March 2020 Update
Making the News
On the 11th March 2020, the World Health Organisation declared the novel Covid-19 (Coronavirus) a global pandemic. Other newsworthy events occurred during March but these were largely overshadowed by news related to the virus. President Ramaphosa announced on Monday 23 March, that the country will undertake a 21 day lockdown period in attempt to contain the spread of the virus in South Africa.
The oil price war between Saudi Arabia and Russia in March resulted in oil prices falling dramatically to around US$30 a barrel. Oil stocks around the world fell heavily on this news. JSE listed company, Sasol, lost around 80% of its value in March on the back of falling oil prices and high volumes of US denominated debt on the company’s balance sheet.
The South African Reserve Bank (SARB) governor cut interest rates by 100 basis points in March. As a result of the significant decrease in economic activity expected due to the lockdown, the Reserve bank now forecasts inflation to average at 3.8% in 2020, 4.6% in 2021 and 4.4% in 2022. Importantly, all forecasts made for the next three years fall within the 3 to 6 percent target band.
Lastly, on Friday 27th of March, Moody’s rating agency downgraded South Africa’s sovereign debt to sub-investment grade (or BB+) and kept the outlook at negative. This was a move that has been long anticipated by markets and has been expected by the Core Wealth investment team as mentioned in previous monthly wrap-ups.
Markets in the Month
As our readers are aware of, global markets (including South Africa) lost substantial value in March 2020. Before we delve into performance of each asset class, it is worth noting that the novel Covid-19 virus has been labelled a “Black Swan” event. This definition points to the fact that it is an event that was not anticipated and therefore its occurrence has created vast uncertainty as seen in March.
The Rand has been heavily impacted by the Covid-19 global pandemic and the Moody’s downgrade which took place in March. As a result, the Rand, an emerging market currency, depreciated by over 10% during the month and now appears to be extremely undervalued relative to hard currencies (i.e. the US Dollar, the Pound and the Euro). South Africa’s stretched public finances coupled with the virus, which has limited business activity, are material headwinds for the local currency. Currently, local year-on-year inflation is at 4.6%, comfortably within the 3-6 percent SARB target band. That said, current SA government policies are not likely to drive inflation higher, we believe that the Rand should recover somewhat, once the Covid-19 crisis passes, provided the right steps are taken to address the local issues.
SA Equities (measured by the FTSE/JSE All Share Index) opened the month at 51 840 and then declined to 37 963 (19th March), a fall of 26.8%. From the 19th the market rebounded to end the month at 44 490 creating an intra-month rally of +17.2%. As such, SA equities ended -12.1% down in March. While SA Equity returns are now flat over the last five years, it is worth noting that even at this low point, the ten and fifteen year returns are still +2.6% and +5.9% per year above inflation.
In contrast to SA equities, global markets benefitted from the Rand weakness during the month and therefore ZAR returns are less disappointing for these markets. Importantly as well, despite the extreme volatility in March, fifteen year returns for developed and emerging market equities are both around +7% above inflation over the period respectively in Rand terms.
The listed property sector in South Africa has lost almost half its index value so far in 2020 (YTD). The main concern for this asset class is the retail sector as the lockdown prohibits consumers from shopping at non-essential stores which are estimated to generate the majority of the revenue from this sector.
Other sectors that will not be as affected as the retail sector are:
- Logistics – given the sustained need for consumables fewer smaller tenants and further drive to e-retailing
- Office Space – because of their longer in-force leases and the ability for business continuity
We had a meeting with Sesfikile Capital during the month and were presented with the following SA property sector valuations (with the effect of Covid-19 priced in):
The table above is based on conservative estimates made by the team but still results in extremely attractive returns for the foreseeable future as evidenced by the 10 year forecast to be +20.7% per annum. We will not be going into detail regarding these estimates, but this can be discussed upon request. In essence, the market appears to have oversold this sector which means many property stocks are too cheap.
SA bond yields (measured by the R186 government bond) have blown out to 11.2% during the month and when measured on an intra-day basis, volatility in the bond market has likewise been extreme with yields moving on an almost unprecedented scale.
