October 2019 Update

Making the News

The Medium-Term Budget Policy Statement (MTBPS) indicated that the country’s finances have deteriorated since the February budget. Subsequently, Moody’s Investors Service left South Africa’s sovereign rating unchanged at investment grade (Baa3), but downgraded the outlook from stable to negative.

Onto more exciting news, the Springboks won the Rugby World Cup and are once again world champions of the game. At a time when South Africa is experiencing profound challenges, we have rallied around the victory in Japan. The outpouring of support for the Springboks on the road to the final once again showed the immense potential of sport to unite us as a people.

Digesting the News

The MTBPS has not been well received by the broader market and much of this has been priced in before the actual event occurred. Overall, market participants are unhappy that there was no clear mention of what the plan would be to pay off Eskom debt. Furthermore, there were little detail of how government intended reducing the deficit, given how poor the economic ratios are currently. The aim now is to reduce the public sector wage bill to help minimize the current budget deficit.

Moody’s decision to change its outlook for the country from stable to negative was largely expected following the budget announcement.  Going forward, the focus will be shifted towards the government’s Budget speech in February 2020 where markets and rating agencies will require a clear plan around curbing expenditure, how government will tackle ballooning debt levels, and provide a path to increase economic growth.

Markets in the Month

The Rand did well during month leading up to the MTBPS but subsequently fell as the statement was not well received by the broader market. As a result, the last day of the month saw a sharp depreciation of the Rand against all major currencies (except the USD which bucked the trend ending the month with an appreciation of -0.8%) after investors were presented with a stark reality of what bailouts for the embattled Eskom will cost the country. This Rand weakness however remains a benefit for our portfolios, especially our global models. Over the longer-term, the numbers indicate that the Rand remained weaker against major currencies.

Despite being +0.4% behind our Emerging Market (EM) counterparts in October, SA Equity (measured by the FTSE All Share Index) returned +3.1% during the month lifting its YTD and 1 year return to +10.4% and +11.5% respectively. Our equity market was driven by the easing of geopolitical tensions and further rate cutting from the US Fed. The resources sector delivered +7.3% during the month with the likes of Anglo American and Northam Platinum up +23.5% and +22.7% respectively.

Local Bonds had a tough month as we headed towards the MTBPS. The asset class lost -0.3% in the month but remains the best asset class over the last year (up +13%).

Impact on Our Portfolios

The strong equity markets resulted in encouraging returns across our models in the month of October compared to some of the previous mediocre months. Once again, the CWM Flexible model (+2.7%) delivered good performance, benefitting from outstanding returns from the underlying managers, most notably, the Centaur Flexible fund which delivered +5.1% during the month.

In the moderate growth strategies, our models delivered robust performance, given the healthier returns from our local equity and listed property markets. As a result, the CWM Balanced and Retirement Growth portfolios both returned +2.3% for the month. Moreover, our regular income portfolios [CWM RI-Growth and RI-Defensive] followed the positive trend, ending October up 1.8% and 1.4% respectively.

Our Income and Defensive portfolios delivered returns in line with what can be expected from these strategies. CWM Income and Defensive delivered +0.7% and +1.5% respectively in October.

5 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies

Our foreign houseviews still dominate performance over the longer-term given the depreciation of the Rand relative to the USD, GBP, and EUR over the last 5 years. For our local models, we remain focused on our long-term philosophy and at current high interest rates and low equity prices; we expect prospective returns to be well in excess of inflation going forward.

Looking Forward

While the possibility of a downgrade to junk status remains a concern for our country, many believe that markets have already priced in much of its potential downside. Market prices are a function of their participant’s views and South African participants have rarely been as negative as they are now.

We have received commentary from Glacier stemming from research done by Russell Lamberti, an economist in Cape Town who is the co-author of “When Money Destroys Nations” – a book about Zimbabwe’s hyperinflation crisis. The research was done with the objective of understanding what happens to markets after downgrades to junk status.

The research sample included the following seven markets that experienced downgrades between 1997 and 2015; Brazil, Russia, Croatia, Hungary, Uruguay, Columbia and Indonesia.

After studying market reactions to these downgrades, Russell Lamberti concluded the following:

1. Much-anticipated downgrades tend to have minimal negative effect with most of the pain having already taken place before the downgrade;
2. After an initial downdraft: Bonds, Currencies and Equities tended to perform better after downgrades than before downgrades;
3. Small-cap value stocks eventually performed especially well (of which our models have a bias towards);
4. Policy rates were lowered; and
5. Currencies were reasonably stable.

To summarise, one cannot deny the pessimistic macro views commented recently, however there is reason to believe that this is reflected in the prices. Referring to selective measurements with the benefit of hindsight adds no value to any investment strategy.

In our experience, building well diversified portfolios with the ability to withstand tough market conditions as well as participate in the upside of thriving markets has always held the odds in our favour. Our long-term, valuation-based investment philosophy positions us well versus short-term thinking, which is mainly influenced by noise in the markets. As is the case with a potential downgrade looming, market participants usually anticipate this before the event occurs and therefore trying to time certain events from a portfolio perspective does not work well.

In conclusion, we would like to congratulate the Springboks for winning the Rugby World Cup 2019, confirming the trend of wining every twelve years. We hope that the same history can be repeated in future for our local equity market; which over the last 15 years managed to deliver 14.4% p.a., more than 8.7% above inflation.

As our President states in his November letter to South African citizens: “Let the goodwill brought by our success at Yokohama inspire us to put our collective shoulder to the wheel as we confront our economic, political and social challenges together – and overcome them.”