February 2021 Update

Making the News

Front and center in the news this month was Finance Minister Tito Mboweni’s 3rd National Budget. Compared to what was projected in the October mid-term budget, the fiscus managed to collect R100bn more in revenues across a broad range of tax categories – especially from the mining sector which saw exceptional profits on the back of rising commodity prices. Other positives include:

1. An expected GDP growth rate of +3% in 2021
2. More than sufficient compensation for fiscal drag and minimal tax hikes in general;
3. Proposed government salary increases over the next 3 years of 1.2% p.a.
4. R10.3bn set aside for vaccine procurement and distribution over the next two years

Treasury expanded their weekly bond auctions during 2020 to shore up their balance sheet, and as a result, will be able to significantly decrease the supply of new bonds in the coming tax year. Not only will this be positive for bond investors, but credit ratings agencies will also take notice.

Despite the positives, the task of steering the budget back into a sustainable trajectory remains daunting. Debt-to-GDP still remains elevated (80%) and is expected to peak at around 89% over the medium term. The Minister does not expect GDP growth to accelerate beyond 2021, pointing towards low fixed capital formation by the private sector and insufficient government infrastructure spend.

Multi-year wage negotiations also still lie ahead. Should Treasury be strong-armed into accepting higher annual increases, it will be hard-pressed to lower the budget deficit which currently stands at a massive 14% of GDP. Coupled with the potential for unplanned additional support to SOE’s, Treasury could have no option but to take on additional debt at a time when servicing costs already appropriate 20% of revenues.

All in all, while the budget was received positively for the lack of tax increases and a commitment to curb expenditure, the margin for error in implementation is very small.

Over in the US, the labour market continues to struggle, with only 49 000 new jobs created in January (only 6000 were in the private sector). Overall, employment numbers are still 10 million below its pre-pandemic level. Citing the weak numbers, President Joe Biden confirmed his intent to enact the $1.9 trillion stimulus program, the blueprint of which had already been passed in the House of Representatives. The program will provide $1400 direct checks to most low- and middle-income Americans, expand eligibility for jobless benefits and provide billions in additional rental assistance.

February also saw the U.S. Senate acquit former President Donald Trump on an impeachment charge of inciting an insurrection. The acquittal came a month after a mob of Trump supporters stormed the U.S. Capitol as lawmakers were counting the electoral results. A majority of senators voted to convict Trump — 57 to 43, including seven Republicans. Fortunately for Donald, a two-thirds majority (67 votes) is needed to convict.

Markets in the Month

The JSE clocked its 4th consecutive positive month (+5.9%) in February, bringing the cumulative return since November last year (a turning point for sentiment towards emerging markets and value/cyclical sectors) to +28.3% (compare Emerging Markets (+13.5%) and Developed Markets (+11.3%) over the same period). Basic Materials (+11.5%) and Telecommunications (10.5%) led the charge.

The JSE Value Index delivered +7.1% for the month, comfortably outperforming its growth counterpart (+4.9%), and bringing local value’s dominance over growth, measured since November, to a cumulative +5.7%. The trend is even more pronounced in the US: +6.6% for the S&P500 Value index in January (0.62% for growth) and a cumulative outperformance of +7.6%.

Listed Property enjoyed a strong month, but remains the only asset class that is still negative over the 1-year mark (-15.8%) and since the start of 2020 (-27.4%).

Driven by the prospect of rising inflation, the 10-year US Treasury yield rose above 1.50% for the first time since the onset of the pandemic. As a result, gold endured its worst month in over 4 years (-6.2%). Our local yield curve flattened, as investors exchanged shorter-dated (ALBI 1-3 years: -0.69% | ALBI 3-7 years: -2.23%) for longer-dated bonds (+1.6%).

Impact on Our Portfolios

The strong relative performance of the JSE in February reflected in our high equity local models, with solid figures for both CWM Retirement Growth (4.7%) and CWM Flexible (+4.2%). SA-focused value managers made outsized contributions. PSG in particular had a ripper of a month, with the Flexible and Balanced funds returning +7.2% and +6.2%, respectively. CWM  Balanced, Retirement Growth, Flexible, RI-Defensive and RI-Growth benefited directly from the performance. In line with the rally in the Listed Property Index (SAPY), our local property manager – Sesfikile Property – delivered a healthy +8.3%.

