Local Market Commentary
Markets continued to climb higher in the third quarter, despite concerns around a resurgence in Covid-19 infections and continued setbacks in the search for a vaccine. Global central banks and governments continue to be accommodative, with low interest rates and committed stimulus providing significant support to financial markets. This is most notably evident from US Federal Reserve Chair Jerome Powell’s comments during August at the annual Fed symposium in Jackson Hole, where he announced that the Fed would switch to inflation targeting, which appears to support the “lower interest rates for longer” narrative. The US Presidential Election scheduled for the 4th of November also took centre stage during the quarter, with US President Donald Trump and Democratic nominee Joe Biden exchanging blows ahead of the much-anticipated election.
South African equities underperformed global markets during the quarter, despite ending marginally higher. Resources (+6%) ended the quarter with strong performance, while Industrials (-2%) and Financials (-2%) ended in the red. The strong performance from the Resource sector was largely driven by platinum counters, which moved sharply higher during the quarter.
Local bonds ended the quarter largely flat, with short dated exposures continuing to benefit from the stable repo rate and long dated exposures continuing to underperform, weighed down by concerns around South Africa’s deteriorating fiscal position. The South African Reserve Bank (SARB) cut the repo rate by another 25 basis points at the July Monetary Policy Committee (MPC) meeting, bringing the policy rate to a level of 3.5%, its lowest in close to 50 years.
Local listed property continued to struggle, weighed down by valuation write-downs and negative earnings growth related to the knock-on effects of the Covid-19 related lockdown. Property counters initial requests to retain more than 25% of distributable earnings to reduce debt failed to materialize, however, asset disposals and South Africa’s transition to alert level 1 lockdown on the 21st of September should provide further clarity on the sector’s distribution prospects.
Local cash provided a stable return for investors over the quarter. We continue to be mindful of the role that cash plays in a portfolio in terms of providing protection in the event of market declines, however, we are aware that the forward-looking returns from cash appear to be less attractive given the interest rate cuts since the start of the year.
SA’s Q2 2020 GDP data was released during September, indicating a 17.1% year-on-year decline in GDP for the second quarter as the hard lockdown took its toll on the local economy. South African Reserve Bank Governor Lesetja Kganyago announced the Monetary Policy Committee’s decision to leave the repo rate unchanged at 3.5%. The decision was split, with 2 of the 5 MPC members favouring an interest rate cut. SA headline CPI fell to a year-on-year figure of 3.1% to the end of August (from 3.2% in July), close to the bottom end of the target range of between 3% and 6%.
In summary, the third quarter was largely positive for investors. All major asset classes (besides local listed property) managed to deliver positive returns, which led to decent performance for investors over the quarter. The final quarter contains some key political and economic events, including the Medium-Term Policy Statement from Finance Minister Tito Mboweni in late October and the US Presidential Election in early November. We would encourage investors to continue to focus on their long-term goals rather than get distracted by short-term market moves. Patient, valuation focused investors are likely to be rewarded with above average returns going forward.
Global Market Commentary
Imagine waking up as an investor from the 1980s, 1990s or 2000s. How would you make sense of today’s dynamics? You would see debt levels at all-time highs, economic output at multi-decade lows, widespread job losses, a global pandemic halting most human interactions… yet global stock prices are at or near record highs. If you are left scratching your head, you’re not alone.
A meaningful part of the narrative is attributable to record levels of committed stimulus. Let’s not forget that interest rates are sitting down at all- time lows for the foreseeable future (at least, that’s what market participants are expecting, with the Federal Reserve hinting that rates will remain low until 2023).
The challenge, of course, is that investors are also required to climb a wall of worry. Here are just a few current investor concerns: U.S. election nerves, Brexit negotiations, the vaccine waiting game, inflation uncertainty, US/China tensions, political division, and the potential for a rise in corporate defaults. Offsetting this, some participants—including professional and retail investors—appear buoyed by vaccine progress and a growing expectation for a 2021 recovery.
Looking within equities, all is not equal. What we’ve witnessed lately—and Q3 saw an extension of this—is diversity of outcome, with “new world” growth demanding a curiously high premium while “established” businesses fall off the radar of investors (this is true across developed and emerging markets). Understanding this dispersion has become one of the biggest talking points among investors.
To get practical, we offer the graphic below, which shows how prevalent this dispersion currently is. Ultimately, it is unpopular stocks that tend to outperform popular stocks in the long run, as validated in several academic studies. Therefore, while 2020 has so far proven to be an outlier in this sense, it is the contrarian investor that has the upper hand probabilistically. This popularity/unpopularity conundrum should not be understated in these extreme times.
Speaking of popularity, interest in ESG (environmental, social and governance) investing continues at pace. This has been undoubtedly supported by sector performance differences, with ESG-friendly sectors generally doing better than some of the “dirtier” industries such as energy (obviously not all of the energy sector is “dirty”, but the composition is an important factor here).
Looking for risk offsets, it is the typical safe-haven assets that investors are looking towards. Gold, despite all its faults, has taken a lion’s share of the headlines in this space. Yet, unsung heroes in times of stress—such as cash and longer-dated bonds—continue to play their role as defensive ballast. Remember that the pledges by central banks to keep rates low has provided some comfort for fixed-income investors, despite the low yields.
Turning to bond holdings, it has really been about balancing credit risk versus the extra return that you can achieve. This spread between riskier holdings (such as lower-quality corporate bonds) and safer exposures (such as government bonds, which tend to offset equity risk) saw a big spike in early 2020, but has narrowed once again, as corporate bankruptcies have remained low to date. Emerging-markets debt remains an area of interest given the high relative yields on offer.
Circling the investment landscape, we can’t forget the importance of currency, which is one of the first places investors express their geopolitical views. This space continues to be important from a risk management perspective, too, although a lot of negative news is still seemingly priced into riskier currencies. In fact, we’ve seen procyclical currencies (those that tend to do well in a growing economy) improve more recently, perhaps acknowledging the extent by which investors sought safety.
Our Message to Clients
Taken together, balancing capital growth and capital preservation is undoubtedly demanding at present. This requires a steady hand. There are the simple things to get right, such as keeping costs low, focusing on the long term, and diversifying the return/risk drivers. But to excel in today’s environment, it also requires advanced analytical and behavioural skill. We continue to drive this agenda in earnest, for the benefit of all investors, and thank you for entrusting us.