September 2018 Update

Making the News

The escalating trade war between the US and China has dominated global headlines with the US applying tariffs to $200bn worth of Chinese imports in September. Brexit negotiations between Britain and the EU appeared to move forward, however that uncertainty coupled with concerns around the Italian budget increased volatility in Europe.

The US Federal Reserve hiked interest rates by 0.25% at their September meeting, and the accompanying hawkish comments from the Fed chair, Jerome Powell, suggested that there may be more interest rate hikes to come in the short-term.

Higher interest rates in the US and continued drama in Turkey saw sentiment towards Emerging Markets deteriorate further, with contagion fears fuelling selling in most EM markets.

Locally, second quarter GDP was negative confirming what most of us already knew, that the South Africa economy is in recession. Interestingly, the weaker Rand has yet to have a material impact on inflation, with the latest figure (+4.9% year-on-year) still comfortably below the upper end of the SARB’s targeted band of between 3% and 6%.

The modest inflation figure gave the SARB some room to manoeuvre and allowed local interest rates to remain unchanged in September despite the higher rates in the US and other Emerging Markets.

Furthermore, the latest version of the Mining Charter was released by minister Mantashe that offers a glimmer of hope to the mining industry. Additionally, President Ramaphosa announced a stimulus package aimed at unlocking domestic economic growth by reducing red tape for business (and tourists specifically), ramping up infrastructure spend and improving the working relationship between government and business.

Digesting the News

Over the last six weeks local investors have faced a toxic mix of falling markets and negative political news. It feels as if every day brings lower portfolio values and even worse news regarding the level of corruption that has taken hold of our government institutions.

You would be forgiven for thinking that the former is completely due to the latter, and that it would be better to simply put your money in a fixed deposit.

This strategy might give you the most peaceful sleep in months, however it will also guarantee you won’t be in the market when the recovery happens, and you are therefore unlikely to enjoy the long-term benefits of riding out the short-term noise.

Instead we would make three recommendations that may assist in keeping the odds in your favour of achieving your long-term objectives:

1. Think Long-Term

The potential risk of being in cash versus equity can be seen in the chart below. The chart shows that over the last 15 years, SA equity would have grown by 3 times more than SA cash.

This additional growth was delivered during a period that included the largest financial crisis in 80 years (when SA equity was down more than 40%), as well as the weak returns over the last four years, including the recent equity market weakness.

It is also worth noting that out of 180 months in this period, SA equity delivered 66 negative monthly returns. Put differently, 37% of the time your portfolio at the end of the month would have been lower than at the start of the month, and would have still outperformed cash by more than 8% p.a.

2. Do not try to Time the Market

For those thinking that they will sit on the side-lines during the volatility and get back in after the dust settles, the risk is nearly as bad as sitting in cash the entire time. Trying to avoid those negative monthly returns has proved nearly impossible, as the negative monthly returns often happen in between the best monthly returns.

The chart above again shows the performance of SA equity over the last 15 years but compares it to the outcome an investor would have experienced had they missed just the 10 best months of equity performance over the period (labelled as the Market Timer portfolio).

By being invested in cash instead of equities during the market’s 10 best months (only 6% of the total period) the market timer portfolio would have grown 59% less over the period versus investors who were willing to ride out the volatility in SA equity.

3. Stick to Your Plan

Baring any material change in individual circumstances, sticking to the plan setup at the start of your investment is almost always the best option.

In the table above, the performance of the major domestic asset classes and global shares are ranked in terms of returns every year (measured to the end of September).

Also included is a balanced fund that is actively managed and can include exposure to all the underlying asset classes.

The major take-aways from the above “smartie-box” are:

1. The best performing asset class over any one-year, changes from year-to-year, and it is impossible to predict the best (or worst) performer year-to-year,
2. Cash was only ranked in the top two twice over the 15 years, however was in the bottom two 10 out of the 15 years,
3. SA equity underperformed cash 6 out of 15 years, but still managed to outperform cash over the full period by more than 8% p.a.,

The balanced fund outperformed cash 11 out of 15 years, but over the full period the balanced fund delivered 14.9% p.a. versus cash that returned 7.6% p.a.

