May 2017 Update
News both locally and globally has been dominated by politics in 2017. This prolonged environment of heightened uncertainty and political risk has local investors worrying about the impact on financial markets. The Zuma, Trump and May administrations are all of concern for investors looking for greater certainty in the current low return environment.
While the political headlines cannot completely be ignored we would suggest that investors cut through the noise to find actual investment trends that are influenced by fundamental data such as economic growth (GDP), consumer price inflation (CPI) and interest rates which can all inform investment decision making.
Digesting the News
The South African economy has technically moved into a recession with the reported decrease of 0.7% in GDP during the first quarter of 2017, following a 0.3% contraction in the fourth quarter of 2016. This is based on the widely accepted measure of recession which is two or more consecutive quarters of negative growth. This is unsurprising given that unemployment (currently 28%) is at the highest level in more than a decade.
In light of this technical recession, it will make logical sense for the South African Reserve Bank (SARB) to cut interest rates in order to stimulate growth in the economy in order to create jobs. This is supported by the inflation rate which has fallen within the SARB targeted band (3% to 6%) and expectations are for it to fall lower mainly as a result of lower food inflation.
However the SARB has to balance weaker growth and lower inflation against the country`s vulnerability to changes in foreign capital flows. Currently South Africa has benefited from the inflow into emerging markets by foreign investors pursuing higher yields. If the SARB cuts interest rates, the lower rates might attract fewer foreign investors to South African assets.
The penalty for the incorrect monetary policy is worsened by the country’s recent credit rating downgrades as well as the expectation that the US Federal Reserve will continue to normalise interest rates.
Conventional economic theory suggests that lower interest rates will directly increase investment spending by lowering the cost of capital, raising production capacity and thus potential future output growth. This would be positive for productive asset classes like SA listed property and SA facing shares. A reversal in foreign investment flows and further deterioration in global investor sentiment towards South Africa could result in Rand weakness, benefitting investments in foreign asset classes.
Markets in the Month
The rand continued to strengthen in May gaining 1.6% against the dollar and 2.6% against the pound. The rand strength can largely be explained by the capital flows into emerging markets as foreign investors pursue high yields available on our bonds, as well as improvements in commodity markets.
The stronger Rand has a negative impact on the performance of SA Shares which is evidenced in the -0.4% return in May, as well as the +2.2% delivered by this asset class over the last year. SA Bonds was the best performing major domestic asset class in May (+1.0%) and over twelve months (+13.3%).
Impact on Our Portfolios
The range of returns across the CWM model portfolios was -0.9% to 0.8% in May, with CWM Income performing best, up 0.8%, driven by stronger returns from SA fixed income asset classes (Cash and Bonds). The weak local equity market and strong Rand weighed on performance of the more aggressive Core Wealth model portfolios.
Short-term performance (weak or strong) can deviate materially from the long-term expected returns of an investment strategy. While uncomfortable, it is important to always remain cognisant of the investment’s time horizon and the long-term aim of the portfolio. We use the target of outperforming inflation over the long-term as our guide for making allocation decisions within each strategy. Enduring some short-term weaker returns is at times necessary in order to achieve the long-term goals.
3 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Houseview Strategies
The chart above shows that the foreign houseviews have performed strongest over the last three years, helped by the weaker Rand (+7.8% p.a. versus the USD) over this period. All our domestic model portfolios (except CWM Retirement Growth) are comfortably ahead of inflation (more than 1.7% p.a.) which in context of low returns from the SA Equity Market (up only 5.6% p.a.), is a reasonable outcome for these portfolios.
Over the last three years the local model portfolios have outperformed their peers (by 1.1% p.a. on average), with the foreign houseviews outperforming their comparative peer group averages by 2.1% p.a. (on average). This performance demonstrates the benefit of well researched investment management.
In most cases when both growth and inflation forecasts are lowered, the likelihood for a rate cut is strong. However, the SARB has consistently worried that the rand is vulnerable to sudden depreciation in the face of US interest rate hikes or domestic political developments.
Positioning a portfolio to benefit from more than a single outcome (lower interest rates, weaker Rand, stronger domestic growth etc.) is the very purpose of diversification. While investing this way does not guarantee the best returns over any one period, it does allow for certain portions of your portfolio to increase in value while other parts are struggling.
Core Wealth Managers will remain long term oriented in the way we manage our clients` portfolios ensuring that we have the ability to take advantage of opportunities across different managers and asset classes to deliver real long-term returns regardless of how tough markets may be over any single month, quarter of calendar year.