September 2020 Update
Making the News
Covid-19 jitters remain a concern to markets as the US leads the way in infection rates while South Korea and Spain, to name a few, show signs of a second wave looming. Additionally, investor uncertainty was compounded in September by the impending US presidential election now just a month away.
The Fed announced revisions to their monetary policy framework, stating that if there is a period when inflation undershoots their target, policy makers can then aim for inflation to overshoot the target for a period thereafter. Furthermore, the Fed also tweaked the way they view unemployment, whereby low unemployment alone would not lead them to hike interest rates. These changes imply that the policy rate is likely to stay at accommodative levels for a considerable period.
Locally, at the September meeting, the MPC lowered both their growth and inflation forecasts, but kept the repo rate on hold at 3.5% (in a split vote, with two of the five members voting for a rate cut). The consensus view on the committee appears that they would prefer to wait to assess the speed of the economic recovery before acting further, with their Quarterly Projection Model (QPM) currently indicating no further rate cuts in this cycle.
More on the domestic front, there has been some better news, with increased consequences for corruption. The week ending September has seen several politicians arrested (although we still await any high profile arrests), and the ANC has said it will repay what looks to be a fair price for an ANC delegation hitching a ride to Zimbabwe on an official SA Air Force (SAAF) flight. Furthermore, it is expected that former president Jacob Zuma will appear before the Zondo commission in the weeks ahead.
Markets in the Month
Equity markets bore the brunt of the second wave Covid-19 fears. Global equity markets ended generally weaker for the month, with the MSCI World down -4.9%. In South Africa, the JSE All Share Index was also under pressure, and returned -1.5% for the month. This was less severe compared to the general emerging market index ending the month down -3.1%. Within the negative September return for SA equities, much of the drag was led by Industrials and Resources losing -1.7% and -3% respectively. Surprisingly however SA financials gained +3.4% in September buoyed by the Banks index which was up over +8% in the month.
SA Listed Property continued to fall during September, ending the month down -3%. The oversupply in the sector coupled with the lack of demand from weak fundamentals, continue to keep the asset class unloved. Covid-19 has exacerbated the asset class’ poor performance, with most stocks in the SA listed property universe now trading at a discount to NAV of about 80%. Experts within the sector believe that current valuations account for more than what the bad news says and believe that while there will be casualties going forward, the bulk of the index companies are going concerns. Positive news throughout the previous months has shown that several companies (Redefine & Arrowhead to name a few) disposed of their assets at close to book value.
SA Bond returns were flat for the month as the yield curve remained under pressure. For now, the market is firmly focused on the SA growth outlook and fiscal trajectory. SA cash, on the other hand, has been marginally positive during the month at +0.3%, but with local rates cut aggressively to 3.5% during the year, the asset class does not show inflation beating prospects going forward.
In conclusion, due to the prevailing “risk-off” sentiment during the month of September, it came as no surprise to see the prices of assets like equities and properties come under pressure. Therefore, in times like these, it is always helpful to look further back over an extended performance period to remind oneself that the market rewards risk assets with additional return. For example, using the fifteen year past performance figures, equities in general [Developed markets (+13.7%), Emerging Markets (+12.8%) as well as South Africa (+11.3%)] have been the top performers, with SA Cash (+7.3%) coming in last.
Impact on Our Portfolios
Model returns during September were marginally negative for most CWM models except for CWM Income ending the month up +0.2%. Other model returns for September range from -1.1% to -2.2% across the risk spectrum. Fortunately, we have passed the third quarter of 2020 and the model returns during this period are positive across the board.
We know that the biggest drag on our models over the last two years has been property, small cap and value manager exposure. Conversely, offshore and defensive SA managers have helped performance, but this unfortunately could not cushion the significant falls in general property and SA Inc shares.
5 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies
CWM Income (+7.9%) is the top performer for our models over the last five years given the poor equity and property backdrop. Our foreign house-views also dominate performance over the period as Rand weakness has helped tremendously. Interestingly, our CWM Flexible fund (a maximum equity model) has outperformed the SA equity market by +0.5% over the last five years and continues to show robust return prospects for the foreseeable future.
Looking Forward
Interest rates, GDP growth and inflation are key macro variables that impact portfolio performance over the long-term. While GDP growth remains lacklustre, both globally and locally, economists expect countries to improve from this low base over the next year and thereafter, provided that the necessary actions are taken by fiscal and monetary authorities. Furthermore, interest rates have fallen precipitously in 2020 and inflation remains relatively benign. This ultimately supports valuations and allow for inflation beating returns going forward.
Over the last 5 years, the FTSE/JSE All Share Index went sideways and simply tracked inflation. This has been held up by the large four shares, namely: Anglo American, BHP Billiton, Richemont and Naspers (including Prosus NV). If one had to look at these four shares independently from the overall index, the picture would be different in that the four shares have shown strong growth while the rest of the index constituents declined in price.
The remaining index constituents are by and large ‘SA Inc.’ type shares and within this universe, there is a lot of variety. Historically, buying SA Inc. shares at points where confidence in the local economy was low have proven to be profitable into the future. According to research from PSG, business confidence in SA has been at cyclical lows four times in the past (1993, 1998, 2002 and 2009). Following each of these periods, the three year subsequent return of a basket of SA Inc. shares (AVI, Standard Bank, AECI and Hudaco) has been exceptional at +23% (June 1993), +39% (September 1998), +30% (March 2002) and +28% (March 2009) per annum.
Property stocks on the other hand have been struggling before Covid-19 and now the sector faces the dilemma of many companies struggling to pay a minimum of 75% of distributable earnings to maintain their REIT status. Failure to pay would result in foregone tax benefits from disposal of assets but will allow the companies to retain earnings and remain a going concern. This is seen as a better alternative for investors rather than issuing equity at a significant discount to NAV. Strengthening of company balance sheets will ultimately reduce the sector loan-to-value ratio from 41% to under 38% over the next three years. Valuations on the other hand look extremely attractive and in the latest research from Sesfikile Capital, we see that the expected returns from local property is +22.9% per annum over the next five years.
On the fixed income side, we recognise the attraction of higher yields on offer across the government bond curve, but also the risk premium that is warranted for investment in longer dated bonds at the current fiscal juncture. This is reflected in the bond allocation within our models (CWM RI-Growth & RI-Defensive and Retirement Growth) by being slightly overweight, until we have greater confidence that SA’s fiscal and economic outlook are on a strengthening path. This pathway will be discussed in greater detail in October Medium Term Budget Policy Statement (MTBPS) meeting scheduled to take place later this month.
To conclude, we expect that October will be a particularly volatile month as we head into the US Presidential Election in early November and expect SA’s MTBPS from the Minister of Finance Tito Mboweni at the end of the October.
