May 2018 Update
Making the News
News in May was dominated by the strength of the US economy and record low levels of unemployment. Labour market conditions are now so tight in the US that the number of unemployed people is less than the number of job vacancies, a problem we all wish we had in South Africa.
Locally, first quarter GDP figures were released just after month end, with the economy contracting by 2.2% in the first three months of 2018. A sobering reminder of the work that lies ahead for the new leadership.
Adding further pressure to the local consumer is the petrol price which hit all-time highs in the first week of June, following substantial increases (+R2/l) over the last three months.
Digesting the News
Logic would suggest that a strong US economy is good news for the global economy given that the US is the world’s biggest market. However, as is often the case in financial markets, good economic news is often bad news for asset prices.
The strength in the US market is suggesting to investors that the US Federal Reserve will continue to hike interest rates to stay ahead of inflation (which is expected to rise given the tight labour market conditions mentioned above).
Higher expected interest rates in the US pose the risk of cooling the economy and therefore slowing global growth. When one couples this tighter monetary policy with a stronger US Dollar which is negative for commodity prices and Emerging Market bonds, the Rand should weaken, and has. A weaker Rand reduces the chances of further interest rate cuts (due to increased pressure on local inflation), which would have been useful to help our ailing domestic economy.
On top of the risks posed by the stronger USD and lower commodity prices, the weak first quarter GDP figure did little for foreign investor confidence in the South African turnaround story. The biggest detractors in the domestic economy in 2018Q1 were manufacturing, mining and agriculture. While Real Estate, Finance and Government supported growth. We would view this as the exact opposite of what is needed to see broad inclusive growth that will cut our bloated unemployment rate.
In addition to the weaker Rand and potentially higher interest rates, local consumers have been hit hard with big petrol price increases since March. The petrol price (95 unleaded at the coast) is up 29% (or 5.2% p.a.) over the last five years (very similar to inflation over the period of 5.3% p.a.), however is up 19% over the last year.
More recently the weaker Rand and higher oil prices are responsible for these increases, both of which are due to global issues (or not RSA specific). However, government’s need to increase taxes over the last 2-3 years has seen the Road Accident Fund and fuel levy become an ever increasing percentage of the total price.
Markets in the Month
Unsurprising given the above developments, both SA Equity (-3.5%) and Listed Property (-5.9%) were negative in May, hurting longer-term investors who have more exposure to these assets.
Both asset classes are negative in 2018, with returns over the last three years below inflation. Longer-term returns more accurately show the reward for patient investors with the 15 year returns more than 10% above inflation for both asset classes.
SA Bonds were down -1.9% in May following selling by foreign investors, as the carry trade unwound somewhat given higher rates in the US. Despite the tough month, bonds are the best performing major SA asset class both in 2018 (+5.2%) and over the last year (+8.1%).
The weaker currency (versus the USD) acted as a tailwind to global asset class returns in May, with Global Equity up 1.6% in May. Over the last twelve months the Rand is stronger against the USD which would have detracted from returns; however Global Equity has still delivered 7.4% in Rands.
Impact on Our Portfolios
Model portfolio performance was weak in May given the negative returns delivered by SA Equity, Listed Property and Bonds. However, each model outperformed all three of these asset classes highlighting the benefits of diversification. The range of returns across the local CWM Model portfolios was -1.8% from CWM Retirement Growth to +0.4% from CWM Income.
Our Global Houseviews, CWM Foreign Balanced and CWM Foreign Equity were up 0.5% and 0.3% respectively, with returns hurt somewhat by Emerging Market exposure.
3 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies
As has been the case in 2018, the low returns from SA Equity and Listed Property over the last three years would have hurt long-term investors with higher exposure to these assets. This is seen in the returns on the more aggressive CWM strategies (Balanced, Retirement Growth and Flexible) which delivered between 3.9% and 5.1% p.a. over the last three years.
More defensive strategies (Income and Retirement Income) have benefitted (on a relative basis) form higher exposure to SA Cash and bonds, therefore it is unsurprising that returns from these strategies are slightly higher (8.6% and 6.1% respectively).
As mentioned last month, all of the above local strategies remain ahead of inflation over the longer-term, and five of six strategies are in the first quartile of their respective peer groups (Retirement Growth is 2nd quartile) since their respective inceptions.
Regular readers will be familiar with our view on short and even medium-term performance, and the need to avoid making decisions based on these returns. When times are tough (i.e. returns below long-term average and risks are perceived to be above average) it may be more comfortable to give into temptation and sit in cash to ensure a reasonable return until things improve, but this a bigger risk in our view.
Unfortunately, no investor (professional or amateur) can with any confidence know when the hard times will end, and when will be a good time to get back into the market. We have written many times about the risk of missing the best months in the market, which so often come between the worst.
Instead we will continue to advocate that clients will be better off sticking to their long-term plan regardless of short-term conditions. We will remain vigilant in our approach to ensuring that we stack the odds of long-term success in our clients favour by ensuring that we continue to allocate their capital in a prudent manner that aims to maximise their returns within their own risk profile regardless of how uncomfortable that may be at their portfolio reviews.