Macro review
In the US, consumer confidence remained strong and retail sales data suggested a rebound in consumption from a softer Q1. The unemployment rate also reached an 18-year low of 3.8%, accompanied by robust wage growth. As expected, the Federal Reserve (Fed) raised the target for the federal funds rate by 0.25% and marginally increased its 2018 forecasts for growth and inflation. The positive economic data were, however, balanced by moves from the Trump administration to impose tariffs on Chinese imports and withdraw from the Iran nuclear accord.
In the Eurozone, the quarter was marked by the return of political risk. There were concerns that Italy could need fresh elections following the inconclusive outcome of the March vote, while Spain also saw a change of government, although this was largely greeted with calm by markets. German Chancellor Angela Merkel clashed with sister party the CSU over immigration policy. Economic data pointed to steady growth but at a slower pace than last year, as GDP growth for Q1 was 0.4%, down from 0.7% in Q4 2017. However, the flash Eurozone composite purchasing managers’ index for June came in at 54.8, an improvement on the 18-month low of 54.1 seen in May. The European Central Bank (ECB) announced that it expects to end its quantitative easing programme in December 2018.
Emerging markets (EM) saw an escalation in global trade tensions which also contributed to risk aversion as US-China trade talks failed to deliver a sustainable agreement. Brazil experienced a truck driver strike which paralysed the economy and amplified political uncertainty. Turkey saw currency weakness which forced the central bank to implement an emergency rate hike in May. China observed concerns over growth which contributed to Yuan weakness. Signs of slowing momentum in the domestic economy were exacerbated by deterioration in the outlook for global trade.
Global and local market review
Global developed market equities made gains in a volatile Q2, as resilient economic and earnings data vied with an unsettling geopolitical backdrop to establish the market’s direction. The MSCI World Index posted a positive Dollar total return of 1.9% (-1.2% for Q1), outperforming the MSCI EM Index (-7.9% in Q2 vs +1.5% in Q1). In the US, equities advanced in Q2 with the S&P 500 gaining 3.4% in Dollars, with positive earnings momentum and supportive economic data ultimately outshining escalating US-China trade posturing. Eurozone equities also posted positive returns in Q2. In EMs, equities recorded a sharp fall with US Dollar strength a significant headwind. Worst performing countries were Brazil (-26.4%), Turkey (- 25.7%) and Hungary (-14.4%), while the only countries to post positive returns were Colombia (+6.8%) and Qatar (+3.5%).
The SA equity market started June on a strong note, reaching a month-to-date total return of 4.2% by 14 June before reversing this to post a loss of 1.5% by 26 June. The FTSE/JSE All Share Index recovered on the last day of trade to record a June total return of 2.8%. Large caps returned 3.8%, while mid-caps and small caps lost 2.1% and 3.3% respectively. On a sector level, SA Resources was the best performer returning a solid 19.6% (Q1: -3.8%). SA Industrials returned 4% (Q1: -8%) while SA Financials lost 6% (Q1: -3.6%).
Portfolio performance, attribution and strategy
After two consecutive very poor quarters, deep Value factors such as Price to Book rekindled its 2016 performance where cyclical value was favoured. To some extent the unwinding of Momentum has benefited these cyclical value measures in the short term, however, should macro uncertainty continue and deepen, we may see a shift towards more defensive Value or Quality strategies. Price to Book remains the worst performing strategy over 12 months. Dividend Yield, on the other hand, has experienced mixed fortunes, as the environment tussled between flight to safety and pro-risk. Over the previous year, however, investors continued to show a preference towards yield as opposed to more deep value.
The conundrum, however, has been that during Q2, this Yield signal has been overwhelmed by sector and Rand risk in the portfolio. These impacts have significantly outweighed the Value and Yield premium embedded in the portfolio.
Top contributors to performance predominantly originated within the Resource sectors, where the fund held overweight positions in South32 (S32), BHP Billiton (BIL), Exxaro (EXX), African Rainbow Minerals (ARI) and Mondi (MND). Despite this sector impact, the largest drawdowns were generated by Rand-sensitive Financial and Industrial counters, including holdings in MMI Holdings (MMI), Coronation Fund Managers (CML), Truworths (TRU) and Foschini (FOS). In terms of stock selection, the largest underperformance over the quarter came from not holding Naspers (NPN), which has a substantial weight in the benchmark. This stock-specific risk has been significant, as any relative performance in Naspers has a meaningful impact on the portfolio regardless of the Quality characteristic. There were no changes to the FTSE/JSE Dividend Plus Index over the prior quarter.