June 2020 Update
Making the News
There was a resurgence in Covid-19 cases during June as economies around the world lifted their lockdown restrictions. At the time of writing, the US continues to lead the way in confirmed cases followed by emerging markets (EM) such as Brazil, India and Russia. Emerging markets (including South Africa) have a greater need to open their economies as these countries do not have the balance sheets to withstand a sustained lockdown where businesses cannot operate.
In June 2020, the US unemployment rate improved to 11.1%, down from 13.3% in May. This was better than expectations and was therefore welcomed by the market, shown by the rally on the S&P 500 shortly after the data was published.
South African Finance Minister, Tito Mboweni, delivered a Supplementary Budget speech in June. The speech highlighted the deterioration in the country’s fiscal position unfolding in 2020/2021. The statistics were by and large unsurprising to the market, and did little to impact the performance of local assets or the Rand. Implementation of this budget and more importantly the MTBPS in October will be crucial in charting the course for the country going forward.
First quarter SA GDP in 2020 contracted by -2% ahead of the Covid-19 pandemic induced meltdown. Forecasts suggest that the World and SA economy will shrink by c.5% and c.8% respectively this year.
Markets in the Month
Global central bank actions and government fiscal stimulus have suppressed global yields, thereby propelling equity markets higher and making global income assets less attractive. Emerging markets outperformed, buoyed by China, as its economy continued to normalise with the manufacturing sector expanding for the fourth consecutive month.
The Rand strengthened against all major currencies in June on positive EM sentiment but still remains undervalued as evidenced by the material depreciation year-to-date (YTD). SA’s stretched public finances coupled with Covid-19’s impact on the economy remain headwinds for the recovery of the local currency.
The JSE had its best quarter in almost 19 years, supported by rand hedges and stimulus measures taken by major central banks to ease the effects of Covid-19. The FTSE/JSE All Share Index (which is an index used to measure SA equity) delivered +7.8% in June and when measured over the second quarter (Q2) of the year, the index gained +22%. Overall, SA equity is now down only -3.2% for the calendar year which is remarkable considering that it was down more than -35% at the lows in March.
The SA listed property market surged in June with the index (FTSE/JSE Listed Property) appreciating by +13.4%. This asset class was the best performer in the month but remains down -37.6% for the year, despite being up +20.4% in Q2.
As with the Rand, SA bond investors continue to place emphasis on the execution of the budget as a key risk to the market. The yield curve steepened during June as longer dated bond yields rose and resulted in an overall return of -1.2% from the index after a strong +7.1% return in May. Going forward, factors such as pension fund reforms, cabinet reshuffle/prosecutions and clarity on the IMF disbursement will all be positives for the bond market. No further negative news in this regard should see yields stabilising, with the potential to strengthen on any improvements.
Impact on Our Portfolios
The aggressive CWM model portfolios led the way over the second quarter, with CWM Balanced, Retirement Growth and Flexible up +14.3%, +14.5% and +14.5% respectively. With monetary stimulus propelling equity markets and lower interest rates supporting valuations, we can expect stronger returns from these portfolios going forward. While volatility is inevitable in these types of assets, long-term real return expectations for growth assets remain attractive.
5 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies
Despite the foreign houseviews dominating over the past 5 years, in Q2 we saw a strong surge on the local front. CWM Flexible outperformed Foreign Equity houseview by +0.3% over the period. Similarly, our CWM Balanced model outperformed the Foreign Balanced houseview by +5% over the same period, benefitting tremendously from the stronger Rand which exaggerated the recovery in SA asset classes.
Despite the 2.75% cut to interest rates already in 2020, we continue to expect further cuts given that inflation is so low at 3%. Furthermore, we expect continued uncertainty around Covid-19. Macro influences such as these are out of our control but we continue to position the CWM portfolios to participate in the attractive opportunities in the broader market.
As mentioned in the market commentary, growth assets (both equity and property) delivered strong returns in Q2 of 2020. Investors who capitulated during the height of the meltdown would have sadly missed out on the strongest quarterly rally from these assets since 2002, destroying wealth by selling at a market low. At Core Wealth we have always believed that helping our clients control their emotions during difficult times will add significantly to their wealth, with the Covid crash now serving as testament to this value add.
The outlook for SA listed property remains very uncertain, which results in a larger range of potential return outcomes (including on the up-side). While economic news has yet to turn upwards, some positive news has emerged from the sector regarding better than expected rental collections. While it is still too early to reach a conclusion as to whether this asset class will experience the strongest recovery after falling the most during the crash, current valuations would suggest that even a modest recovery should support inflation beating returns over the longer-term.
Given that yields globally appear anchored at record lows, we do not expect strong returns from global bonds and cash. Similarly in SA, money market funds or money saved in the bank are not expected to deliver inflation beating returns as they did over the past 5 years.
SA Bonds however, continue to provide an interesting investment case over the medium-term. We believe that current yields fairly accurately reflect the risks present, especially when one considers South African real yields relative to real yields available in other emerging markets. We appreciate that some may be concerned with default given the deterioration in the nation’s finances, however we view the long-dated nature and limited foreign debt as mitigating factors when considering the risk and return profile of these assets. This appears to be the consensus in the market, as bond issuances by treasury continue to be comfortably oversubscribed, indicating that there is more than enough demand for these bonds.
In conclusion, the first half of 2020 has proven to be extremely volatile. We expect this to continue at least until Covid-19 passes or a tested vaccine is approved. As was the case with growth assets in Q2, it is crucial that investors remain disciplined during times such as these. The volatility experienced so far in 2020 could lead people to draw different conclusions. The first reaction could be to give up on equity investments and conclude that the best returns are to be had in money market funds. Alternatively, the conclusion may be that this is a great time to make equity and bond investments as the next five years are unlikely to be like the last. Historically, investors who arrived at the second conclusion grew their wealth far in excess of inflation.