At the beginning of 2018 the stage looked set for synchronized economic expansion and the potential for further gains for growth assets in a risk on environment. We saw the S&P 500 (a measure for the largest 500 shares in the United States) end every single month of the calendar year in 2017 with a positive return. It came very close three times before: in 1958, 1995, and 2006, when it had 11 positive months. It had been a wonderful 12 months for global equity markets.
As South Africans we also had many reasons to be optimistic about the future since the rise of the “Cyril Spring”. We’re a country with so much potential and so many possibilities – potentially 2018 was going to be our year. Even Goldman Sachs, the world’s third-biggest investment bank singled out South Africa as country with massive ‘emerging market’ potential.
The fact that the credit rating agency Moody’s came out with a statement to confirm they’re not dropping our credit rating but rather, they’re changing the outlook from negative to stable was a big positive for us. A drop in credit rating would have caused a $16 billion forced sale of South African bonds by international investors. We’ve steered past this significant obstacle so things are looking up from a macro perspective. Analysts commented that the change in political leadership appears to have halted the gradual erosion of the strength of South Africa’s institutions.
The pertinent question during the first quarter of 2018 was, however how long the “goldilocks” conditions would continue i.e. strong global economic growth with low inflation supporting risky assets such as equities and emerging market assets?
As we all know the markets are volatile and unpredictable. Some of the biggest winners in 2017 were the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Alphabet’s Google), which have been a favorite of many. The question is where these big names go from here in 2018. These FAANG lost around $400 billion during the first quarter of 2018 as investors took profits. In less than two weeks after the Cambridge Analytica disclosures, Facebook alone fell by $75 billion – in a local context, that’s the combined value of FirstRand, Standard Bank and Absa.
Furthermore, the broader market reacted negatively to the tit-for-tat trade policies between China and the US as such was potentially threatening the prospects for global growth and trade. Our market also felt the brunt of such. As the saying goes “When elephants battle, the grass suffers.” US President Donald Trump denied that the US was in a trade war with China.” We are not in a trade war with China, that war was lost many years ago by the foolish, or incompetent, people who represented the US,” Trump wrote in a post on Twitter.
Locally, investors were also rattled by the passing of a motion to amend the Constitution to explicitly allow the expropriation of land without compensation. Furthermore, scathing allegations reports about Resilient (a large local listed property share) bruised the local property sector performance. The share dropped more than 50% over the quarter and such pulled down the broader listed property index which lost as much as 20% from its peak.
Whilst the market correction over the quarter ending March was greater than anticipated, it was not unexpected. We’ve had a good run in 2017 and we should never be greedy but rather always balance our portfolios with investments that compensate us for the risks taken. It was also a reminder that returns don’t come in a straight line – we have to be patient long-term investors. When opportunities arise we should also not be scared to buy back in.
Local growth assets such as the listed property market and the equity market lost 19.61% and 5.97% over the quarter, and global listed property and equity markets also sold off by 4.60% and 0.96% in Dollar terms.
For the 12 months ending March 2018 the local property market had now lost 7.09% whilst the All Share Index was still positive with a 9.60% return. Global listed property and equities remained in positive territory for the 12 months yielding a 2.85% and 14.85% return in USD terms.
Cash and bonds were the place to be over the quarter – local money market assets yielded 1.76% and local government bonds a very strong 8.06%. Offshore cash and government bonds yielded 0.43% and 1.36% respectively in USD terms.
Over the 12 months, local money market assets yielded 7.45% and local government bonds 16.23%. Offshore cash and government bonds yielded 1.36% and 6.97% in USD terms.
The tables below outlines the major local asset classes in Rand terms and the offshore asset classes in USD terms.
|SA Inflation||SA Money
|SA Fixed Rate Bonds||SA Listed
*Returns exceeding one year are annualised
|US Inflation||USD Cash||Global Bonds||Global Property||Global Equities|
*Returns exceeding one year are annualised
INVEST ALL ASSEST IN CASH?
