April 2020 Update
Making the News
By now, it is no surprise that the global economy is operating at a slowdown, unlike anything seen in recent history. The resultant effect of an economic slowdown is a surge in unemployment figures. In the United States (US), approximately 33 million people have claimed unemployment benefits. Conversely and more unfortunate, the informal nature of South Africa’s economy means the job and income losses will probably be more severe than in developed markets like the US.
The fiscal and monetary response to the current crisis has also been unprecedented. In the past 10 weeks alone, the US Federal Reserve has announced US$13 trillion in stimulus packages. For context on how extreme this is, in 2008/9 during the global financial crisis (GFC), the stimulus package implemented for the entire year totalled US$2 trillion.
In SA, the government implemented a R500 billion stimulus package to help buoy the economy. Coupled with that, the South African Reserve Bank (SARB) cut the repo rate by a further 100 basis points, in an effort to reduce the strain on South African households.
Lastly, the oil market continued to face supply side complications. Despite the West Texas Intermediate (WTI) futures crude reaching an unbelievable negative spot price of -$39 intraday, both WTI and Brent crude markets have recovered somewhat. The Brent market is less affected by storage and closed the month at $25 a barrel, possibly the more accurate reflection of the global oil market.
Markets in the Month
Sentiment was negative towards South African assets prior to the COVID-19 crisis. Additionally, the lockdown announced at the end of March coincided with teh Moody’s downgrade has resulted in many foreign investors exiting SA markets. As a result, the rand is one of the worst performing Emerging Market (EM) currencies year to date (down over 20% relative to the USD, EUR and GBP). Arguably however, SA is looking better than their EM counterparts such as Brazil (that faces a potential president impeachment) and Turkey (that are running low on reserves).
The volatility in markets has resulted in sharp bounces in most asset classes. For instance, any person invested in SA equities (as measured by the FTSE/JSE All Share Index) between 19 March until the 30 April would have been rewarded with a +31.5% return. This unfortunately could have gone both ways; therefore timing the market is not prudent and investors are advised to have a diversified portfolio and to remain disciplined to their long-term strategies.
April has been a very good month for asset classes, particularly for local growth assets such as equity (+14%) and listed property (+7%). As the table above summarises in Rand terms, SA shares outperformed their Emerging Market counterparts by 1.8% in April.
Although we have seen a strong bounce in April, returns have disappointed over the last five years for SA shares (+1.6%) underperforming inflation by 3.4%. It is understandable why clients are anxious regarding the prospects for SA shares, however, it is worth mentioning that over the last 10 and 15 years, SA shares have outperformed inflation by +4% and +7.3% respectively.
After the significant weakness seen in March, April saw some stability return to the SA bond markets, with the All Bond Index (ALBI) returning c.4%. The additional 100 basis point interest rate cut provided considerable support to bonds improving the relative attractiveness of this asset class when measured against cash. The recovery in April resulted in yields ending the month trading at levels only slightly higher than they were trading just prior to the COVID-19 and downgrade sell-off in March.
Many investors were nervous ahead of the World Government Bond Index (WGBI) rebalancing at the end of April. However, the last week of April saw demand for SA Bonds, with the 10-year yield rallying 60 basis points in the last few days of the month, implying that many foreign investors had already re-positioned for the index related flows.
Impact on Our Portfolios
Core Wealth model portfolios have participated well in the upside presented in local and global markets in April. Model portfolios with more exposure to growth assets benefitted the most as evidenced by our most aggressive model portfolio (CWM Long-Term Growth) ending the month up by +11.8%. Additionally, CWM Balanced, Retirement Growth and Flexible all delivered returns in excess of 10% in the month.
Furthermore, the more defensively positioned model portfolios still delivered reasonable performance. Our lower equity models such as CWM Defensive and the regular income strategies (CWM RI-Growth & CWM RI-Defensive) delivered around 7% during the month followed by our CWM Income portfolio, a portfolio with only exposure to Bonds and Cash, which delivered +2%.
