December 2018 Update
Making the News
In a year dominated by politics, and specifically US politics and politicians, the US Government shutdown dominated the news in December. President Trump remained unmoved in his commitment to building the wall on the border of Mexico which has seen the federal government grind to a halt.
The US Federal Reserve raised interest rates by a further 0.25% despite tweets from Trump suggesting that further rate increases would hurt markets and could potentially result in the Fed governor Powell losing his job.
UK Prime Minister Theresa May fought off a vote of no confidence within her own conservative party, while a key parliamentary vote on Brexit was delayed until January as she looked to secure support for the deal she negotiated with the EU.
Digesting the News
The uncertainty surrounding the US government shutdown coupled with higher rates and slow progress in the trade talks between the US and China brought nervousness to global markets.
Global Equity Markets were down 3.6% (in Rands), with the US market (as measured by the S&P 500) down 5.6%. Even the tech giants that have led markets higher over the last 18 months were lower during the month (Apple -8.4%, Microsoft -5.0%, Facebook -3.3%) as weaker economic conditions in China started to weigh on company outlooks.
Despite the nervous sentiment that saw foreigners selling both SA Equity and SA Bonds during December, the SA Equity market bucked the trend delivering 4.3% growth, pushed higher by Resource shares that added 12.3% during the month.
The strong return from SA Equity in December recovered some of the losses suffered earlier in 2018, however the local stock market still ended the year, 8.6% below where it started 2018. The weak performance was however accompanied by strong earnings growth from JSE listed companies growing profits by 14.5% during the year.
The combination of weaker price performance and strong earnings growth has seen the ALSI PE ratio come down to 16.4, which is similar to its 20-year average of 15.5. Importantly the one year forward PE is 11.9x versus the 10-year average of 12.9x indicating potentially good value for local investors. When we combine the much-improved valuations on local equities with the improvements achieved by the new leadership in RSA during 2018, the potential for local investors to be surprised on the upside going forward is significant in our view.
The US market also delivered negative performance in 2018, despite earnings growth in excess of 20%. This has resulted in a material rerating of the US market and a dramatically improved outlook for US equities, (and by implication) global equities going forward.
Markets in the Month
The Rand was weaker against all three major currencies in December (by between 4.6% and 5.6%), which saw the local currency’s losses in 2018 increase to 17.2% against the USD, and approx. 10.5% against both the Euro and the Pound. Some of this weakness can be credited to SA specific issues, although most of the weakness is a function of poor sentiment towards Emerging Markets in general.
SA Growth assets (Equity and Listed Property) had a mixed December, with SA Equities bouncing strongly (+4.3%) and listed property losing a further 1.1% during the month. For the 2018 calendar year SA Equities and Listed Property were down 8.5% and 25.3% respectively.
Of all the major asset classes shown in the table above, SA Bonds delivered the best returns in 2018 (+7.7%), marginally ahead of SA Money Market (+7.1%). Given the above-mentioned Rand weakness against the US Dollar, US Cash as a result has delivered an exceptional return of +18.6% when measured in Rands in 2018.
Impact on Our Portfolios
The more conservative strategies performed well in December, benefiting from positive returns from SA Bonds and the Rand weakness. The CWM Income model portfolio performed best, delivering +0.9% and the CWM Defensive portfolio returned +0.6%.
The weak returns from Global Equity and SA Listed Property resulted in small negative returns (down between 0.1% and 0.3%) from the longer-term growth orientated portfolios (CWM Balanced, Retirement Growth and Flexible) in December.
The CWM Foreign Equity portfolio fell 3.1%, which was marginally better than the Global Equity index which fell 3.6% during December. The Foreign Balanced Houseview delivered +0.2% growth helped by the weaker Rand, which offset the weakness from global equity exposure within this portfolio.
5 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies
SA Equity and SA Listed Property both delivered +5.7% p.a. over the last five years, only marginally above inflation of 5.2%. These modest asset class returns have supressed the performance on the local CWM model portfolios, especially those with limited foreign exposure and a more aggressive risk profile (i.e. CWM Retirement Growth).
The Rand has weakened by 6.6% p.a. against the US Dollar over the last five years, which has helped drive returns from global equities over this period (11.1% p.a. in Rands). For a long-term investor this has been the only major asset class to deliver returns above inflation at a reasonable rate (relative to long-term expectations) and the only asset class to not disappoint materially over the last five years.
As a consequence of the weak local growth asset markets over the last five years, returns from the local model portfolios have been modest in absolute terms. However, long-term performance relative to the average fund in their respective peer groups remains strong despite a weak relative performance in 2018. All of the local model portfolios have performed well relative to their respective peer group averages and have outperformed since their inception in 2012/13..
2018 was an extremely testing year, especially for a South African (i.e. Emerging Market) based long-term investor. Not only were all major growth asset classes down in 2018, but the wild swings in sentiment both locally and globally weighed heavily on many investors’ ability to stick to their long-term strategy.
In addition to the swings in the macro sentiment, SA investors had numerous company specific issues to contend with that also hurt investor confidence and resulted in many questioning the need for exposure to long-term risk assets that “can’t outperform cash”.
Our philosophy has always been to be patient and take a long-term view. We aim to understand what has happened in the past but prefer to focus on the current conditions and their impact on fundamentals and returns going forward.
Doing this right now, we are far more optimistic than most investors. Economic growth globally remains robust and local growth seems to have turned a corner (both in terms of general economic growth and underlying company earnings). Valuations have improved locally and globally, potentially indicating an improving long-term return outlook for those investors willing to ride out the short-term noise.
We remain committed to our philosophy and process given the benefits we have seen over the long-term and in so doing, we believe we are able to stack the odds of long-term investing success in our clients’ favour in all market conditions.