In aggregate, the capital value of local bond prices (measured by the All Bond Index) dropped by -9.7% in March. SA government bonds now trade at yields that price in a significant risk premium. Based on valuation metrics, a patient long-term investor can exploit the following bond market opportunities:
- SA inflation is under control and currently in the middle of its target band at 4.6%,
- Yields, as mentioned above, are offering more than 10%, therefore offering exceptional yields above inflation (real yields),
As shown in the bar graph below, these real yields are higher than most countries’ with similar or lower credit ratings (i.e. Brazil, Turkey and Mexico), making South Africa an attractive market for global investors seeking yield.
Impact on Our Portfolios
As expected, March was a difficult month for our models because all asset classes, other than cash, had negative returns. This resulted in all the CWM models having negative returns in March. We are making some manager changes within the models to exploit certain opportunities mentioned above and this will be communicated once completed.
Despite cash being up within the month by +0.6%, CWM Income was down 3.1%. The underperformance can be attributed to the exposure to domestic credit and bond exposure in the underlying income funds. Domestic credit exposure in the funds hurt performance because of the recessionary risks facing the local economy. Coupled with that, our domestic bonds are highly liquid and investors having short-term obligations to fulfil had to sell out of SA bonds which ultimately added more downward pressure to the funds within the portfolio. We have seen the market beginning to normalise since month end and as a result has made up some of the pullback.
With reference to the graph below, despite the negative return in March, CWM Income still outperformed inflation by +2.3% p.a. over the last five years and most importantly cash by +0.3% p.a. after fees over the same period.
5 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies
The graph above also shows flat growth for both CWM Retirement Growth and SA equities over the last five years. CWM Retirement Growth is an aggressive retirement solution and the exposure to growth assets (listed equity and listed property) within the solution has hurt performance over this period. CWM Retirement Growth is however a long-term strategy and with current valuations overly depressed due to the short-term uncertainty created by Covid-19, we expect returns from this solution to handsomely reward investors over the long term.
Our view on oil prices and low interest rates:
Looking at this purely from a consumer’s perspective, we know that with oil price coming down, motor vehicle users will benefit from the large decline in the petrol price during April. Furthermore, interest rates coming down by 100 basis points (or 1%) should help consumers pay off their debt faster given that these rates have reduced. Additionally, this also means that money invested in the bank will yield a lower rate and therefore is less attractive from an investment standpoint for clients who are nervous about the markets and possibly wanting to move their discretionary savings into cash.
In terms of SA, oil prices reaching all-time lows mean that the government will pay less for importing oil from other countries and therefore this will help reduce the country’s current account deficit.
In terms of our local equity market, as interest rates are less attractive to bank accounts, investors will seek more attractive returns which could potentially result in inflows into SA equities.
Our view on Moody’s downgrade:
We expect lower returns in the medium term from SA facing sectors and companies in general. The JSE is cheap but for a good reason and therefore, our managers’ ability to select good stocks will be crucial in generating healthy returns for our clients.
The Rand is expected to continue weakening in the short-term, but will potentially revert sharply towards purchasing power parity as more certainty around the economic effect of the Coronavirus is achieved.
The risk of Eskom being a binding constraint on SA growth remains a concern going forward. Much work is required after the lockdown to regain the support of the rating agencies and global bond investors in general. In the interim, SA government bonds currently trade at yields that offer significant compensation for risk in our view. Additionally, we do not expect any material risk to inflation in the short-term and therefore forecast that these bonds will deliver inflation beating returns at a lower risk compared to growth assets.
Our view on Covid-19:
While we are in uncharted waters currently, we remain positive that the government has been proactive in containing the spread by implementing the lockdown sooner rather than later. Our responsibility as a nation would be to apply the basic hygienic protocols and implementing social distancing during this period.
Core Wealth’s business will continue as usual as our team has the benefit of working remotely in our homes in order to provide the valuable service to our clients. For any client needing to contact their advisor during this time, we will be available to have meetings over the phone, email, or alternatively via Skype and other similar forms of communication such as Google, Jitsi or Zoom. To all our clients in SA and abroad, we would urge you to stay at home and most importantly to be safe during this period. This is a challenging time but we believe, as a nation, we will get through this!