Markets in the Month

The Rand recovered some of the losses experienced in August and appreciated by more than 3.5% against all three major hard currencies (USD, GBP and EUR) in September. The stronger Rand coupled with the risk-off sentiment hurt returns from SA equity, which was down 4.2% during the month.

This pushed returns from SA equities in 2018 to -3.9%, as major stock specific issues at several JSE heavyweight companies (i.e. Steinhoff, MTN, EOH, Tiger Brands, Resilient, Nepi Rockcastle, Aspen and Fortress B) and negative sentiment towards Emerging Markets has hurt the domestic market.

In addition to the losses suffered on the above-mentioned stocks, Naspers (which accounts for approx.  20% of the SA Equity index) is down 11.4% in 2018 (more than 32% from its peak in late 2017) on the back of weakness in Tencent’s share price (the Chinese internet company that Naspers owns c. 30% of, and that accounts for more than 100% of the Naspers share price).

The recovery in the Rand during September did little to offset the weakness experienced in the first eight months of the year, with the Rand still 14.8% weaker against the US Dollar. This of course helped returns from global equities (when measured in Rands), that are up 18.7% so far in 2018.

SA cash is the best performing major domestic asset class in 2018 as higher interest rates in the US has seen liquidity and global risk appetite dry up, resulting in outflows from both EM equity and bonds market (which include SA equity and bond markets).

Impact on Our Portfolios

The market conditions in September resulted in weak returns from most strategies (both local and foreign), with the most conservative portfolio (CWM Income) the only portfolio to deliver a positive return (up 0.5%).

The returns from the rest of the local strategies were all negative (down between 2.1% and 3.5%) for the month. These portfolios were unable to shake off the impact of the SA equity market being down 4.2% as well as the Rand being 3.7% stronger.

The Foreign Balanced and Equity Houseviews were hurt by the stronger Rand and lost 4.0% and 3.6% respectively.

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

All the local model portfolios have delivered real returns (above inflation) over the last three years, despite only modest returns from SA Equity and negative returns from SA Listed Property. In addition to the ceiling placed on returns due to the low return environment, regulations limiting foreign exposure within a retirement product would have placed further downward pressure on potential returns given that Global Equities performed relatively well over this period.

It is worth noting that simply having foreign exposure would not have helped portfolio returns, as the Rand only depreciated against the US Dollar by 0.7% p.a. and was in fact, 4.2% stronger p.a. against the Pound over this period, which would have detracted from returns.

As would be expected, both Foreign Houseviews are materially ahead of SA inflation over the last three years, with the CWM Foreign Balanced Houseview returning 9.0% p.a., and the CWM Foreign Equity Houseview returning 15.5% p.a. given higher foreign equity exposure.

As mentioned last month, all six of the above local strategies remain ahead of inflation and five of the six strategies are in the first quartile of their respective peer groups (Retirement Growth is 2^nd quartile) since their respective inceptions in 2012/13.

The low level of absolute returns over the last three years has been a testing time for most investors. We are fortunate that while we have also been constrained by these difficult market conditions, we have managed to continue to add value to our clients’ portfolios, as illustrated by the strong relative performance versus other strategies that are run to similar mandates.

Looking Forward

Core Wealth celebrates its 10-year anniversary in October and as was the case in 2008 (during the Global Financial Crisis), we are drawing on a significant amount of our experience and expertise during these difficult times to ensure our clients remain correctly positioned and invested to meet their individual objectives.

The pillars of our investment philosophy have remained unchanged over the last decade and continues to be centred around being: Diversified, being long-term focused, and using valuations to make our capital allocation decisions.

The consistent implementation of our process coupled with soundness of our philosophy gives us the confidence that we will continue to add value to our clients as we have over the last ten years.

When we take this confidence and add it to the attractive valuations that have begun to emerge during the recent volatility, we are feeling more and more optimistic about future returns that our clients will receive.