Macro review
Globally, real GDP and industrial production momentum has been firm year to date,
with consensus forecasts for global real GDP growth on track for 3.3% for 2017. In
the US, rates was raised by 25 basis points while the median market participant still
expect one more hike this year and another two to three next year. The Federal
Open Market Committee appeared unfazed by the slew of weak inflation prints,
believing it to be temporary. Additionally, US consumer spending data remained
resilient, adding to hopes the US economy would bounce back in the second quarter
following GDP growth of 1.4% in the first quarter (annualised). In Europe, the most
recent European Central Bank meeting revealed the bank was optimistic on growth
and inflation and expected tapering to start early next year. Recently released
macroeconomic data is pointing towards a steady near-term growth path for China.
Political uncertainty remained an important feature globally, as US President Donald
Trump dismissed FBI director James Comey, which raised doubts over the ability of
the administration to push its fiscally expansive policies. In Europe, French and
Italian political uncertainty faded, as the moderate Emmanuel Macron won the
French presidential and later parliamentary elections convincingly, while the
possibility of an early election in Italy was ruled out.
South Africa started the last quarter on the wrong foot with the unexpected Cabinet
reshuffle at the end of March. This markedly increased political uncertainty, and
coupled with credit downgrades, weighed heavily on domestic confidence and
subsequent consumer sentiment. As such, a business cycle recovery will likely be
protracted until such time that confidence recovers. To add insult to injury, first-
quarter GDP posted a dismal -0.7%, plunging the economy into a technical
recession. Growth expectations for 2017 is seen at 0.75% (down from about 1.5% at
the start of the year), with a recovery to 1.25% in 2018, mostly driven by a rebound
in household demand.
Global and local market review
Global equity markets advanced in the second quarter of 2017 with the MSCI World
Index returning 4.2% in US dollars, and 12% year-to-date. A strong corporate
earnings season and generally positive economic data supported gains, while
political risk eased in Europe. Emerging market (EM) equities however outperformed
their developed world counterparts, returning 18.2% during the first half of 2017.
This streak of outperformance is now six months long, as this region continues to
benefit from a supportive global backdrop. Top performers in EM were Poland
(+33%), Turkey (+29%) and South Korea (+28%), while Russia experienced a sharp
decline (-15%) amid a fall in Brent crude prices. In terms of global style
performance, Growth (+7.0%), Quality (+5.1%) and Price Momentum (+5.5%) have
been the clear outperformers since the start of the year.
Global government bond yields were well supported for most of the quarter, but a
sell-off in the final week reversed earlier gains for Bunds and gilts and pared gains
for US Treasuries. This sell-off was drawn by comments from central bank leaders in
the US, Europe and the UK, taken as signalling increased hawkishness. High-yield
(+6%) and investment-grade bonds (+4%) also delivered positive returns for the
period.
The Bloomberg Commodities Index declined in the second quarter, with Energy the
weakest component as Brent crude fell 9.3%. Industrial metals were down, with iron
weakest component as Brent crude fell 9.3%. Industrial metals were down, with iron
ore falling heavily on concerns of weaker demand from China and elevated
stockpiles in the country.
Year to date, South African equities (SWIX) delivered a mild 3.3%, slightly
underperforming bonds (+4.0%) and cash (+3.7%) as expectations of a delayed
economic recovery and political uncertainty weighed on equities. Within equities we
saw divergent sector performances, as Industrials added 9.0%, while Resources fell
4.6% and Financials added 1.1% over the first half of 2017.
Over the last three months, the SWIX return was flat. In terms of major contributions
to this return, Media (Naspers) was the star performer, as Tencent continued to
improve its competitive position and market share, although June saw profit-taking
in the global tech sector. Some noticeable contributions also came from Steinhoff
(+4.5%), which outperformed as it announced the proposed listing of its SA retail
assets. Aspen (+4.5%) also bounced back, driven by a rally in the euro/US dollar
exchange rate. Materials (-6.7%) detracted the most, given weaker precious metal
prices, exacerbated by the introduction of the new Mining Charter. This was followed
by Discretionary Retailers (-9.3%), out of favour, as business/consumer confidence
nosedived. Telecoms also contributed negatively, as MTN (-6.5%) fell again, partly
driven by oil prices declining (Nigeria) over the quarter.
The year ahead
Despite the rollercoaster of emotions, global equities hit record highs during the past
quarter. Looking ahead, a global economic slowdown with a concomitant lack of
earnings delivery would be a major risk to equity markets. We also cannot discount
further political uncertainty and monetary tightening as a threat; however, there is
sufficient earnings momentum to support gains in global equity markets over the
short term. Return expectations in other asset classes are still at multi-year lows,
and it is hard to see major rotation out of equities into defensive assets just yet.
Domestically, lacklustre corporate earnings growth will be a key determinant that will
impact JSE company margins and share price performance. Recent discussions
around the South African Reserve Bank’s mandate and ownership have been
market negative, and along with the new proposed Mining Charter, we continue to
monitor the impact of these developments on our local currency. Continued
deterioration in the macro outlook and political noise will in our view increase the
likelihood of a further downgrade in local currency debt rating. The S&P investment-
grade status on local currency debt is likely to be lost mid-2018 with a follow up from
Moody’s downgrade in the second half of 2018. A commodity rally would be a
tailwind, but a meaningful rally seems unlikely at present with the expected growth in
China moderating. We stay very cautious on the returns from local equities for the
immediate future.