Low interest rates, subdued inflation, positive economic data surprises out of the major economies and ongoing stimulus continued to support global markets during the quarter. The impact of and narrative around the COVID-19 pandemic continues to influence short-term confidence. Global risk appetite continues to oscillate around the progress being reported in global vaccine trials, negative real yields, US-China tensions, the run-up to US elections in November and the quantum of further stimulus required to extend and/or sustain the current global recovery.
SA exited the first half of 2020 visibly scarred but hopeful; as households and business activity returned to some sort of adjusted normality. Financial markets in aggregate have largely recovered from the ravaging of Q1 2020, with the long-term impact on economies, markets and investors being subject to expectations formulated under uncertain conditions that will likely define this decade.
Table 1: Total return of selected SA indices at 30 September 2020
|Returns in ZAR||Qtr %||1 Yr %||2 Yr %*||3 Yr %*||5 Yr %*|
|SA Equity (J203T)||0.7||2.0||1.9||2.4||4.8|
|SA Property (J253T)||-14.1||-46.1||-27.6||-23.8||-12.9|
|SA Bonds (ALBI)||1.5||3.6||7.4||7.3||7.6|
|SA Preference Shares (J251T)||-4.8||-19.8||-2.0||0.1||3.5|
|SA Cash (Call Deposit)||0.9||5.3||6.0||6.2||6.4|
|SA Cons Inflation (CPI) **||2.0||3.1||3.7||4.1||4.6|
* Returns are annualised / Source: Morningstar Direct / **Inflation lags by 1 month due to data availability
Due to the current heightened uncertainty in financial markets, the SA Reserve Bank with its mandate to ensure the stability of SA’s financial system, has cut interest rates by 300 basis points from 6.5% at the start of 2020 to all-time lows, with the Prime rate of interest now 7%. We expect that we must be close to the end of this falling rate cycle with the efficacy of monetary policy interventions being closely monitored going forward. Prudent fiscal policy and the necessary structural reforms must take the lead from here on out in order to revive the SA economy. Consumer inflation remained contained in August, rising 3.1% on a year ago and is expected to remain around current levels in the short-term given low global inflation and the lack of aggregate demand in SA.
SA Government bonds are seen as offering relatively attractive real yields at current levels, despite being priced in an environment of increased Covid-19 funding requirements and expectations as to limited scope for further rate reductions. While Cordatus has raised allocations from very low levels at the start of 2020 as yields more than adequately reflected the risk attached to the asset class, we remain largely underweight across our client base and funds. The All Bond Index rose 1.5% during the quarter, with Cash delivering 0.9% as the rate cutting cycle took effect on short-term rates.
Domestic listed property fundamentals remain relatively weak as deteriorating economic growth; high/rising unemployment and depressed Covid-19 related business/consumer sentiment keep consumers, tenants and thus landlords under pressure. Listed property share distributions are expected to disappoint income dependant investors in the sector as REITs are forced to preserve balance sheets through reducing, deferring or just not paying dividends (subject to legal approval and possible impact of losing REIT status). The SA Listed Property index declined 14.1% during the quarter, shopping and work habits have changed and we remain underweight the sector despite the potential value apparent at current share prices.
SA listed preference shares, an important component of portfolios for tax-sensitive high new worth income investors, remain under pressure in 2020 as investors liquidated positions during the Covid-19 related panic and liquidity/geographic preferences directed capital elsewhere. The sector is now offering relatively attractive after-tax income opportunities relative to cash and bonds, yet remains under pressure, delivering total returns during the quarter of -4.8%.
Stocks with strong balance sheets and future relevance are preferred as we attempt quantifying the impact and cost of limited trade, higher unemployment and a changing political landscape as we emerge from what has been a trying and “data-led” lock-down. The structural impediments to a growth recovery in SA remain firmly in place however and the need for action by policymakers is now urgent. Any recovery in SA focused shares requires immediate, not necessarily perfect, execution as relates to all the “plans” that currently exist. We are encouraged by the first signs of the NPA swinging into action and the impact on sentiment, as well as the awarding of labour intensive infrastructure projects.
SA equities (led almost exclusively by the mining, precious metals and industrial metals sectors) rebounded strongly from the Covid-19 depths seen earlier in the year in Q2, as China economic activity (closely followed by the USA on very different drivers) rebounded to pre-Corvid levels on the back of a massive infrastructure boost. The local market levelled off in Q3 with the FTSE JSE All Share Index (ALSI) returning 0.7%. Year-to-date gold miners (+82%), industrial metals (+29%) and miners (+19%) have provided the returns. Over a similar 9-month period, travel & leisure stocks (-60%), listed REITS (-50%) and the chemical sector (-53%) more than offset the gains from the resource sector with the ALSI delivering -2.51% YTD.
