Although this overview is aimed to communicate our asset class views and positioning, we cannot ignore the importance of the challenge and grief we all deal with at present due to the COVID-19 disease.
The last quarter saw many market moving scenarios play out globally, as well as in our beloved South Africa. Most notably the impact of the riots in Durban and Gauteng, more political woes, semiconductor shortages, global supply chain crisis and a new wave of COVID-19 infections caused by the Delta-variant.
It is now a statistical certainty that the COVID-19 virus left almost no South African unscathed, be it directly or via friends and family. Although the South African economy was hit hard with lockdown regulations, movement restrictions and alcohol bans, we are seeing most sectors going into recovery. Especially now that tourism can return to our shores, after the lifting off the UK red list, we are excited to see what the next chapter of our recovery journey holds. We sincerely hope that you and your families are managing through these unprecedented times.
Factors that influence market behavior
As highlighted in our last quarterly commentary – an apt description of the current global scenario is a ‘global COVID war experience’. What we mean is that people’s lives, health, and psychology are being challenged while many suffer economically as well – i.e. pretty much the same effect that a war will have on people and their economies. The aftermath of a ‘war’ is normally associated with economic stimulus to kick-start the economy and create job opportunities (a war would imply widespread construction activity too). Over the past year developed market central banks and politicians certainly reacted in a similar ‘war-like’ fashion by introducing loose monetary policies and unprecedented fiscal stimulus. Unfortunately, the fiscal stimulus – that basically pays citizens massive grants to survive – was more prevalent in developed markets like the US, UK, Europe, Japan and larger emerging markets like China. Africa and Latin American economies were not stimulated in the same way or similar proportion. That put these economies at a great disadvantage relative to develop economies. Even vaccination relief was first centered around the named developed and emerging countries and in many cases more than 70% of the population is vaccinated. This will kick-start these economies faster relative to most emerging economies.
In short, the following factors will influence market behavior and cause upside and downside volatility as we approach the end of 2021:
- The success of the vaccine roll-out and herd immunity, especially in emerging economies and most definitely South Africa.
- How long and how low interest and bond rates will remain especially in the light of signs of tapering the bond purchases by the US and Europe.
- The economic recovery in developed and emerging economies is challenged due to higher inflation, supply side constraints and lately a global energy supply crisis.
- The inflation debate – especially in the US – will it simply be transitory or will it persist due to supply bottlenecks or demand growth due to fiscal stimulus and a ‘party’ atmosphere as consumers celebrate the ability to live normally again. We do, however, think that the inflation debate is not as straight forward as “transitory vs structural”. We’ve got so many moving parts to consider, it’s oversimplistic to suggest that it’s fully structural or fully transitory. The fact of the matter is that a lot of the things that are pushing inflation numbers around are a mixture of both. So, the conclusion from all of this is that, yes, you are going to see higher inflation with a structural element to that. But that doesn’t mean that you are going to have a run-away inflation rate, the truth is probably somewhere in between.
- The high government debt levels of especially developed economies and emerging economies with structural headwinds (again SA comes to mind) – the trajectory of debt levels will influence market behavior in the next 2-3 years – especially interest rates and bond yields.
- Elevated valuations in certain asset classes. Here we refer to low bond yields that effectively can only go up from here over the next 2-5 years. Also, certain growth stocks in the US trade at elevated levels and will be under pressure to manage margins and repeat the earnings windfalls caused by COVID-19 and fiscal stimulus.
- Bubble areas in the market. Dare we say Cryptocurrencies? A price collapse of this phenomenon could create a short-term negative wealth effect.
- Reflation trade or back to a stronger USD? The US Dollar price relative to other currencies always influences market and asset class/sector behavior. In this case, the argument for value vs. growth stocks will also be an important source of returns in the short term. We believe that the US Dollar will remain stable especially as tapering of US bond purchases may mean higher bond yields, which should benefit the US Dollar relative to other Developed Market currencies. Tapering may also make long duration assets less attractive (bonds and expensive growth stocks as example) and therefore we ensure that we expose our local and global portfolios to more value managers/sectors/stocks relative to the past 5 years.
