November 2020 Update
Making the News
Markets flourished in November on the back of a Democratic victory in the US, coupled with extremely positive news of multiple vaccines. The BioNTech and Pfizer developed vaccine test results showed it to be 90% effective at preventing Covid-19 infections. These two significant news events prompted record share price increases during the month in areas of the market which have been unloved and brought about a more stable outlook for the year ahead.
Interestingly, this created a “risk-on” sentiment which overcame rising Covid cases in the UK, US and much of Europe as investors bet on lockdowns being short, and less economically damaging than in March.
Turning to South Africa, the Reserve Bank decided to leave the Repo rate (Repurchase Rate) unchanged at 3.50% at its MPC meeting. The decision was not unanimous. Two members of the MPC voted for a cut of 25 basis points, while three members wanted rates to remain on-hold.
In November Moody’s downgraded South Africa’s international credit rating by one notch from Ba1 to Ba2 and maintained a negative outlook for the rating. Fitch also downgraded South Africa’s credit rating by one notch from BB to BB-, also with a negative outlook. In contrast, S&P kept South Africa’s credit rating unchanged at BB-, but with a stable outlook. This means that S&P and Fitch have South Africa on the same credit rating, while Moody’s is effectively one notch higher.
After crashing to an all-time low of five at the height of the COVID-19-induced lockdown in the second quarter, the RMB/BER Business Confidence Index (BCI) increased noticeably from 24 in the third quarter to 40 in the fourth quarter. This is a welcome surprise.
Markets in the Month
The Rand has strengthened significantly during the second half of 2020, particularly in November when the Rand ended up 6.2% stronger against the Dollar. This has led to an appreciation between the start of July to November month end of c.12% versus the significant depreciation seen in the first half of 2020 of c.28%. The Rand has depreciated by 9% YTD against the Dollar and remains undervalued.
Most equity markets around the world rallied following the news of a Biden victory and promising results for the potential cure. Emerging markets, particularly South Africa, were beneficiaries of this favourable backdrop. The FTSE/JSE All Share Index returned +10.5% during the month which was +6.4% ahead of the MSCI EM index. Moreover, the MSCI World also participated in the rally, ending the month up +7.4%. Interestingly, countries such as China for instance, ended the month just shy of 1% up (in Rands) given the strong recovery experienced in this market earlier this year.
Listed property delivered the strongest return across the asset classes, especially on the local front. The SA Listed Property Index ended the month up +17.5% from a low base following prior months of weak returns when the asset class was oversold. Listed property in 2020 is down significantly (YTD -42.4%) but there is tremendous value embedded in the sector.
The All Bond Index returned +3.3% and the inflation linked bond index was up +2.0%, both handsomely outperforming Cash by +3% and +1.7% respectively. The yield curve flattened, with very short-dated yields rising (as risk on sentiment prevailed during the month), and the longer end rallying on positive global news.
Impact on Our Portfolios
A risk on environment always supports long term portfolios. Our models participated in the sharp bounces across the risk asset classes. In absolute terms, our model returns ranged from +1% to +8.7% across the risk spectrum (CWM Income to CWM Flexible), as shown in the table below. CWM Balanced delivered the highest return in November at +8.7% and is in line with CWM RI-Growth with best outperformance.
Encouragingly, the strong returns in absolute terms were not only a function of markets moving higher, but also additional returns (or alpha) over and above from our underlying managers.
On a five-year basis, performance across the models are reasonable but still carry significant value that would be unlocked as we see a rotation out of growth stocks in the years ahead. CWM Flexible remains our top local model over the five-year period, outperforming its ASISA category by +1.9%. We are also pleased with CWM Retirement Growth’s performance over the last five years given that the alpha generated has just turned positive during November (ending the month with +0.3% outperformance versus the ASISA category). Foreign house-views remain strong in Rands given the strength of the Dollar during the period.
5 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies
The outlook leading into 2021 is more stable because of a few positive factors. Firstly, Donald Trump is no longer the president of the United States and therefore, trade negotiations between China are expected to be done more cautiously. Secondly, Covid-19 vaccine results have been more promising than expected. At the time of writing, the UK became the first western country to approve a Covid-19 vaccine, with its regulator clearing Pfizer Inc. and BioNTech SE’s shot ahead of decisions in the US and European Union. And then lastly, interest rates globally appear to be anchored at low levels, inflation is relatively benign, and the mighty Dollar has been weakening over the past months and could weaken even further given that it is overvalued on a purchase power parity (PPP) basis.
