June 2019 Update
Making the News
Markets during the month were supported more by overseas events although there has been some positivity on the local bourse given the SONA speech delivered by President Ramaphosa, which importantly also included the plans to improve the debt burden on Eskom.
Globally markets have priced in a high probability of the Fed applying an “insurance cut” to interest rates in July, which provided support to Emerging Market (EM) currencies such as the Rand. Furthermore, additional optimism arose from the G20 Summit which was held during the last weekend in June. Many positive outcomes came from the meeting with the most important take-away being the headway made between the US and China on the trade talks.
In the UK, while the soon to be ex-Prime Minister Theresa May refused to promise unconditional support to her successor’s Brexit plan, the battle for the Tory leadership between Jeremy Hunt and Boris Johnson heated up, with the victor to be announced by the end of July.
Digesting the News
The SONA speech from President Ramaphosa addressed serious issues such as unemployment, land expropriation, and most importantly the Eskom debt which continues to weigh heavily on the local economy. Although some critics labelled the speech as more dreamy than concrete in terms of plans to implement immediately, the President promised R230bn from the fiscus in order to cover 60% of the utility company’s current debt. Despite this massive government guarantee, the President confirmed that the utility only has enough cash to last until October 2019, highlighting the precarious position the company and therefore the country finds itself in.
Despite the improvements in trade-talks between the US and China, consensus is for an interest rate cut in the US. Highly esteemed members on the board (James Bullard and Mary Daly) both support the more dovish views of a potential 0.25% cut. Additionally, the animosity between President Trump and Fed Chair Powell adds more pressure to cut rates. The strong upsurge in the market in June shows the importance of liquidity to global investors. There is a risk of higher volatility in the short-term as markets may react negatively if the expected monetary stimulus does not materialize in July.
As noted last month, US President Trump is unlikely to soften his aggressive negotiating tactics with key trading partners (i.e. China, Mexico, Europe etc.). This will keep market volatility elevated; at least until US elections take place in 2020. Fortunately for global markets, his aggressive style also often includes a deep desire to close the deal, helping him position himself for re-election in 2020. Thus, we have seen a sense of relief in global news following an amicable meeting of minds at the G20 summit. At the meeting, it was agreed that trade talks will resume after been suspended, with the US suspending further tariffs on Chinese imports, lifting of the ban on Huawei and large commitments made to the US Agricultural sector.
In Brexit news, the front-runner to replace Theresa May, Boris Johnson, sees a high probability of Brexit happening with a deal in place, while describing the chances of a no-deal Brexit taking place as “a million to one”. Despite the desperately small likelihood of this worst case scenario, the market appears to be transfixed on this outcome, putting significant downward pressure on Sterling denominated assets.
Markets in the Month
The Rand rallied in June after the government signalled it will give additional support to power firm Eskom and as emerging currencies were lifted by expectations that the Federal Reserve signalled US rate cuts on the back of lacklustre economic data (US Jobs in particular). As a result, the local currency appreciated against all major currencies, most notably being 4.3% stronger against the US Dollar and 3.9% against the Pound. The Rand is stronger against all three major currencies so far in 2019, and is mixed over the last year.
The local equity market recovered in June (+4.8%, as measured by the All Share Index (ALSI)) following the first negative calendar month in 2019 (May, -4.8%). This recovery brought the ALSI back to double digit returns in 2019 (+12.2% year-to-date). In a reversal of what we have seen over the last five years, the ALSI is comfortably ahead of its EM counterparts (+8.4%) in 2019, benefitting from a strong recovery in the Naspers share price and high momentum driving our resource sector.
In 2019, both local and global equity markets remain the best performing asset classes with comparable Rand returns of +12.2% and +14.7% respectively. In contrast, SA Listed Property delivered a relatively modest return (when compared to the ALSI) in June of +2.2%, bringing its 2019 YTD performance to a reasonable absolute level of +6%.
SA listed property remains materially behind SA equity over the last 3 years (9.2% p.a.) as the sector struggles to overcome questions regarding governance and is faced with local economic headwinds that have created a relatively poor short to medium-term outlook. The negativity that has engulfed the sector has resulted in valuations last seen during the financial crisis 10 years ago, which in our view represents a significant long-term opportunity for patient investors.
These attractive valuations bode well for potentially higher future returns, as Listed Property delivered 13.0% p.a. over the last 10 years, outperforming inflation by 7.8% p.a., supporting our view that significant opportunities are present for long-term investors willing to ride out the short-term volatility.