The ZAR having breached ZAR19/USD in April (from ZAR14.0/USD at the start of 2020) appreciated to ZAR16.7/USD at quarter-end and is still seen as relatively attractive in an environment of global risk taking, massive global liquidity, low domestic inflation and higher commodity prices as China recovers. That said, while a weaker USD points towards further support for the ZAR and emerging markets in general, domestic fiscal risks, upcoming US elections and volatile global Covid-19 news-flow could keep the ZAR from appreciating materially in the short-term. The ZAR appreciated 3.8% against a weaker USD during the quarter and ended largely flat against the GBP, EUR and AUD. The upcoming medium-term budget speech in October is vital in terms of confidence, with clarity and commitment sought around public sector wages, SAA support, etc.
Table 2: ZAR movement against selected currencies at 30 September 2020
|ZAR vs||Rate||Qtr %||1 Yr %||2 Yr %*||3 Yr %*||5 Yr %*|
* Returns are annualised / Source: Iress
Cash returns globally remain suppressed as the balance sheets of central banks expand. The recovery in economic growth globally after the ravages of Covid-19 earlier in the year has been led by the “first in- first out” China (through a massive public works and infrastructure program) and the USA (a consumer led recovery aided by massive financial aid programs). These two contrasting approaches have been very effective, our only concern being around the sustainability thereof as continued stimulus is debated.
The strength in the USD faded during the quarter as US rates remain depressed, with those of their major trading partners. The GBP appreciated 4.1% against the USD over the past quarter, with the UK government facing difficult fiscal trade-offs and the BoE committing to act promptly and aggressively.
Looking back over the past quarter, we see very little that has introduced a fundamental change in the relatively favourable long-term prospects for the USD. Risks that would encourage a change in our view relate to US growth underperforming others globally during the current recovery, real yields remaining uncompetitive, US election results shift the outlook for US assets, whether “risk-on” means continued safe-haven USD weakness and whether the EU’s “Next Generation EU” plan remains unmolested by euro-sceptics.
Globally, emerging markets (MSCI EM +9.6%) outperformed developed markets (MSCI World +7.9%), with global energy (-16.0%) and financial (+1.8%) sectors lagging as global consumer discretionary (+16.0%), IT (+11.8%) and industrial (+11.7%) stocks lead the gains over the quarter. IT stocks have performed exceptionally well over the past year and as we go forward, our focus is more selective, focusing on those stocks with recurring income relating to cloud storage, cyber security and online services (delivery, education, gaming, etc). Healthcare stocks offer similar opportunities going forward in the form of a global populace that will be looking forward to having their constitutional right to being a hypochondriac restored as Covid-19 reserved beds are released. Earnings globally are expected to encounter some pressure in 2020 and 2021 and thus stocks look decidedly uncertain for those sectors that have benefitted exclusively from the lock-down. Volatility is expected to remain elevated as the growth/value dynamic plays out and we approach US election which is unlikely to proceed smoothly.
We have remained on the side-lines when it comes to offshore property during the quarter and have been underweight the asset class for some time. Has the impact of Covid-19 created an opportunity for us to take a fresh look at a sector that that requires reinventing itself as e-commerce increases, supply shocks require an inventory build-up closer to home, an expanded digital world requires more data centers and the need for social distancing requires an office space rethink? We see opportunities in the above areas and expect these themes to be enduring going forward.
Within equities, investors are being asked to navigate with low forward visibility and a wide range of potential outcomes in a time of declining earnings. Some economies will lag in any sustained economic recovery, remaining tethered to their pandemic timelines and the resultant fiscal consequences. Those companies with strong balance sheets are to be favoured, as are structural winners in a disrupted future. As portfolio risk gains prominence once again, some rotation out of mega tech companies could guide investor preferences, while gold remains favoured during economic uncertainty, increasing Government deficits and the resultant expectation of future inflation.
Table 5: Total return of selected global indices at 30 September 2020
|Returns in USD||Qtr %||1 Yr %||2 Yr %*||3 Yr %*||5 Yr %*|
|MSCI World NR USD||7.9||10.4||6.0||7.7||10.5|
|EPRA/NAREIT Property TR USD||2.0||-16.7||-2.7||-0.8||3.5|
|FTSE World Gov Bond Index USD||2.9||6.8||7.5||4.4||4.0|
|BofAML USD Libor TR USD||0.0||0.8||1.6||1.6||1.2|
|US BLS CPI USD **||1.4||1.3||1.5||1.9||1.8|
* Returns are annualised / Source: Morningstar Direct / **Inflation lags by 1 month due to data availability
The evolution and future of the US-China relationship remains important, with the risk of a new “cold war” a very real possibility. The timeline of the pandemic cycle will likely influence further monetary and/or fiscal stimulus by individual central banks and as such, policies and objectives is expected to remain largely unsynchronised.
Your assets managed by Cordatus remain well diversified and liquid, with position sizes and geographical tilts being a function of valuation, capital flows, liquidity, your wealth objectives, risk tolerance levels and investment horizon. We take this opportunity to thank you sincerely for the support and trust that you have placed in Cordatus. Managing your wealth is a privilege and a duty we take very seriously.
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