In terms of how this trickles down to asset class performance and fundamentals, specifically SA assets starting with Bonds, most of the capital appreciation during November has been a function of those factors listed above. Additionally, foreigners have been reducing their exposure to the domestic bond market in recent years, with foreign holdings reducing to below 30% (from over 40% of the SA bond market as recently as 2018). However, the increase in appetite Emerging markets during November saw foreigners turn net buyers of SA bonds again, with foreigners purchasing R12bn in November (from a R13bn outflow in October, based on Bloomberg data).
These significant inflows have also driven the strength of the Rand which is very supportive for the local bond market. Moreover, downgrades occurring in the country have historically impacted the currency and bond market. From a financial market perspective, there are certain downgrades that matter a great deal and certain downgrades that are more academic in terms of impact. Fortunately, these latest downgrades would fall into the latter category and the rand vs US dollar exchange rate was slightly firmer on the Monday following the announcement, while bonds were effectively unchanged in value and yield. Going forward, implementation around public wage cuts is key to the investor confidence around this asset class.
Despite the outflows in prior months (excluding November) and the further downgrade from the various ratings agencies, yields on offer remain more attractive for emerging markets, particularly for SA longer dated government bonds, compared to their developed market counterparts.
For just over 5 years, the SA equity market has been largely flat. Therefore, it is understandable why investors currently steer away from local equities. At Core Wealth we recommend that investors look over an extended performance period to understand that the market rewards equities with additional return. Using the fifteen year past performance figures, equities in general [Developed markets (+13.6%), Emerging Markets (+12.9%) as well as South Africa (+11.6%)] have been the top performers, with SA Cash (+7.2%) coming in last. Bear in mind that this 15 year period includes the last 5 years of flat returns!
For a while now we have been communicating that valuations of a lot of equities on the local stock market and even abroad, are extremely attractive. Returns in these equities have sadly not come to the fore yet given the gloomy economic backdrop and disappointing historic earnings from these companies. Looking forward however, the valuations are not going unnoticed and recently, we have seen managers add SA Inc. exposure to their portfolios.
Two examples to look at are PSG which we hold in our models and Fairtree which we do not have exposure to within our models. Over the third quarter, PSG sold out of domestic bonds in favour of domestic equities. This was a result of more clarity around the emergence from severe lockdown and the favourable conditions for investing in domestic counters.
Fairtree have been very vocal about their view on SA Inc. in their most recent presentations hosted in October. The price of precious metals has rallied during this year and the price of oil has fell precipitously in 2020. Precious metals are exported from SA which means more money flows into the economy. Conversely, oil is imported into the country and since the price is cheaper, it results in favourable terms of trade and a current account surplus which can go back into the country’s economy.
Strong terms of trade coupled with a weakening dollar will see a migration into EM assets. Fortunately, South Africa could be prime beneficiaries of this given how cheap the Rand is, how high the yields are for SA governments bonds and most importantly, how cheap valuations of the SA equity market are currently versus their history.
Finally, we discuss the most unloved asset class in 2020, listed property. While the challenges faced by SA listed property are real and founded, one has to ask what scenarios could cause the extremely pessimistic forecasts implied by current share prices and wide discounts to net asset value to materialise.
To illustrate this negative sentiment, in recent research by PSG, they consider the portfolio of Growthpoint (comprising of a listed global investment portfolio, the V&A Waterfront and the residual South African portfolio). The graph below contrasts the Growthpoint overall share price with its underlying global listed investment portfolio share price and a 20% discounted V&A Waterfront Net asset value. Share price values are as at 30 October 2020 and NAV is published as at 30 June 2020.
By combining these two items alone [global listed investment portfolio (R8.50) and 80% of V&A Waterfront NAV R2.50)], we end up with the prevailing share price of Growthpoint overall (R11 = R8.50 + R2.50). This implies that the market values the residual South African portfolio at zero, which is a stark contrast to the published June 2020 NAV of R9.10. In simple terms, investors buying a Growthpoint share will pay nothing for its residual underlying South African portfolio which has an intrinsic value of around R9 a share.
In conclusion, the chart below, produced by Prudential Investment Managers, shows the expected real returns for asset classes both local and global going forward. It is clear from this chart that local assets (equity, property, and bonds) show the most compelling real returns going forward.