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October 2017 Update

Medium Term Budget Policy Statement

On the 25th of October 2017, the Minister of Finance delivered his Medium Term Budget Policy Statement (MTBPS) for 2017/18, shortly after the country had creeped out of recession – technically speaking. Considering the Finance Minister`s perceived lack of credibility with investors and ratings agencies, especially when compared to his predecessor, on top of the afore mentioned state of the economy, Malusi Gigaba delivered the best budget he could.

While the speech itself was devoid of any major surprises, the Finance Minister delivered an exceptionally frank and honest assessment of the dire state of the economy particularly with regards to the size of the potential deficit. As we expected, this news was not well received, and the market reacted negatively with the Rand depreciating strongly following his speech.

Digesting the News

The MTBPS was presented under difficult economic and political circumstances. The weak economic growth, massive revenue under-collection and deteriorating SOE finances meant National Treasury was always going to have to report further fiscal slippage. Unless decisive action is taken to chart a new course, the country could remain caught in a cycle of weak growth, mounting government debt, shrinking budgets and rising unemployment.

The Minister of Finance revised down SA economic growth forecast for 2017 from 1.3% to 0.7%. In addition, the growth rates for 2018 and 2019 have also been lowered from over 2% previously to a little over 1%. South Africa’s per capita income (the average income earned per person) has begun to deteriorate and National Treasury’s projections imply that this will continue in the years ahead. The SA economy is projected to recover slowly to reach 1.9% GDP growth by 2020, but this will depend on rising confidence, improved investment outlook and growing exports.

The current economic situation forces Minister Gigaba’s hand, needing to decide between:

  • Raising taxes to cover the shortfall (unpopular with tax payers),
  • Cut government spending (unpopular with his party and voters), or
  • Carry-on as normal, and issue more debt (unpopular with rating agencies and global investors).

Most investors, financial practitioners, as well as the rating agencies would have liked to see concrete plans to minimise government spending, especially with regards to State Owned Enterprises (SOEs) such as SAA, Eskom and Transnet etc. However this is obviously a politically unpopular choice.

While we will credit the minister for his candour, we fail to understand the logic behind selling the government’s shares in Telkom, to raise much needed revenue and fund the financially distressed South African Airways (SAA).

In general, the budget speech did not entice confidence on the credit rating, with probability of a downgrade to sub-investment grade before year end being higher than before. There remains a small possibility that the rating agencies might wait for the elective conference in December before announcing their outcomes. This will give the ANC a chance to choose the right leaders who are willing and have the potential to revive this economy, create employment and boost investor confidence.

Markets in the Month

The domestic equity market, as measured by the FTSE/JSE All Share (ALSI), was up strongly (+6.3%) in October. The All Bond Index (ALBI) declined -2.0%, Listed Property (SAPY) 2.0% and Cash gained 0.6% last month all contributing positively to a balanced portfolio’s performance.

Calendar year to date (YTD), the ALSI is up 19.6%, outperforming all other domestic asset classes (SAPY 10.3%, ALBI 5.6%, Cash 6.2%). While SA Equity appears to be in good health, upon further analysis one discovers that much of the market’s buoyancy in 2017 has been driven by the biggest counters, such as Naspers, BAT and Richemont.

The rand depreciated by 4.2% against the US dollar, 2.7% against the Pound and 2.8% against the Euro last month. The rand weakness was mainly driven by the revelation of the current state of the economy as presented by the finance minister.

Impact on Our Portfolios

As would be expected when the stock market (ALSI) is up and the Rand is weaker, October was a good month for our model portfolios. The range of returns across the local CWM Model portfolios was +0.5% to +5.1% in October, with Long-Term Growth the best performing local strategy. Our global Houseviews, CWM Foreign Balanced and CWM Foreign Equity were up +5.9% and +6.5% respectively, supported strongly by the rand weakness.

3 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies

Given the strong returns delivered by the local equity market and recent Rand weakness, the medium-term performance figures in the table above are looking stronger. All of the CWM model portfolios are now outperforming inflation by more than 2% per year over the last three years. The foreign Houseviews continue to enjoy the weakening currency, delivering between +9.1% and +12.3% above inflation.

The stronger returns from growth assets recently have begun lifting the returns of the longer-term strategies (CWM Retirement Growth and CWM Flexible) relative to the more conservative strategies (CWM Income and Defensive), although remain below our long-term real return expectations, given the modest local equity returns over the three year period (+9.0% p.a.).

Looking Forward

Investors should be very careful not to panic and take steps that could be detrimental to their portfolios in the long run. The political situation is very fluid and if the current political direction is reversed at the elective conference next month, we could be closer to an end of the policy uncertainty and political noise which will in turn create significant investor confidence in South African assets.

We acknowledge that the MTBPS shows that the state of the economy is deteriorating and might lead to credit downgrades. This has the potential to set South Africa on a negative trajectory. However, rather than trying to predict what the ultimate outcome will be, we look to incorporate this new information into our investment decision making process.

Given the current economic distress, we have already increased our offshore exposure in our long-term strategies to protect your investments on the down side should the negative possibility plays out.

We are convinced that having a diversified portfolio which includes both local and offshore exposure, as well as managers who are good at picking stocks and making asset allocation decisions when information changes, will help our clients’ portfolios through this turmoil.

September 2017 Update
November 2017 Update