July 2021 Update
Making the News
July was marked by the widespread riots and looting that broke out in KwaZulu-Natal (KZN) and parts of Gauteng in the wake of former president Jacob Zuma’s incarceration. A government survey of 1000 businesses in KZN found that over 900 had been affected and more than 10 000 jobs were at risk because of unrest-related losses. The SARB believes the unrest fully negates the impact of Q1’s better-than-expected GDP outcome on full-year estimates and has decided against the intended upward revision of its 2021 forecast (4.2%).
Against the turbulent backdrop, Treasury announced a new fiscal relief package of R39bn. The lion’s share of the package will be for the temporary reintroduction of the R350 p.m. social relief of distress grant. Importantly, the package will be fully financed through higher-than-expected government revenue collections thanks to strong mining corporate tax receipts. Compared to the pre-pandemic period of 2Q19, government revenue is up by 19% in 2Q21.
Another important milestone is the finalization of the public sector wage deal for 2020/2021. The 1.5% wage increase (+R2bn) and additional cash allowances (+R18bn) is said to be budget neutral, financed through spending reprioritization. Encouragingly, commentators agree the relief package and wage deal should not compromise the budget outlined in February. Estimates are now for a budget deficit of 8% of GDP (previously 7%), which is still below the initial 9% as per the budget speech.
On the monetary front, policy meetings in both the US and Eurozone left the target for interest rates and the rate of bond purchases unchanged. In a statement, the Fed said that while progress has been made towards maximum employment and 2% inflation, there is no consensus as to when “tapering” will begin. The SARB also kept rates unchanged. It did, however, adjust its forward guidance to a single 25bps rate hike in Q421 (previously 2 had been signaled).
Markets Commentary
Market news in July was dominated by the events in China. After launching a formal investigation into Didi Global and its listing in the US in June, where its compliance with certain SEC requirements was deemed a potential threat to national security, the CCP set its sights on the locally listed private education sector. For a variety of reasons, some seemingly legitimate and others perhaps motivated more by a desire to enforce a centrally planned economy, it ruled that the companies in the sector must operate on a non-profit basis going forward. Unsurprisingly, the news caused alarm and saw the sector lose half its value in subsequent trading.
Will the CCP target other industries next? Massive Chinese internet platform businesses, including names like Alibaba and Tencent, might come under deeper scrutiny. Both could be attacked on antitrust grounds, or the legality of their underlying ownership structures challenged. The regulator gave teeth to its existing antitrust laws by ordering Tencent Music Group to give up its exclusive streaming rights, causing a 60% decline in its share price.
The result of the heightened regulatory uncertainty is an increased risk premium required by investors in Chinese stocks. The MSCI China Index lost c.11% in the month. The JSE also has large exposure to China through Naspers’ 29% stake in Tencent. The local heavyweight saw its share price plunge by up to 15% during the month but managed to claw back some of the losses to end the month down 6%.
Despite Naspers’ setback, the JSE still managed a healthy 4.2% return. The positive number owes to the important Resources sector, which saw a whopping 11.8% return on the back of strong demand for commodities. The overall bourse’s performance was in line with Global Developed Markets (+4.3%) and bucked the Emerging Markets trend (-4.4%) which was grappling with spill-over effects from China.
Our local bond market suffered foreign outflows of c. R5bn in July. Both the looting and contagion from China could be responsible. Fortunately, the flight to safety by foreigners was offset by local inflows, which saw yields drop across the maturity spectrum (albeit marginally). The Rand declined by up to 4% against the Dollar during the month but settled at R14.6 (down 1.5%).
Impact on Our Portfolios
Having exposure to equities (both local and developed markets) has benefitted the CWM portfolios with the CWM Retirement Growth model leading the way on the local front during July (up +2.0%). All other local models delivered a return above +1% except for CWM Income which delivered +0.6%. Year-to-date performance is pleasing and above peer group performance across the board. It has been good for the longer-term returns, with the one-year bracket being the standout point in time measurement period.
Over the five-year period, CWM Retirement Growth and Flexible have outperformed their peer group averages by +0.5% and +2.1%, respectively. Underperformers such as CWM RI-Growth, Balanced and Defensive are on the road to recovery as value continues to outperform. Conversely on the global side, our foreign house views continue to dominate performance given the weakening of the Rand coupled with the more robust offshore equity, property, and bond markets over the period. Since inception returns are above peers for most of the CWM models (local and global) apart from CWM RI-Growth/Defensive which underperformed by -0.3%.
Looking Forward
The impact of the social unrest can be measured directly as well as indirectly in terms of the effect it had on South Africa’s economy. The direct impact has been the significant loss of life, supply shortages in fuel, food, and medicines; vaccine rollout setbacks; and cash shortages in KZN, due to many ATMs that were damaged. It directly impacts growth in the country as household consumption and industrial production experienced a decline, consumer and business spending slowed down, and jobs were lost with little opportunity for those now unemployed to find work elsewhere.
Indirect costs for the country can be measured by a higher perceived risk for businesses located in areas considered hotspots and an increase in business costs associated with the transportation of goods, insurance, and security that could lead to higher inflation. Given all the damage, it is expected that GDP growth will be impacted negatively in Q3. The SA Reserve Bank will be under pressure to delay any rate hikes in 2021 with the QPM predictions now factoring in hikes in each quarter next year.
Due to the unfavourable macro environment and the rising unemployment rate, we remain cautious on the South African property market. We continue to expect negative rental reversions and increased vacancies, both in retail and office subsectors. Longer term, we believe that listed property represents good value for investors willing to stomach the volatility over the short to medium term.
The Delta variant, China’s regulatory clampdown on the technology sector and global inflationary pressures waned on EM investor confidence during the month. While there has been a spill-over into the local bond market, there are positives that maintain a level of market stability for local bonds. The fact that temporary social relief packages and the recent wage settlement with public servants have both been accommodated within the existing budget, are favourable for the bond market. With this in mind, we continue to believe that longer dated local bonds present investors with competitive yields on a global scale.
Lastly, equity valuations in the US remain elevated because of high liquidity in the financial system. We expect the global economy to continue its recovery and inflationary pressures to persist on the back of continued disruptions to inputs and labour supply. Monetary policies are likely to remain accommodative for the next 18 months. Interest rates in the US are likely to increase in Q1 2023 and to reach a terminal rate of 2-2.25% by Q4 2025. Due to the potential for policy error during this time, market volatility could be heightened. At least the volatility should not be compounded by excessive global political risks, which have moderated under the Biden administration.
In conclusion, the social unrest which occurred during July should not deter investors from their long-term goals. Although GDP growth is expected to decline, it is not all “doom and gloom” for the country as much progress was made on initial reforms (e.g., the arrest of Jacob Zuma arrest, Ace Magashule’s suspension, privatising SAA, etc.). At times like these, investors tend to react by taking all their money offshore. At Core Wealth, however, we encourage our clients to maintain a balance between offshore and domestic exposure, particularly within the equity asset class. History has shown that it is not a foregone conclusion that offshore equities outperform domestic equities. Considering this, the CWM portfolios follow the principle of diversification, balancing both the risks and opportunities present in local and global markets.
