Global Impact on SA Asset Classes – Asset prices of domestic assets are dominated and influenced by global market events. More than 65% of the JSE ALSI 40 earnings growth is derived from global consumer spending, emphasising the importance of global economic growth to the SA equity market. The correlation between the behaviour of the MSCI World Equity Index and the ALSI 40 is 0.84 (or 84% correlation) over the past 10 years.
It is therefore prudent to understand that global economic growth is slow, negatively affecting the earnings growth potential of corporate earnings globally. Developed Market (DM) cash and bond yields trade close to 0% and culminates in investors having to assume higher risk, in either high yield bond & property markets or global equities, to generate capital growth above inflation. There are concerns that inflation is too mild in the developed world and that it may spiral into a deflationary environment which can cause negativity in equity prices. Fortunately, most global central banks are acutely aware of the large debt burden on consumers and governments.
Central Banks in the developed world use quantitative and monetary tools in an attempt to stimulate domestic / global economic growth. The All Share Index and most of the larger stock markets globally have had no positive returns since late April 2015. The S&P 500 US Index and the JSE ALSI 40 trade within 1-2% of their respective highs in April 2015, but many global equity indices are down between 8-18% from their respective highs last year. The Bloomberg Commodity Index still trades more than 50% below its 2011 peak since the credit crisis. Emerging Market (EM) indices are also down 18% from their highs and trade at a significant 24% discount to the MSCI World Index. Herein lays the message that positive returns were hard to come by over the past year.
The opportunities within global markets are within the attractive valuations of EM equity / bonds, as well as value stocks globally. It needs a soft landing and more industrial demand from China, a softer USD and no / little US interest rate hikes to follow on a 20% recovery from commodity and EM equities since 20 January 2016. It is fair to include European and Japanese equities in the fair value camp with a cautionary note on expensive US Large Cap shares.
Most DM Bonds trade close to 0%, with the exception of US treasuries. Current medium term earnings growth prospects for global real estate stocks remain relatively robust, predominantly due to the lag effect of long term leases and solid current fundamentals. In light of this, the estimated forward yield of 4.78% for listed real estate looks attractive, considering the current yield at which global bonds are trading.
SA Market Conditions and Challenges – Apart from well publicized political instability, the SA Economic conditions are challenging at best. Higher interest rates, a drought (impacting food prices), a higher oil price (impacting transport prices), increased administrative prices and higher inflation as a consequence, all effecting consumer spending and sentiment negatively. Higher than CPI salary increases by the government seems to continue to motivate consumers to spend. SA Retail sales grew by 4.4% on a year to year basis. Corporate SA are cautious in spending and hiring, as political instability and a weak Rand effects business sentiment negatively. A lot of the bad news was in the January 2016 prices. Mining stocks were sold off heavily since 2011 and traded at large discounts to net asset value before recovering from long-term lows in the past 3 months (on average a 26% recovery in prices year to date). Our small exposure to mining stocks, which caused a drag on performance in 2015, served us well to date.
The ALSI 40 Index was up 7% year to date at the time of writing, after a 9.88% collapse in prices in January 2016. The Index has not recovered from its 24 April 2015 high, explaining most of the disappointing returns of the past 12 months. The All Bond Index returned no more than 0.7% over the past year, as ‘Nenegate’ caused a jump in bond yields in December 2015. Since the Rand recovered, bond prices did the same and have returned more than 7.5% year to date.
The market anticipates a downgrade on SA government debt later this year. This will mainly be driven due to a lack of any signs in GDP growth, even though our budget and current account deficits have improved lately. We remain in the last five when rated on these deficits globally and last when rated on unemployment numbers.
In the event of a downgrade (maybe only by December 2016) market prices will be volatile, although a lot of the ‘bad news’ is in the price. We expect Rand weakness and another upward retracement in local bond yields in such an event. This may end up in an excellent buying opportunity for SA Bonds as most local asset managers believe that any yield close to 10% on our 10-year bond will be an ideal buying opportunity in the long term.
A lot of ‘moving parts’ will affect the value of the Rand and bond yields before the potential downgrade event. One of which is the Anheuser Busch Inbev SA purchase of SAB Miller, which will effectively result in a USD 7 billion inflow into SA, potentially effecting the Rand by up to ZAR 3 per USD. No one in the industry has any idea when and how this purchase will take place and how the SA Reserve Bank will process the inflows. A ‘known unknown’! Another factor is the direction of US Interest Rates and the value of the US Dollar. Current market forces indicate a weaker US Dollar, which is good for EM currencies and bonds, while a hint of increased industrial demand for commodities and a ‘softer landing’ in China affects commodity prices positively at the moment.
All the above factors can be good for SA asset prices.
Actions over the past quarter – Within our funds and portfolios, we have taken profit from February 2016 by selling global equities and global real estate funds, as the Rand weakness was extended beyond rational valuations. We rotated the assets back into SA and increased our underweight SA Equity and Bond exposure marginally. We also increased our cash holdings as 12-month yields increased beyond 8.5%. Our SA Equity exposure benefited from small holdings in Gold / Resource stocks, which have rallied since late January.
Asset Allocations relative to our long-term Strategic Asset Allocation Plan – We take into consideration both strategic and tactical decisions (overweight / neutral or underweight) within various asset classes in each of our multi-asset funds and model portfolios, according to an optimized portfolio profile per risk profile and investment horizon of each mandate. In that context, this report deals with our views on short-term tactical calls; this may differ from our long-term strategic views. We believe this is prudent practice, in a world dominated by debt de-leveraging and political interference.
- SA Equity – marginally underweight. This is despite purchases in January and February 2016.
- SA Bonds – underweight. We have more long-dated fixed rate exposure relative to 2015 year end, but await more attractive yields in the event of a downgrade to increase government bond exposure.
- SA Cash – large overweight. The market offers attractive 12-month yields, at 8.6%, at very low risk.
- SA Listed Property – neutral. The SA Property market had a poor 2015, which caused us to increase exposure early in 2016. Prices have rallied recently, which may lead us to review our neutral position soon.
- Global Assets – neutral. We took profit from February 2016 by selling global equities and global real estate funds as the Rand weakness was extended beyond rational valuations.
As the calendar flips to May, the global stock market enters what is historically its worst six months of the year, in which it typically underperforms the November to April time frame. This is a well documented seasonal trend with solid historical numbers behind it. The numbers back it up. Looking at US Stock Market history back to 1950, most of the market’s gains have been made from November to April and the market has generally gone sideways from May to October. The November-April period produced an average gain in the Dow Jones industrial average of 7.5% since 1950, compared to an average gain of just 0.4% from May to October.
However, we do not subscribe to short term thinking in our funds and portfolios. Unless one is a day trader, an appropriate investment philosophy is ‘time in the market’, not ‘timing the market’. Alternatively, it is referred to as ‘re-investment’ risk.
We are confident that our processes, the diversification benefits of many asset classes and the teams of large and small asset management groups within our funds and portfolios will consistently outperform our stated objectives over time.Q1-2016 South Africa Asset Allocation Report