Industrials with a total return of 4%. SA Resources only managed a gain of 2.4% in the second quarter after the large 17.8% total return in the previous quarter. The FTSE/JSE All Bond Index (ALBI) returned 3.7% after posting a similar return of 3.8% in the first quarter. SA Property managed to outperform bonds, posting a total return of 4.5%. Among the other important indices the FTSE/JSE Shareholder Weighted All Share Index (SWIX) (2.86%) performed in line with the FTSE/JSE Capped Shareholder Weighted All Share Index (Capped SWIX) (2.90%).

In the first half of 2019, SA Equities was the best performing asset class, with the ALSI delivering a total return of 12.2%. SA Bonds gained 7.7%, whilst SA Property was the worst performing asset class with a total return of 6%. Cash posted a total return of 3.6%.

Portfolio performance and changes

The FTSE/JSE Capped Shareholder Weighted All Share Index (Capped SWIX) realised a positive return of 2.9%, behind that of the FTSE/JSE All Share Index (ALSI), which was one of the best performing general equity indices for the second quarter of 2019, up 3.9%. Both these indices are now in positive territory over the last 12 months. Year to date the Capped SWIX ended up in double-digit returns. The months. Capped SWIX and the SWIX performed in line with one another during the last three months.

The difference in return between these two indices could be explained by the relative underweight exposures to BHP (BHP), Richemont (CFR) and Anglo American plc (AGL) in the Capped SWIX, which all had strong share price performances over the quarter. Relative overweight positions in counters such as the poor performing Sasol (SOL) and British American Tobacco (BTI) further detracted from performance. The relative overweight position in MTN and most of the bank shares negated some of the underperformance.

Your portfolio underperformed its benchmark by about 10 basis points. The difference in your return was mainly due to our optimised model portfolio underperforming the SWIX. This happened in April when some small cap shares, in which we had no exposure, such as EOH, Ocean and Storage, all performed well. Trading costs, due to cash flows and rebalance trades, also influenced performance. Our optimised portfolio holds between 135 and 140 shares out of a possible 160-plus shares at an ex-ante active risk of between 7 and 10 basis points.

During the June 2019 FTSE/JSE index review there were no constituent changes implemented on the index. Weight changes happened on Naspers, BHP and Anglo American. The one-way turnover was just more than 1.4%.

Conclusion

Despite a poor economic backdrop and populist rhetoric, the JSE posted solid returns after a poor 2018. Patient investors will know that the best investments are made when sentiment is bearish. The JSE is trading on a forward P/E of 12.5x and an attractive forward dividend yield of around 4%.

Global Markets

MSCI developed markets experienced an exceptional quarter with a US Dollar return of 12.5%, outperforming emerging markets, which in turn also realised good absolute numbers of 9.9% year to date. After experiencing their worst December since 1931, global stocks posted their best January since 1987 and global equities had their second-best quarter on record. But the rally wasnft plain sailing with economic data releases surprising on the downside. Global growth is trending around the 3% mark, but the key question remains whether global growth has indeed bottomed at around trend levels.

The temporary ceasefire in the trade war and the postponement of the 25% tariff rate have provided the markets with some relief. The US Federal Reserve (Fed) joined the party with some dovish comments and markets now expect the Fed to cut rates both this year and the next, with only a modest rise in the US 10-year bond rate being anticipated. Finally, lower volatility provided a more favourable environment for risky assets.

Despite the S&P 500 Index posting its best start of the year in a decade, the inversion of the US yield curve at the end of the quarter put a damper on the initial bullish mood with concerns of a recession looming. The Fed will be using interest rates to target inflation, but Fed Chair Jerome Powell mentioned that the US was not at the neutral rate providing optimism that future hikes will be delayed. The Fed has effectively paused the federal funds rate at 2.5%, which is below the neutral level of 3%. This provided a boost to risk assets and weakened the greenback temporarily.

However, the possibility of a no-deal Brexit is also in the balance with another extension expected beyond the crucial 2 April vote. There is an increasing possibility that Britain will go for the customs union route (a so-called esoftf Brexit), but there remains the possibility of a referendum and an early election.

The Chinese economy continues to experience a soft landing with growth expected to be in the 6.0-6.5% p.a. range in the year to come, the slowest growth rate in three decades. The Chinese are stimulating their economy further with tax cuts . the latest measure to be implemented . and at the end of March the manufacturing PMI surprised on the upside with the biggest month-on-month increase since 2012.

