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March 2022 Update

Making the News

News about the invasion of Ukraine continued to dominate headlines during March, with relentless Russian bombing of cities throughout the country. The chief economic fallout of the war has been a major global supply-shock, which was reflected in the prices of commodities during the month: around mid-month, Brent crude-oil traded just shy of $140/bbl and wheat prices soared by over 40% in the space of a week. SA’s terms of trade were bolstered by the doubling of the price of coal to $400 / tonne, effectively shielding the Rand from a firmer Dollar.

Several Central Banks convened in March to decide on interest rate policy. After a strong jobs report at the beginning of the month (678k new jobs added in February vs 200k expected) and multi-decade high inflation (7.9% most recent), the US Federal Reserve’s 25bps increase to its target federal funds rate came as no surprise. Markets are now assigning a 78.8% probability of a 50bps hike at the next meeting in May. The SARB also increased its repo rate by 25bps to 4.25%. Indicative of rising inflation pressures, 2 out of the 5 members had preferred a 50bps hike, and the Bank’s inflation expectation for 2022 was revised to 5.8% (4.9% previously).

SA’s 4Q21 quarter-on-quarter real GDP growth came in at 1.2%, pointing to an incomplete recovery from the COVID third wave and July riots in 3Q21, when real GDP declined by 1.7%. Compared to a year ago, the economy is now 1.8% bigger; however, compared to the pre-pandemic level in 4Q19, it is still 1.7% smaller.

Encouragingly, the Constitutional Court dismissed an appeal by public sector unions and confirmed that the government was justified not to implement the last leg (2020) of a three-year public sector wage deal that was signed in 2018. Implementing the 2020 increase would have cost the state about R30bn. Also, after multiple delays over a decade, the Communications Authority of SA (Icasa) finally auctioned off high-demand spectrum in the last week of the month.

Market Commentary

High metal and coal prices offset the surge in oil and allowed the South African terms of trade to remain favourable and supportive for the Rand. Coal for example is up more than double its spot price since the start of 2022 [1 January ($116) to 31 March ($254)]. Given that coal and precious metals form a high weight in South Africa’s export commodity basket, the spike in prices resulted in Rand strength for the month (5.4%) as well as year-to-date (8.5%) against the US dollar and other major currencies.

Global equity markets experienced a difficult first quarter in 2022 as rising interest rates and overall negative sentiment towards emerging markets resulted in negative returns. In March, 23 central banks raised rates including the US Federal Reserve and the South African Reserve Bank. The MSCI World which is a proxy for developed markets struggled in the face of higher rates evidenced by the -13.2% return year-to-date. In contrast, the MSCI EM index is down -14.8% YTD with much of this drag being caused by Russia/Ukraine (for February & March) and the ever-increasing worries regarding the growth trajectory in China.

While the FTSE/JSE All Share Index (ALSI) ended March flat at 0.01%, the FTSE/JSE Capped SWIX index returned +1.5% benefitting from its lower exposure to Naspers & Prosus which fell -13.2% and -17.9% respectively. The influence of Naspers/Prosus weakened the Industrial sector (down -4.3%) following weaker reported earnings from Tencent during the month. Resources, after a stellar February, closed modestly lower, losing just -1% while financial stocks experienced a strong month (up +12.2%) on the back of a stronger rand. Despite the month yielding a flat return from local equities, over the last three months the ALSI was up +3.8%, strongly ahead of both DM & EM equities.

The star asset class performer in March was SA Listed Property which returned +5.1% but performed worst over the quarter at -1.3%. To contextualise the last three-month performance, it is important to remember the strong 2021 calendar year SA listed property had (up +36.9%, with an especially strong last quarter return (Q42021) of +8.4%). Given the continued uncertainty around this asset class (i.e., Office sector headwinds for example), it is possible that the market cooled off in January and February from the strong levels in 2021.

Impact on Our Portfolios

Despite March being a volatile month for equities, most of the CWM models outperformed their peer groups as seen above.

Outperformance was largely a function of domestic exposure within our core model range. SA listed property (+5.1%) and our preference to favouring value shares (+1.4%) as opposed to growth shares (-1.7%) improved returns relative to peers. The higher listed property exposure benefitted the post retirement portfolios (i.e., CWM RI-Growth/Defensive) as well as the most aggressive pre-retirement model (i.e., CWM Retirement Growth) while the underweight to growth shares benefitted all the CWM models as the same valuation philosophy is applied across the model range.

Underperformance for CWM Defensive and Flexible were largely a function of higher offshore exposure which was hurt by significant Rand strength. Another factor hurting model performance, especially CWM Global Growth, was the allocation to emerging markets, of which China constitutes a significant portion by default. Over the short-term, Chinese stocks will remain volatile but valuations should unlock over the longer-term.

As seen in the table above, since inception and one year returns for the CWM models are strong with significant alpha generated. Going forward, the portfolios remain well positioned to continue to deliver inflation/peer group beating returns for the foreseeable future.

Looking Forward

Despite the rally in the JSE over the last 2 years (+35.1% p.a.), SA Equities remain our preferred asset class. The SARB recently updated its SA GDP forecast to 2% (from 1.7%) due to better-than-expected performance in 2021, continued momentum in 2022Q1 as well as higher export commodity prices. The latter also underpins the SARB’s improved current account surplus forecast (3% of GDP).

Besides the improved growth forecast, SA valuations remain cheap on various metrics: both the Forward (10.5) and Trailing (11.9) PE ratios are well below long-run averages. At a 2.7% real yield, the asset class also compares favourably to SA Cash (real yield of -1.6%). Another boon to SA equities is the local interest rate cycle: while in the process of tightening, rates have not yet reached the inflection point where the JSE starts to come under pressure. Historical models suggests that a further ±75bps in rate hikes are needed before the tighter financial conditions become a headwind for local stocks.

We remain circumspect when it comes to Global Equity. The combination of lofty valuations in the US and Eurozone, combined with rising interest rates, pose a significant headwind for these markets. We believe the next decade will be one in which prudent stock-picking will lead to outperformance, unlike the previous decade where easy financial conditions and quantitative easing indiscriminately pushed all market constituents higher. Global emerging markets and select developed markets (e.g. Japan, the UK) are our preferred regions.

SA Bonds continue to offer excellent real yields (SAGB2030 at 3.7%). While the Covid pandemic introduced a step-change in the country’s debt-to-GDP ratios, the 1) rebasing of SA’s GDP by +10% last year, 2) improving tax receipts on the back of rising commodity export prices and 3) strong commitment to fiscal discipline over the last 3 years, has improved the outlook for the trajectory of debt-to-GDP. In any event, the risk of the asset class is well priced. The SA yield curve remains one of the steepest globally, with a superior real yield compared to emerging markets peers. When compared to local property (which has a similar real yield), local bonds are preferred because the latter’s expected returns are significantly less volatile.

In terms of inflation protection, we have recently increased the commodity exposure in some of our models. We prefer metals that will benefit from structural trends like Electric Vehicle (EV) production and green energy infrastructure spend (e.g. copper, nickel, cobalt, lithium), as opposed to PGM’s and economically sensitive metals like iron ore. Given underinvestment in traditional fuel sources like oil and coal, we believe that prices could remain higher for longer.

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