Impact on Our Portfolios
Due to the strong performance across most asset classes, it is no surprise that all CWM strategies were up during the month with the best performance coming from strategies with higher equity exposure (both local and offshore). The CWM Flexible strategy was the best performer in June delivering a return of +1.4% in line with its peer group. This strategy has comfortably outperformed the peer group average over the last 5 years, delivering an additional +2% p.a. over the period.
On average, the other model portfolios delivered 1% during the month, improving the YTD and 1 year performance across all strategies. The CWM Income portfolio continued its smooth growth trend in June (+0.7%) given the limited growth asset exposure within this strategy.
Despite the Rand strength in the month, the performance of our Foreign Houseviews (HV) was strong in Rand terms (most notably the Foreign Equity which delivered +1.6%). YTD performance also remains robust, with Foreign Balanced and Equity generating +7.4% and +13.7% respectively.
5 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies
With SA equity (+5.8% p.a.) and SA listed property (+5.6% p.a.) both delivering less than 1% above inflation (before fees) over the last five years, most SA based investors might feel disheartened having endured an extended period of seeing their wealth struggle to grow in real terms. The silver lining however is that from a longer-term perspective, when one references the 10 and 15 year average returns of these asset classes, it is clear that through a full market cycle, patient investors have seen their wealth grow in excess of inflation by +10.1% and +11.5% p.a. respectively. Importantly, this significant outperformance includes the recent poor 1, 3, and 5 year return environment as shown in the table.
We are reasonably satisfied with the performance of the CWM portfolios versus peers over the last five years, despite the modest absolute returns shown above. Only CWM Retirement Growth and CWM Defensive have lagged their respective peer group averages over this period, largely dragged lower by above average exposure to the SA Listed Property sector.
All the local strategies are ahead of their peers since their respective inception dates (2012/13) with only Retirement Growth now marginally behind for just the second time in almost 7 years. On average, all local model portfolios have added +0.7% p.a. above their respective peer group averages since inception. Similarly, both foreign HVs are ahead of their respective peer group averages over the last five years and since inception. The relative outperformance from these funds is on average +1.3% p.a. above peer group over more than 10 years since their inception.
From a South African perspective, there is no question that the local environment is uncertain at the moment. This level of uncertainty is clearly visible when evaluating how cheaply most SA-Inc. companies (companies that make most of their money in South Africa) are trading. As is the case with SA listed property, most of these businesses are trading at valuation levels last seen during the Global Financial Crisis 10 years ago.
In our view, the distorted valuations create an opportunity for higher returns for patient long-term investors. While cheaper shares, certainly do not guarantee higher future returns, they most definitely stack the odds in your favour. Therefore we position our portfolios to take advantage of different management philosophies and expertise (particularly at an asset class level) which thereby allows our models to be well diversified to deliver inflation beating returns over the longer-term.
We know that for investors who have endured poor returns for an extended period, as has been the case over the last 5 years, it is often difficult to look forward with confidence, especially in an uncertain environment. We have seen this in our own client base where many investors are struggling to stick to their long-term strategy (i.e. continue to hold growth assets like SA equity), and now are preferring to move into Cash.
The chart below shows the relationship between the returns delivered by equity versus cash over a five year period, sorted by the relative performance of SA equity versus cash over the previous 5 years (Q1 being the worst quintile). The chart clearly shows that the weaker the relative performance of SA equity versus SA cash over the last five years, the more equity tends to outperform over the subsequent 5 years.
In fact, if an investor had just endured a 5 year period that falls into the lowest quintile, equity has on average outperformed cash by 11.3% p.a. over the next 5 years, which bodes well for local investors, given that this is exactly where they find themselves right now.
When we couple supportive valuations with the steps we have already seen taken by President Ramaphosa and his team aimed at turning South Africa and the economy around, we are more optimistic looking forward.
We believe that the steps taken by our President to improve Eskom and to appoint competent professionals such as advocate Shamila Batohi as the new leader of the NPA to repair creditability are definitely steps in the right direction. These small, yet important steps are expected to restore business and consumer confidence, which will ultimately lead to much improved investor confidence. All it takes is small incremental upticks in positive sentiment in order to see markets improve strongly as we have seen in 2019 so far.
Just as we do not expect all South Africa’s problems to be fixed overnight without setbacks, a return to better performance from local growth assets is expected to come with time and some volatility in the short to medium-term. We view this as the ideal environment for patient long-term investors to be surprised on the upside.