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
Global trade uncertainties and other geopolitical risks weighed heavily on investor minds over the prior quarter. This resulted in a clear ‘risk-off’ performance of global styles. While Low Risk, and in particular Low Beta, were the best performing factors, the cyclical factors such as Momentum and Growth did not completely roll over and instead only suffered from some mild rotation and profit-taking.
In South Africa, there was large consistency with global outcomes, where we saw factor reversals as the cyclical Price Momentum factor underperformed. What was interesting, however, was how Earnings Momentum (a sub-component of headline Momentum) and Price Momentum exhibited divergent performances over the quarter. As opposed to Price Momentum, Earnings Revisions came alive in Q2, as investors gravitated towards companies with positive earnings sentiment. This could be seen as investors viewing Earnings Revisions as a more defensive component, which is aligned to how we utilise this factor in our overall Momentum strategy.
As an overall factor, however, the Momentum strategy struggled during Q2 2018 relative to the FTSE/JSE Shareholder Weighted Index (Swix). The strategy’s positive contributions to performance was largely attributed to off-benchmark stocks, of which the stocks it held in the portfolio included Naspers (NPN), Clicks (CLS) and Richemont (CFR). Stocks which added value that the portfolio did not hold included Barclays Group Africa (BGA), Vodacom (VOD) and Shoprite (SHP). In terms of underperformance contributors, these included overweight positions in in Harmony (HAR), Mr Price (MPC), Barloworld (BAW), Dis-Chem (DCP) and an underweight position in Sasol (SOL).
At the last rebalance date (mid-June), we transitioned the portfolio based on the evaluation of new factor signals and the risk levels in the portfolio. Based on these signals, only Massmart (MSM) was removed, whereas exposures to Harmony (HAR) and Dis-Chem (DCP) were cut due to their waning strength of momentum signal. On the positive side, we added BHP Billiton (BIL) based on its current strong signal, and also increased allocations to Anglo American (AGL), all in line with the risk objective of the fund.
We remain convinced of the factor’s medium- to long-term significance and the premium it offers in the South African capital market and remain disciplined in our implementation and extraction of the factor.