Some key risk that remains for 2019 is that the tailwind of quantitative easing is turning into the headwind of quantitative tapering. Net purchases by central banks were running at $23 billion per month and could turn negative this year, especially in the case of the Fed. This is likely to add to the uncertainty and volatility during the course of the year. While inflation in the developed world remains contained with US inflation below 2.5% p.a., the pickup in wage growth is a concern (from 1.5% to 2.5% p.a.) in the US. But it is noteworthy that there is no inflation pressure in Europe and Japan.

The International Monetary Fund (IMF) is forecasting a slowdown in the US this year with the rest of world growth stabilising. The risk remains that the Fed may still tighten rates further. However, the risk of a recession remains low in our opinion.

Local Markets

In the past decade economic growth has been hampered structurally by poor productivity. The SA Reserve Bank (SARB) leading indicator has started pointing downwards due to low manufacturing confidence and orders. Manufacturing confidence and orders have remained low for 10 years with the latest data showinga deepening contraction. We expect, nonetheless, a mild recovery from the GDP shock suffered in the first half of 2018, which is partly linked to weakening terms of trade and a weaker exchange rate (PPP Rand/Dollar being closer to 13) to shift our growth rate back towards a tepid 1.4% run rate (structurally we remain stuck below 2%).

South Africa is experiencing a steep yield curve, which would suggest that the economy should be improving. But the poor fiscal position has meant that the government has crowded out the private sector. This, in part, explains the low rate of credit growth at a sub-par 6% p.a. South Africa needs the private sector to invest but the return on investment remains too low. We do, however, expect a rebound in agricultural production to boost growth.

A key risk remains Eskom with the electricity availability factor dropping to 65% at the beginning of the year, leading to stage four load shedding. This has already negatively impacted manufacturing output. In the National Budget government committed to provide some R69 billion of support to Eskom over the next three years, partly allaying short-term fears given its balance sheet hole of some R200 billion.

At the end of the quarter, Moody's also gave us a stay of execution postponing the release of its credit review until after the elections.

The JSE had a solid quarter with the FTSE/JSE Capped Shareholder Weighted Index (Capped SWIX) posting a return of about 3.85% (FTSE/JSE All Share Index (ALSI) return 7.97%) for the quarter, but is still staying in negative territory for the past 12 months. The market has rewarded businesses that have been stable and focused on organic growth while businesses that have been acquisitive and laden with debt have been punished. We are in an environment where there is a serious risk that liquidity will be withdrawn by central banks. Businesses which were very acquisitive and funded these acquisitions with debt have been at the mercy of the economic slowdown, which contributed to poor returns.

On a sectoral basis resources stocks were the stars of the JSE once again, up close to 18% this quarter. Platinum stocks continued to shine bright, up close to 50% aided by rising basket prices and the benefit of good cost management over the past few years. Financial stocks were flat this quarter with credit growth being very weak and corporate credit growth dipping below household credit growth for the first time in almost a decade. Industrial stocks posted solid returns, up close to 9% this quarter, a welcome difference to the recent past.


Fund performance

Although the FTSE/JSE Capped Shareholder Weighted All Share Index (Capped SWIX) had a positive performance of 3.87% for the first quarter of 2019, it underperformed against the FTSE/JSE Capped All Share Index (Capped ALSI), which had a return of 6.7% for the quarter. It also underperformed the SWIX, which realised a return of 6%.

Some of the contributors to the difference in return between the two Capped All Share indices could be explained by the relative underweight exposures to especially BHP Group (BHP), Richemont (CFR) and Anglo American plc (AGL), which all had strong performance for the quarter. Relative overweight positions in financial counters like Sanlam (SLM) and FirstRand (FSR) were further contributors to the underperformance of the FTSE/JSE SWIX Top 40 Index. An overweight position in British American Tobacco (BTI) negated some of the underperformance.

During the March 2019 FTSE/JSE index review the one-way turnover for the index was around 3%. Any difference in performance of your fund relative to its benchmark could be attributed to cash flows, which in turn could affect the market impact and trading costs.

Conclusion

Despite a poor economic backdrop and populist rhetoric ahead of the elections, the JSE posted solid returns after a poor 2018. Patient investors will know that the best investments are made when sentiment is bearish. The JSE is trading on a forward P/E of 13x and an attractive forward dividend yield of close to 4%.