Our investment committee meeting discussions focused internationally on the trajectory of oil and energy prices and US earnings results. Locally, we discussed the Forward Rate Agreement (FRA) market expectations and the position of SA Rand and SA Nominal Bonds while we await the final results of the recent local elections. Roeloff Horne provides a summary of this week’s investment meeting below:
It was great to have some of our investment committee members back in the office for our regular Tuesday meeting this week. It is remarkable how the quality of discussions have more passion when one meets face to face.
Our technical indicators have confirmed the two tiered global equity market performance as developed market equities continue a bullish trend, while emerging market equities lag behind in US Dollar terms.
We could not discuss the outcome of SA municipal elections but we were reminded of our structural headwinds when Eskom filed another load shedding notice the morning after the elections. Our indicators reflect that we are at a very important inflection point with reference to the direction of the SA Rand and SA Nominal Bonds. Any further weakness in the SA Rand above the R 15.45 : USD level can be followed by an aggressive break up which can also lead to a move higher in SA long-dated nominal bond yields. Conversely, the current levels can be forming a top and can break lower if positive catalysts counter the current negative trend. While our portfolios are benefiting from the current trends (the only exception is the higher SA Bond yields) we will watch the action closely this week.
Andy Pfaff shared a tongue in the check comment from Peter Brandt at the start of his presentation:
‘A chart shows where prices have been and they answer some things:
- What is the path of least resistance?
- Is there a price level that, if reached, might indicate supply or demand has become dominant?
But, if you find a chart that shows where price is headed, please send it’
The main drivers of our discussion were the trajectory of oil and other energy prices. One of the supply chain indicators, the Baltic Dry Index, has now corrected lower and serves as a short term indicator that the supply & demand imbalances post lockdowns are settling in and can return back to normality. From a technical perspective, we believe the oil price has hit a short term top formation. We discussed the actions in the oil market as China is releasing state oil reserves and the USA is calling on OPEC for an increase in output. Armin Diem remarked that we need to realise that if the global economy normalizes in the next 6 months, demand for oil will resume as aviation consumption is still 40% below pre-Covid levels and will resume activity soon. Very little capex was spent on new oil production plants and we remain of the opinion that oil prices will remain to trade between US$ 75- US$ 90 per barrel in the next year or two. The resources to supply the new economy energies remain well short of global demand and it will take many years/decades to move closer to a carbon free environment.
We have seen improving supply chain issues in the US lumber and the global iron-ore industry causing prices to revert to more normal levels for those commodities. There are still major complications in the global shipping and logistics industry, not in terms of capacity, but rather in terms of having the capacity available at the right time and place.
We also discussed a report from Stonehage Fleming on US equity earnings results which conclude the following:
- Sales continue to grow in high double digits in both the US and Europe. Two thirds of the US constituents declared better than expected sales, with a high surprise ratio of 61% also in Europe. Earnings continue to grow at a high pace in both the US and Europe. Expectations for growth have been underestimated meaningfully in both regions (by 10% in the US and 9% in Europe). The US’s earnings 82% surprise factor is off the preceding record level, but still the second highest reading on record.
- The consensus S&P 500 target valuation is also getting revised upwards. The current target valuation of $5052 reflects a 10% upside on the current price. This upside compares to an +11% average upside over the past ten years. On this basis, they therefore conclude that valuations are generally still in favour of investing in equities.
- They also reflected further conviction in global earnings expectations which bodes well for the MSCI World Equity Index.
From an SA market perspective, we discussed the FRA market expectations for higher interest rates. We think that the market is wrong in expecting much higher rates (up to 3% higher from here) but it is reasonable to expect at least a 0.25% hike in November on the back of Fed tapering starting soon. Many of our fixed interest managers agree that we can only expect another 0.5% hike in 2022. Anything higher will continue to derail any change of an SA economic recovery. It is clear that Fed tapering expectations, higher developed market bond yields, the sentiment towards China/Emerging Markets and the SA municipal elections have affected SA bond yields and the SA Rand negatively in the short term.
There are no changes in our risk scores and we will monitor the Fed’s actions as well as any short term news which can affect the direction of the SA Rand and Bonds in the short term.
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At MitonOptimal we utilise our proprietary optimiser to calculate a SA and Global risk rating. This is a rating out of 10, with a rating of 5 reflecting our neutral risk position, 0 being a totally risk-off stance and 10 totally risk-on. We review and set the tactical risk rating on a weekly basis at our global investment meeting, and the outcome of this review may result in a tactical tilt to our portfolios. In extreme circumstances we might review our strategic risk score. For example: when we declare a risk score of 4, it means we are cautious relative to our long term strategic asset allocation plan – alternatively, when we declare a risk score of 6 we are more aggressively positioned relative to our long term strategic asset allocation plan.
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Head of Portfolio Management
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