- The timing of tapering – tapering by central banks will have to be implemented as it is not feasible for the US and Europe to continue the frequency and size of bond purchases to perform monetary stimulus for ever and a day. Markets will have to adjust to this fact and announcements in this regard will create volatility in both equity and bond markets, but equity markets could respond well if the tapering is due to improved economic growth.
- Developed Market stimulus in 2021 appears to be moving toward US$ 4-5 Trillion. A very positive factor as broad-based developed market GDP YOY growth could increase to 6.1% according to the IMF and may stimulate company earnings growth even further.
- The autocratic way China is regulating its economy by introducing ‘harsh regulations’ to achieve common economic and social prosperity has affected sentiment toward China technology companies negatively. These regulations have damaged earnings expectations for stocks like Tencent/Naspers/Prosus negatively during the past quarter. This has caused many managers in our portfolios to reduce exposure to these stocks and the current question is how much of the bad news is in the price and how long will it take for sentiment to improve for Chinese assets.
- Companies have managed costs well over the last year and this plus improved economic activity have led to better than expected company earnings growth in 2021/22.
- Infrastructure plans are potentially moving forward in the US and China. This could further stimulate demand for commodities which will certainly benefit the SA commodity stocks again.
- Lack of foreign interest to buy SA assets remains a concern, despite attractive valuations in our SA Equity and Bond markets. We watch this space carefully as any form of foreign purchases could move our markets positively. We think markets await the outcome of our medium-term budget and municipal election results to determine the risks and opportunities in our capital markets.
- The success of a SA vaccination roll-out and herd immunity success is fast becoming an important factor in determining the ability of the SA economy to normalize – especially the service and tourism sectors as we are now removed from the red list and already experiencing an influx of tourists.
- A positive SA trade balance and improved tax collection due to massive taxable profits in SA mining companies has stabilized the SA Rand. This may change in the short term as improved economic activity could lead to higher imports, while lower commodity prices could stem the tide in terms of trade negatively due to potential lower exports (especially if ports in Richards Bay / Durban continue to be sabotaged) and tax collection.
Earnings revisions for the general miners
- Investors were surprised as better than expected earnings results generated a positive re-rating for the majority of JSE equities.
- Our SA Government bond real yields remain attractive, as they sold off due to higher US bond yields and global inflation fears and only a handful of offshore investors have re-invested back into our bonds since their exodus over the past 4 years.
- The JSE All Share Index excluding Naspers / Prosus is trading at massive 40-50% discount to peers. If our economic activity improves due to positive political rhetoric, successful management of our fiscus/vaccinations and improved business confidence, foreign investors may seek to invest in our SA equities and bonds.
- Our portfolios and funds are currently positioned with equal weighting in SA Incorporated stocks and SA Rand Hedge stocks.
- SA Cash and Money Market yields remain unattractive, especially as the benefit of positive real yields between 2016 – 2020 have now become negative real yields.
Percentage differential between the 5 year SA Government Bond Yield & Short Term Cash Rates
- Despite our concerns for lower historic forward yields in the SA Property Sector, the valuations and balance sheet risks have improved, and we have increased our exposure to this asset class during the year. We do however have concerns in terms of the property stocks facing retail / office sectors in SA and remain cautious in allocating to this asset class at present.
All of the factors above lead us to state that our highest conviction action in portfolios is to embrace a diversity of asset classes in different geographies at present. Diversification remains the free lunch to provide protection and optionality in portfolios. There is no need to pay for ‘insurance’ in portfolios.
We wish our investors peace of mind and to remain focused on protecting yourselves and your family’s health and safety.
Director and Head of Portfolio Management
WATCH: Q3 2021 ASSET ALLOCATION VIEWS
Head of Portfolio Management, Roeloff Horne, discusses our asset allocation views against the Q3 2021 macroeconomic environment.
The content of this article is for information purposes only and does not constitute an offer or invitation to any person. The opinions expressed are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness.