Market review | Global and local equity markets
With the first three months of the year now done on a normalisation in investor sentiment (in Q1 2017 the VIX Index had its lowest average quarter since Q4 2006), the general call for the second quarter is to remain overweight equities and underweight bonds/cash, reflecting the view that real rates are in a bubble and there's risk of a significant repricing in the medium term as the rate hike cycle gathers steam. The Trump put may have a bit more to go. By avoiding a drawn-out battle over the health care bill, investors' focus has shifted to tax reform and as this takes centre stage, stimulus-fuelled optimism could wane as friction around funding the tax bill rears its head. Stocks have been boosted by accelerating global growth and improving confidence.
But the risk today is that, just as the Trump put may begin to fade, data could grow choppier. With positive economic surprises at five-year highs, the math alone makes it difficult for data to accelerate from here. With the French elections, Turkish referendum, OPEC, and Brexit all on the calendar at a time when global central banks are transitioning to a tightening bias, we see a chance that the markets might take a breather at some point this year.
As anticipated, rating agency Standard & Poor’s (S&P) eliminated South Africa's foreign currency sovereign investment-grade (IG) rating, downgrading it to BB+ from BBB- with a negative outlook. While SA currently remains IG, SA’s IG status could be impacted following the review scheduled for this Friday by Moody’s, but it should be noted that Moody’s currently rates SA two notches above a sub-IG rating. Fitch is also likely to pull forward its decision earlier, likely to result in forced selling, as SA loses its IG status. Numbers involved here could be substantial.
The MSCI SA Index (-0.1%) underperformed the MSCI EM Index (+2.5%) in March in dollars, as the rand (+2.6%) was the worst-performing EM currency, on the back of a Cabinet reshuffle, with finance minister Pravin Gordhan removed.
The FTSE/JSE All Share Index (ALSI) managed to deliver a good return of 3.8% over the last three months, with the best-performing sector being Consumer Discretionary, which was driven by the very good returns of Richemont, British American Tobacco and Naspers. In the basic materials sector Coal Mining and Forestry and Paper experienced a very good quarter. Laggards were Healthcare (-7%), heavily influenced by Netcare (-18%), and Banks (-6%), which were down on a weaker rand, weighing on the inflation outlook and consumer confidence. The worst-performing sector was Industrial Engineering, down a massive 15%. The FTSE Shareholder Weighted All Share Index (Swix) managed a total return of 3.3%, which was slightly worse than that of the ALSI, mainly driven by the higher weighting of resource companies in the latter.
For our many of our clients, the question is why does a downgrade matter? There is an obvious risk that, in order to balance the books, taxes will rise, import tariffs will increase the cost of living and higher interest rates will discourage private sector investment and job creation. The key concern remains our local currency debt junk rating, which could make it more expensive to meet our fiscal commitments in the long term. The Cabinet changes have had a significant impact on financial markets to date. South Africa relies on foreign capital flows to fund its deficits, and with increasingly likely downgrades of its sovereign debt looming, further sharp declines in the rand is possible. The importance of the loss of independence of an institution like the Treasury is not something that should be underestimated While SA domestic equities might appear close to the bottom, failure to deliver on a turnaround in confidence in the political landscape could see the likelihood of a further near-term sell-off (with a vote of no confidence unlikely until early May), therefore we think that domestic equities such as Banks and Retail should offer better entry opportunities in the weeks to come. On the upside one could see some further outperformance of some industrial rand hedges, on the back of a further weakening in the currency.
Portfolio performance, attribution and strategy
Dividend yield and other cash flow-related measures of value had a strong 2016 calendar year along with deeper extractions of value like price to book. The yield factor struggled to get out of the blocks in 2017 but still kept reasonable tread to the market. On an absolute basis the value family of factors provided a solid start taking inflation into account. Exposure to Exxaro (EXX), Truworths (TRU) and Sibanye Gold (SGL) played a strong role here. The concentrated nature of our market index proxies and its Naspers exposure was pretty much behind the relative underperformance; this index holds no Naspers exposure. The FTSE/JSE Dividend Plus Index had its review in March. A summary of the major additions and deletions are below:
Additions: African Rainbow Minerals (ARI), South 32 (S32)
Deletions: Richemont (CFR), Momentum Holdings (MMI)
As long as the extraordinarily uncertain market environment persists, this factor is likely to provide investors with the necessary defensive character inside their portfolio construct.