October 2020 Update
Making the News
Sentiment in global markets was largely driven by the expected outcome of the November 3rd US election and the progress in negotiations on a second US stimulus package. Democrats were holding out for additional relief of $2.2trn to support families and businesses, while Republicans were offering $1.8trn.
Taking their lead from developments in the US, emerging markets rallied whenever a deal was in sight. Polls showing Biden as the favourite to win emboldened investors to seek out riskier currencies (the Democratic candidate’s rules-based approach to international relations will reduce policy uncertainty). As a result, MSCI’s gauge of emerging-nation equities reached its highest since January and the Rand strengthened by up to 5%.
In the latter part of the month, however, the mood turned decidedly sour. Stocks were heading for their worst weekly decline since March due to rising coronavirus infections sweeping across Europe and the US Midwest. Italy, Spain and Germany returned to lockdown as record one-day cases were surfacing.
On the local front, president Ramaphosa shared his Economic Recovery Plan which was criticised for a lack of detail regarding how the proposed infrastructure spend would be financed. The Minister of Finance’s Medium-Term Budget Policy Statement cast a further shadow on the proposal. Local Bonds and the Rand weakened at the news that national debt is expected to reach R5trn by the 2023/2024 fiscal year and more bailouts were required for SAA and the Land Bank. Positives included a commitment to curb the public sector wage bill, a lack of tax hikes and projected GDP growth of 3.3% in 2021.
Markets in the Month
The JSE did not escape risk-off sentiment that swept across global markets towards month-end. News of second wave outbreaks across Europe erased all gains the index had accumulated throughout October, ending -4.7% in the red. Major mining companies led the declines (BHP Group -13%, Glencore -8%) with the Basic Materials Index falling -10.9%. As the graph shows below, the Consumer Goods (Richemont -9.9%, ABInBev -7%) sector was also hit hard.
The Oil & Gas Industry’s whopping 47.8% return for October catapulted it into the best performer of the year. The spurt is solely attributable to the news that Montauk Holdings – a renewable energy developer operating chiefly in the USA – is set to list on the Nasdaq in 2021. Barring the outlier of a month for Oil & Gas, the tech sector solidified its front-runner status for the year with another solid performance (+6.7%), propelled forward by heavyweights Naspers (+6.8%) and Prosus (+5.5%). In a bid to close the gap between its share price and its underlying assets, Prosus announced a $5bn share buy-back.
Local bonds outperformed most of the sectors of the JSE, benefiting greatly from the prospect of a Biden administration and of easing geopolitical tensions. Following the tricky fiscal situation outlined by the Finance Minister in the MTBPS, it was not surprising to see the shorter end of the curve (1-3 years +1.09%) outperform the longer end (12+ years +0.38%). It was also true for the inflation-linked bond sector (1-3 years +1.04%, 12+years +0.95%).
Listed Property was the third worst performing sector of the JSE in October (-8.5%), extending its YTD losses to -50.9%. It now has the dubious honour of boasting 10 out of the 20 worst performing stocks of 2020, with Hammerson (which owns shopping centres in the UK and Europe), taking the top spot. The company reported that rental collections were steadily improving during the month as tenants started to resume operations, but at the time of writing we know that the UK again announced national lockdowns on the 5th of November. To be fair, the SA Listed Property index recorded a 3.8% gain between April and September 2020. It was also in positive territory until the last week of the month, when fears of second-wave lockdowns triggered panic selling in the market.
Impact on Our Portfolios
Our models were negative for the month across the board, with CWM Income being the exception, ticking up 0.33%. CWM TFSA Long-Term Growth took the most pain (-4.35%), followed by CWM Global Growth (-4.04%), with the bulk of the latter’s decline stemming from the strengthening of the Rand (+3.5%).
5 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies
Owing to sentiment that for the most part leaned towards ‘risk-off’, the CWM models underperformed ASISA peers (the exceptions being Global Defensive and Global Balanced), due to their higher relative risk profiles.
To provide some context for Model Portfolio returns year to date (YTD), it is useful to break them down into 3 time periods in 2020: Jan – March, April – October, and YTD. All models have delivered very strong returns over the April – October recovery period (Global Defensive has a high bond exposure and had already served its defensive purpose by performing well during Jan – March). Importantly, owing to the higher risk profiles of the CWM portfolios, almost all enjoyed greater upside during the market rebound than their ASISA peer groups. This characteristic bodes well for the models as the global economy slowly returns to normal.
After years of economic malaise, South African stocks now trade at the biggest discount on record relative to their emerging-market peers. And their discount to US equities is the widest in more than 12 years. A driver of the relative underperformance is the exodus of foreign capital out of our local stock and bond market over the past 5 years. By the end of October, $7.2bn had fled the JSE since the start of the year, and $3.9bn out of the bond market.
The result is a local stock and bond market that is looking increasingly attractive from a valuations point of view. To be sure, caution is required when selecting specific shares / fixed interest securities for portfolio inclusion, as some are trading at the current low levels for good reason (e.g. City Lodge Hotels). However, many SA Inc. shares are trading at a sufficient discount to intrinsic value, that even if short-term earnings were to disappoint, there is still sufficient margin for upside in the price (e.g. Standard Bank).
Overlaying the valuations story with a Biden victory – for which the consensus view is greater policy certainty, improved international relations and declining protectionist measures – the Dollar is set to weaken as capital gains renewed confidence to venture into emerging markets. The graph below, from Foord Asset Management, plots the aggregate fortunes of said markets against Developed Markets, and the long-term correlation with the strength of the US Dollar (up means Dollar weakness):
As of October, approximately 90% of global bonds that offer real yields (yields above inflation), were found in Emerging Markets. South Africa tops the list comfortably (5%+), with Brazil and Indonesia rounding out the top 3. This is against a backdrop of roughly $16trn worth of negative-yielding bonds globally, and a total of $17trn of fresh liquidity injected into the global financial system in response to the pandemic – all of which will be looking for real returns once the risk environment improves. The confluence of factors bodes well for our local bond market. The industry believes double digit returns are possible as yields revert to fair value.
Finally, the outlook for the Rand also improves with a Biden presidency, for many of the reasons alluded to above. However, some of the scepticism surrounding government’s ability to cut its wage bill and stabilise debt will remain a cloud over the currency. The outcome of the negotiations around wages will only conclude in 2021, with the Finance Minister pushing for inflation-related increases (as opposed to the 7.2% p.a. granted over the past 5 years). Nevertheless, analysts are indicating R15 to the dollar as increasingly plausible. On the back of Rand strength, increasing offshore exposure in a phased approach becomes a definite consideration.