For most of the past 2 years we have experienced a Goldilocks offshore investment environment. The market was not too hot or too cold, with moderate inflation, low market volatility, and above-trend global economic growth across most countries.
Significantly, the US market (S&P 500) had run nine and a half years without a fall of 20% or more. On the 22nd of August 2018 it became the longest bull run in U.S. history. Many investors who missed the opportunity to benefit from this performance call it “the most hated” bull market, as they perceive it to be artificial due to stimulus roles played by global central banks.
Bond investors also have had it relatively easy over the past two decades. There has been very little volatility along with falling interest rates from much higher levels.
But the US Fed had now raised interest rates 6 times in the past 3 years and the 10-year U.S. Treasury yields broke through the level of 3%. Also, on the 14th of September, the United States announced significant tariffs on import goods from China. Beijing responded with tariffs on imports from the United States. The trade wars had started…
Higher US interest rates, the US China trade wars, US dollar strength and finally political dysfunction in Turkey, Argentina and Brazil then suddenly exposed emerging markets. Market commentators also started speculating that oil prices could rise above USD100 per barrel. Higher oil prices would boost inflation around the world and spark an increase in US borrowing costs, which in turn will have a negative impact on borrowers, especially those in emerging markets.
It simply meant that the brakes had been tapped and as a result emerging markets flew through the windshield. Several emerging market currencies fell to all-time lows against the U.S. dollar. Many investors started to fear a full-blown emerging market crisis.
Locally, adding to investors concerns, the Ramaphoria effect faded into what may be referred to as “Ramapause” or “Ramareality”. The market suddenly paused to reflect on the massive tasks ahead. During this time, Tito Mboweni became South Africa’s sixth Finance Minister since December 2015. Investors can however at least take confidence in the fact that Mr. Mboweni is not new to the financial sector as he was at the helm of the Reserve Bank for 10 years. He has previously demonstrated a safe pair of hands and have the respect of the investment markets and investors.
It’s been a tough 5 years for our local equity market. This year has been no different and may just be the toughest calendar year since 2008. According to Denker Capital, for the calendar year to the end of September 2018, just 6 of our largest 40 companies companies had made any gains. Further, almost 40% of stocks in the All Share Index are currently trading at prices below where they were 5 years ago. When adjusted for inflation, 60% of stocks in the All Share Index are currently trading at prices below where they were 5 years ago. In other words, nearly two thirds of the market has gone backwards in the last 5 years.
One of the largest detractor over the course of this year has been Naspers, the largest stock in the market. The stock has come under pressure primarily due to the drop in Tencent share price, a company which makes up 80% of Naspers’ net asset value.
Further, whereas local listed property had been the darling for investors over the past 15 years it has now lost value over the past 3 years due to the sell off which occurred in the first quarter of 2018. Even over the past 5 years it has now barely outperformed inflation.
Many investors have now lost faith in risky assets such as equities and property as cash has been king over the short term. Specifically, over the past year an investment in a money market account yielded 7.27% outperforming all the other major asset classes.
|SA Inflation||SA Money Market||SA Inflation Bonds||SA Government Bonds||SA Listed Property||SA Equities*|
Investing in growth assets such as offshore listed equity and property has been the place to be over the past 3 years yielding 6.86% and 13.40% in US. Dollars respectively. As expected, global bonds produced negative returns as interest rates ticked up. Cash continues to produce negative real returns and as a result investors have had to take risk to grow their savings in offshore real terms.
|US Inflation||USD Cash||Global Hedge||Global Bonds*||Global Property||Global Equities*|
On the currency front, the Rand is once again proving to be the most volatile currency in the world. The local unit has over the past 12 months switched from the best performing emerging market back to the worst thereafter. It has more recently lost nearly 20% against the US. Dollar during the emerging market sell off. As a result, such Rand weakness has boosted offshore investment performance in local currency.
|US Inflation||USD Cash||Global Hedge FoFs||Global Bonds*||Global Property||Global Equities*||ZAR/USD|
The current period of increased volatility and weakness in investment markets reminds us of similar times in the past when severe short-term pessimism created an opportunity to increase positions to risky assets.
The central question for many investors through the end of this year will be the path for U.S. interest rates. The US Fed will most likely continue with their tightening policy. Further, the ongoing uncertainty around the US-China trade war remains the biggest risk to global financial markets since the global economic crisis.
We think we’re in the later innings of the business cycle and that we’re most probably in “extra time”. The classic signs of a US economy that has reached the full extent of the expansion post the 2008 crisis is becoming more and more evident.
We also know that volatility typically increases in mature bull markets as investors worry about valuations. But we know bull markets normally only come to an end once interest rate rises have been severe enough to constrain company profits. The current market correction may not yet be over and may have another leg to go. Looking past the immediate short-term risks we think that the long-term bull market is not just over yet.
From a valuation perspective, global equities are currently less attractive than many emerging markets including our local market. Global equities are especially skewed by the US – which is one of the more expensive markets. We therefore continue to hedge our clients’ exposures to US markets for any immediate downside surprises.
As before we remain negative on the outlook for global bonds. The multi-decade bond bull market has potentially ended, with US treasury yields having risen above 3%, and poised to continue rising over the coming years.
In terms of emerging markets we believe the recent selloff has restored value relative to developed equity markets. Whilst the emerging markets sell-off may not be over it is potentially overdone and that current valuations represent a buying opportunity.
The SA equity markets also currently presents an attractive entry point as we expect some form of recovery into the next 12 months. We have advised our clients to buy SA equities into the current weakness. Even if we do see further emerging market weakness our equity market should outperform their emerging market peers as it is underpinned by rand-hedges, with approximately 50% of SA equity revenues emanating offshore.
With inflation currently around 5%, local bonds offer a compelling real yield of roughly 4%. We have increased our client’s allocations. If we do experience a credit ratings downgrade this year we would treat any significant increase in local bond yields as a further opportunity to increase such allocations further.
We have retained our positive view on local listed property. We believe this asset class has been oversold, currently provides more downside protection than local equities and has the potential to quickly rebound should our economy start to turn around.
Looking at the big picture, investors must unfortunately realize that expected returns in the short to term might remain low at a time when volatility is increasing.
The best investors can do is to look through the immediate cycle and to ensure that they have well balanced, risk cognizant and robustly constructed portfolios.
The market is fickle and may well revert back to higher levels of volatility than we have seen in recent years. The unwind of quantitative easing will continue to have material effects as liquidity is removed from markets.
A prudent short term approach remains to buffer an investment portfolio against any unintended near term risks or downside surprises. As we always insure our lives, our houses and our cars, so do we have to insure our investments by hedging for downside risks across currencies and risky assets such as US and local equities.
In the medium term growth assets such as emerging market and local equity assets may rebound so stay the path and retain a balanced allocation to such assets.
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