Many investors are now thinking to just take profits after a good 2017 and to park their monies in cash. The problem with that strategy is that you may just miss out on further upside. The recent pull back may just have been as a result of profit taking and not so much off the back of fears of a potential trade war. Remember, it’s not about timing the markets but time in the market.
Old Mutual recently produced interesting research – “The return from cash in South Africa over the last 88 years has been 6.9%, compared to inflation of 6.2%. That is before tax. To combat inflation, what investors need is exposure to higher growth assets such as equities and listed property. Over the same 88-year period local equities have produced returns in excess of inflation of 7.8% per year on average.”
INVEST ALL ASSEST OFFSHORE?
Other investors are thinking that now that the Rand has strengthened so much against other major currencies now is the time to take as much assets offshore as possible. Many investors think offshore investments have a better chance of outperforming local markets, as the Rand should now most probably depreciate against major world currencies. These perceptions, can tempt investors to take more capital offshore than their risk profile justifies. But a mistake like this can have significant financial consequences.
While the Rand is now trading at much stronger levels, investors should not assume such has had its run and will now most surely weaken again, but should remain aware of further potential Rand strength. With a risk on environment, a positive commodity cycle and the Ramaphosa effect, the Rand has potential to strengthen even further and if it does it could trade below R12 to the US dollar in the next 12 months. On the downside, the Rand could weaken to around R13.50.
Furthermore, developed offshore equity markets, especially the US is trading at expensive valuations (even post the recent pull back) and could see further profit taking. It is therefore important to size an investor’s offshore allocation appropriately to cater for such all scenarios.
Investors should keep in mind that South African listed equity markets still deliver competitive returns. Our stock market has been one of the top three equity markets over the past century and we were again reminded of its strength during 2017 when it rose by 21%. Over the past 10 years our equity market performed in line with global developed equity markets in rand terms, returning 11% per year in Rand terms.
For all these reasons, we believe it is prudent to not always blindly maximise one’s offshore allocation. It is important to size the allocation optimally according to your risk profile.
SELL LISTED PROPERTY
Many investors are fearful that listed property markets are now too volatile and that monies can be invested better elsewhere. As noted, the recent Resilient sell of scared many investors.
For us, we see the recent pull back in the listed property sector as an opportunity to overweight our clients’ portfolios to this asset class. Whilst the asset class is not yet cheap it does offer a lower entry point at this stage. Our meetings with more than ten investment managers which we believe are specialists in the field of listed property valuations reflects that Resilient is not another Steinhoff matter and that most of the downside is now priced in and opportunities now present itself for the longer term investor.
The concern going forward remains that global equity valuations remains extended (especially in the US as depicted by the S&P 500 Index), There are also potential warning signs that the business life cycle of the equity market may likely slow down in the next 12 to 18 months.
Despite such concerns, we maintain our broader optimistic outlook for global growth and for risky assets both locally and abroad as we see more potential investment opportunities than challenges. We remain bullish on Emerging Market Equities as their earnings and valuation profiles look more attractive than their developed market peers. Where our mandates allow us we have towards the end of 2017 started hedging our client US exposures and we will continue to do so going forward when the markets reach new highs.
Further, as noted post the recent sell off of local listed property shares have we increased our allocations to an overweight position. We have been waiting for an entry point to increase our allocations and believe that at current levels, albeit that the ride may remain bumpy, will compensate our clients over themed to longer term.
Of course, we remain vigilant as continued trade uncertainties between the US and China may reduce our positive outlook for risky assets. Hopefully, the initial trade actions between the US and China are simply the start of further negotiations rather than a trade war.
In conclusion, as Benjamin Graham, one of the fathers of value investing, said: “The essence of investment management is the management of risk and not the management of returns.” Risk can be managed well if one is aware of the risks and makes decisions about diversification based on fundamentals rather than emotion.
We continue to balance our client’s portfolios across asset classes and investment managers and funds to ensure that we meet our client’s investment objectives over the longer term but to take cognizance of short-term risks.
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