The CWM Global Models (Defensive and Growth) also fared well. Similar to the local story, it was the value managers and property sector that outperformed globally. Dodge & Cox Worldwide Global Stock fund returned a healthy 8%, while our global property tracker – the iShares Developed Real Estate Index – added 3.9%. The global bond sell-off reflected in the performance of the PIMCO Emerging Markets Local Bonds fund (-2.4%) and was the month’s biggest detractor in the global models.

Looking Forward

Local Equities – forward-looking valuation metrics for the JSE point to a relatively cheap local market and a promising year ahead. After a damaging 2020 in which 12-month aggregate earnings growth dropped to -26.3% in December, 2021 earnings are expected to recover with the re-opening of the economy. Conservative estimates that factor in lingering weakness in the local economy, put the current forward PE ratio of the FTSE/JSE SWIX index at around 12 which is significantly below its 15 year average of 13.8.

Global Equities – repression of interest rates by global central banks since the start of the pandemic has spurred a rally in global stocks, initially led by developed markets, and followed by emerging markets in the final quarter of last year.

By and large, emerging market valuations are still looking relatively attractive; however, there are exceptions. Having already been in favour with investors due to its outsized economic growth, China solidified its appeal during the crisis by dealing with the virus more effectively than any other country, essentially closing the gap in economic output within a single quarter. The nation’s buoyancy is reflected in their stock market and currency – both of which have moved into expensive territory.

In the developed world, markets that offer value include the UK (currently the leaders among large nations in the vaccination race, with more than a 3rd of the population having taken the jab); and Japan, who surprised with their Q42020 GDP figure. As a major exporter in the region, it stands to benefit most from the manufacturing recovery in China and South-East Asia.

Lofty US valuations make it especially vulnerable to rising interest rates – especially the large tech sector which is disproportionately affected by the discount rate.

Local Property –  news that anchor tenants like Edcon and Ster-Kinerkor have been placed in business rescue (the former already being sold off to Retailability and TFG) casts a shadow over the asset class’s outlook over the short to medium-term – especially in the retail and office space where vacancies are still high and balance sheets remain impaired.

A positive is that companies are using this time to de-leverage and improve their balance sheets. The preferred methods of achieving more sustainable debt-to-equity ratios, have been asset disposals and dividend reinvestment schemes (as opposed to outright equity capital raises, which permanently lowers profitability). Notably, asset disposals as a percentage of NAV are expected to peak in 2021 (11.7%), before dropping to 9.6% in 2023.

Another massive boon to the industry –  which cannot be overstated – is the non-repeat of hard lockdowns. The opening of the economy will undoubtedly facilitate a gradual stabilisation of property fundamentals. For the time being, however, despite the attractive yields on offer, we remain cautious of the sector and continue to monitor its progress.

Local Bonds – while the SA +10-year government bond bracket is yielding about 1.32% above its long-run average at 9.78%, the effective yield foreign investors can expect in the long-run, after accounting for currency effects, is equal to c.6.6% (the real yield). These equity-like expected real returns are the result of a significant steepening of the yield curve during a time of muted inflation (c. 3.2%). Barring any further fiscal deterioration, we see foreign capital flowing into our market in the search for yield, and bonds investors realising double-digit returns.

Global Bonds – by the end of 2020, the global supply of negative yielding debt reached a peak of $18trn. Since then, that amount has shrunk to $15trn, indicative of increased global inflation expectations. In fact, in less than 40 trading days since the start of 2021, US Treasury long-dated bonds (30+ years) have fallen by as much as 14%. The sensitivity in long-dated bonds stems from their historically low yield to maturity (±2.17%) – with current duration (23 years) close to the highest on record. With most of the developed world’s bonds being equally or even more expensive, we remain cautious of the asset class.