5 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies
Despite this strong performance, the one year returns for our models are negative with the exception of CWM Income being up by +4.6% (or 0.5% above inflation) over the period.
As mentioned in the market commentary, returns from SA growth assets over the last 5 years have been low. This in turn affects performance of our models over the period which provides an understanding when looking at the bar graph above. On the global side however, returns remain more robust as evidenced by the CWM Foreign Balanced and Foreign Equity houseviews which delivered +10.8% and +12.4% respectively due to better performing global markets and a weaker Rand.
We are currently in a global recession as the US economy posted its biggest quarterly economic contraction (-4.8% GDP for Q1) in 12 years. According to estimates from the Bureau of Economic Analysis, second quarter GDP data is expected to be worse at -27.7%.
In South Africa in 2019, the economy grew by a meagre +0.2%, down from an already weak +0.8% in 2018. Covid-19, the biggest challenge in 2020, will negatively impact global and domestic economic growth through the first half of the year, and potentially longer depending on steps taken to limit its spread.
While Oil companies will unfortunately struggle during this time, countries such as South Africa could potentially benefit from the drastic decline in oil prices. These benefits include the consumers enjoying a R1.74/l drop in the petrol price, coupled with the relief for the government’s current account deficit given that our country is an oil importer. Lastly, inflation is also expected to benefit, with some estimates for the June inflation print to be as low as 1.6% year-on-year (Y/Y), and inflation for 2020 to potentially be as low as 3%.
Despite the negative economic reality presented above, we remain optimistic about valuations currently and therefore return expectations going forward. This is discussed briefly below by looking at the broad main asset classes:
In our Big Questions Zoom event which took place on 30th April, we discussed how attractive valuations are on a global scale of 32 equity markets. Valuations of these markets remain a core pillar in our process and we monitor this on a monthly basis in our investment meetings.
Simply put, of the 32 global equity markets we track, 16 (or 50%) were trading cheaply prior at the end of February (prior to the crash), subsequently, 30 (or 94%) are now trading below there long-term averages. Only the US and Switzerland are trading expensively, benefitting from the flight to quality. On average these markets were trading at fair value before the crash, however now trade at an average discount of 20% versus their long-term trading levels. This is positive for long-term investors, as the price you pay for an investment is often the most important factor in determining future long-term returns.
As discussed in our March monthly wrap-up, valuations in the local listed property space are extremely attractive. However, we are more cautious on the sector in the short-term due to the challenge of a tough South African economic backdrop.
While there are areas of excess supply in certain property sectors valuations have become excessively cheap levels, trading at multiple times lower than previous crisis levels (e.g. Global Financial Crisis in 2008/9). Despite the macro economic headwinds, some asset managers expect listed property to perform best over the longer-term given how cheaply it is currently trading. At Core Wealth, we include listed property as a diversifier in portfolios but expect to strong rewards over the longer term due to the extreme discounts in current prices.
Local bonds are currently offering inflation-beating yields at lower volatility than listed equities and property. We presented research from Prudential in our March monthly wrap-up showing how local bonds were trading at significantly higher real yields than countries’ with similar/lower credit ratings (i.e. Brazil, Turkey and Mexico), making SA an attractive market for global investors seeking yield.
Despite trading at stronger levels than in March, SA bond yields still carry a large risk premium relative to developed market bonds, well evidenced by the 9.6% differential between the SA 10 year bond yield (10.2%) and US yield (0.6%). We believe this asset class will reward investor well over the medium-term.
In conclusion, we would like to emphasize that we do not construct portfolios with exposure to only one asset class. Our philosophy revolves around investing in a range of assets that will do well across many different scenarios. We continue to encourage our clients to stay invested during these uncertain times. Your investments are in safe hands and we will continue to manage the risks while prudently taking opportunities that present themselves for long-term investors.