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February 2020 Update

Making the News

The State of the Nation Address and the Budget Speech were big talking points in February. While there were positives highlighted in both speeches, these were not only overshadowed by rowdy honourable members in parliament, but more importantly, by continued poor performance with regards to addressing unemployment & managing SOEs and the country’s debt level.

The Corona-virus continues to contaminate sentiment on a global scale. The final two weeks in February led to severe global stock underperformance (as well as South Africa) and has been compared to 2008 when fear gripped the market at the onset of the Global Financial Crisis.

Digesting the News

In the SONA speech our President addressed the nation’s concerns around crucial topics that require urgent implementation. Key positives were increasing Eskom’s exposure to Independent Power Producers, having Ministers sign performance agreements to ensure accountability and cutting red tape for businesses to encourage entrepreneurship, which will hopefully lead to greater job creation.

Although these are positives, the challenges of state capture, high unemployment, failing municipalities remains. The Minister delivered a tough budget speech, determined to curb government expenditure. Implementation of the measures discussed in the budget are vital to turning the economy around.

In February, global markets were shocked by two factors linked to the Coronavirus. The first was the increase in confirmed cases during February and the second was the number of cases reported outside of China. The virus continues to restrict travel and the movement of people, which will have a negative impact on service orientated sectors, however the impact of supply chain disruptions has been limited thus far. The most accurate global mortality rate is 1% at the time of writing and although this strain is more infectious than previous coronavirus strains, it has a lower mortality rate.

The reason for the correction in February is lost production, manufacturing, and economic activities which have an impact on the earnings of companies in the short-term. When investors anticipate that earnings will be lower, they normally reduce exposure to those companies, forcing a decline in the share price. Time will tell whether the degree to which company share prices have fallen accurately reflect the real economic impact of the virus.

Markets in the Month

The Rand had been under pressure in February because of fears over the spread of the Coronavirus and concerns over the country’s stretched public finances. As a result, the Rand weakened by 5.2% against the USD & EURO as well as being 3.1% weaker against the British Pound (using SARB data) and continues to remain weak over the last year, especially against the USD at 11.2%.

SA Equities fell sharply in February (-9%) on the back of heightened fear regarding the Coronavirus becoming a global pandemic. Global Equity markets (MSCI World) were down 4% during the month and the S&P 500 posting its largest single-day decline since 2011 and as a result ended the month down 3.8% (in Rand terms). The MSCI World and S&P 500 were down c.8% in dollars in February. The MSCI EM index ended the month marginally down in Rands (-0.7%) but down 5.3% in USD.

Over the longer-term however, these markets still have shown strong growth and as markets pull-back they create attractive entry points for long-term investors, especially where recent selling far exceeds the potential economic risks to company profitability.

Local bonds returned +3.0% over the last three months making its one year return +8.9%, or 4.4% ahead of SA inflation. The local bond market reacted positively to the Budget Speech, as the rand gained approximately 1% against the dollar at the time and the 10-year bond yield declined to 8.7% resulting in a capital gain of +0.7%.

Going forward, the market will monitor how well the government executes on reducing the wage bill and how well the country contains the Coronavirus spread between provinces. Another significant event scheduled to take place in March will be Moody’s decision on South Africa’s sovereign rating. We mentioned in previous wrap-ups that we believe a downgrade will take place which would likely see SA bond yields move higher, creating attractive buying opportunities for investors as the prices on those bonds will be discounted.

Impact on Our Portfolios

It has been a negative month for our model portfolios given the large declines experienced in the equity and listed property markets, both locally and globally. The only model portfolio which remained positive in the month was CWM Income.

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

The market pull back in February has not deterred us from our long-term strategies. During times of severe declines in asset prices, investors should not panic or be reactive by selling in fear but rather remain disciplined, and stick to their long-term strategies.

Looking Forward

The biggest uncertainty currently is the Coronavirus and potential impacts it may have on economies over the long-term. In history, there have been occasions where markets as a whole lost substantial value. These occasions include the crash on “Black Monday” in October 1987, the early 1990s when Japanese stocks imploded, 1997/8 Emerging Market Crisis, early 2000s technology stocks meltdown and 2008 Global Financial Crisis.

In all of these events, financial markets were hit hard by news which was further exacerbated through aggressive short-term selling following more news updates. What we learnt from these events was that markets recover and long-term patient investors are rewarded handsomely. As Warren Buffet says “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”. This wisdom applies to current market conditions as this event has caused markets to fall in tandem on a global scale causing extreme uncertainty and investors to act in an irrational manner.

The graph below shows how the Johannesburg Stock Exchange (JSE) fared over the last 40 years:

All of the market crashes mentioned above, while at the time created anxiety, become insignificant over the full time horizon of the average person’s “investment life”. Over the last 40 years, the JSE grew by +7.2% per year above inflation, in spite the above mentioned crashes.

Clients who have short-term goals will be in cash like portfolios which are less exposed to this short-term volatility. Clients with long-term goals will be in diversified portfolios in which the values will move up and down, but not as much as the stock markets because of the different types of assets and managers in these portfolios.

The way we manage portfolios where clients draw income is focused on the yield that the underlying investments generate. While the values of the portfolio might drop in the volatile markets the income has not dropped materially – in fact bond and property yields are even higher for investors buying these assets now.

Lastly, to long-term investors making new investments, either lump-sum or regular monthly contributions – current valuations in the markets mean that the expected future returns are extremely attractive.

We trust this information helps provide context and insight which will enable you to avoid making decisions based on fear. We have a proven investment philosophy and strategy that has and will provide good outcomes for our clients over your respective time horizons.