API Second Quarter Summary 2020

LOCAL MARKETS IN A NUTSHELL

The South African stock market participated in the global rally over the quarter, posting its best quarterly performance since the Dot-com Bubble burst in 2001. The JSE All Share Total Return Index gained 23.2% over the quarter.

Chart: Performance of the FTSE/JSE All Share Index over the past ten years (2009/03/01 – 2020/06/30)

Chart: Performance of the FTSE/JSE All Share Index over the past ten years (2009/03/01 – 2020/06/30)
Source: Trading economics

The second quarter of 2020 saw a recovery on the local stock market which was supported by interest rate cuts from the South African Reserve Bank.

The economic conditions in South Africa were poor pre-covid 19 and have understandably deteriorated further. This is in contrast to the sharp recovery on the local stock market. The biggest contributors to the recovery have been the resource stocks as well as the rand hedged stocks which are mainly proxies for companies which derive the majority of their earning from offshore.

The recovery gave investors a much-needed reprieve from the March lows.

“More people lost money waiting for corrections and anticipating corrections than the actual corrections.”
Peter Lynch, Interview with Fidelity (2019)

Sector Performances
Source: Money Mate 30/06/2020
* Annualised Performance

WHAT IF YOU HAD SOLD IN FEAR?

Following the sharp and distressing fall on the JSE in the first quarter of 2020, investors where asking themselves whether they should sell their investments and go to cash or other safe haven assets.

The risk at this point is making a financial decision based on our cognitive biases.

“In a highly uncertain world, we crave certainty. We have a natural tendency to avoid situations that threaten our wellbeing, and we prefer choices that allow us to avoid pain. When a risk seems benign, we may overlook or underestimate it, but when a risk becomes front and centre, we will often prioritise minimising that risk at the expense of all other action – more so if the risk is vivid and visceral.”
Rory Kutisker-Jacobson, Allan Gray Portfolio Manager

The chart below shows the performance of the FTSE/JSE All Share Index year to date.

We assume that an investor receives their quarterly statement 10 days after the end of the quarter. Shocked at the fall in their investment they instruct their adviser to sell either all of their investments or a portion of their investments and move it into cash so that they “don’t lose any more money”. We assume a further 5 days for the investment to be switched from its underlying holdings into a money market fund.

The red dot represents the 15th of April, the day that we assume an investor would have sold their growth asset exposure in favour of cash. We believe that this is a realistic scenario which illustrates selling into a falling market.

Chart: FTSE/JSE All Share Index year to date performance ending 14th of July 2020
Chart: FTSE/JSE All Share Index year to date performance ending 14th of July 2020
Source: Trading economics

Had an investor decided to reduce their growth asset exposure at that point, they would have missed the subsequent recovery period which accounts for a 25,3% recovery from the 15th of April to the 14th of July 2020.

The market could have conceivably continued to fall in value. However, the decision to make extreme financial decisions when on the back foot, coupled with our fear of a global pandemic and possible global recession, can lead to poor investment decisions. This highlights the repetitive narrative of looking beyond the current context and rather taking a long-term view.

“Investing isn’t about beating others at their game. It’s about controlling yourself at your own game.”
Jason Zweig

The quote below reiterates that financial advisers much like the average investor, may be tempted to change course during times of extreme volatility and uncertainty. We however remain committed to following a disciplined approach in helping our clients protect and grow their wealth over the long-term based on sound financial planning principles. Much like a fund manager who must adhere to their processes in order to achieve desired investment outcomes.

“The key for us, as well as financial advisers and their clients, is to stay disciplined and follow our processes.”
Allan Gray: Discipline is key at times of distress

Asset Class Return Expectations 3 – 5 Years

Local investors are looking for hope to make up for poor returns after the lost years of 2015 -2019 and the subsequent Corona crash of 2020.

The table below shows the expected annual asset class return expectations over the next 3 – 5 years. The large well-known asset managers are shown first. What we can see is that they are positive about the possibility of attractive returns over the next 3 – 5 years from the various asset classes with the exception of global bonds.

The boutique asset managers support the consensus view of the large asset managers.

expected annual asset class return expectations over the next 3 – 5 years

What does this all mean to someone who just wants the bottom line? The table below is the average return expectation taken from the above managers. It has then been put into a bear case (more pessimistic), base case (central expectation) and a bull case (more optimistic).

Annualised Average Of All External Asset Class Return Expectations Considered

These return expectations may in part be contrary to what we may see and expect on the ground as the South African economy seemingly claws its way back from the precipitous brink of systematic state failures. A diversified portfolio is now essential to participating in the recovery over the next 3 – 5 years.

It’s important to have the correct expectation of the nature in which this return may materialise over the coming years. There is a consensus that the return profile over the next 3 – 5 years could be exceedingly volatile (large moves in the price, both up and down).

“We don’t have to be smarter than the rest, we have to be more disciplined than the rest.”
Warren Buffett

FORWARD OUTLOOK (LOCAL)

The forward outlook for the local stock market is uncertain over the remainder of 2020. We have benefitted from a strong recovery from the low point which we saw in March. The long-term outlook for returns, remains positive however investors tend to crave insight into the possibilities over the short-term.

The quote below represents the sentiment of many asset managers and research analysts.

“As things stand, we have plenty valuation support in our portfolios; it’s the cycle that we’re grappling with. Are we witnessing the early stages of synchronised global growth? Will that growth be explosive or gradual? And will the macroeconomic relationships of old still hold their ground in this new world?”
Obsidian Quarterly Commentary – Q2 2020: A rebound reserved for a few

We don’t know if the stock market will continue to rally over the next quarter however asset managers are aware of the concerns around another fall in the market.

The most notable immediate concern for the local environment is the course and nature of the Coronavirus pandemic over the next 3-6 months. The danger isn’t that of a second wave (an inevitable occurrence) but rather how the government will respond. Another series of “hard lockdowns” could see a complete collapse in a number of industries which are already fully stretched. As per the announcement from the president on the 12th of July, the infection rate is increasing at an exponential rate which could suggest harsher lockdown conditions but his sentiment to suggest that it may cause more damage through harsher economic consequences, comes as a relief to the local economy. There may well be a compelling argument to avoid harsher lockdown conditions in order to save lives over the long-term.

The state of the local economy is the worst that we have seen it since the dawn of our democracy. We are likely to see hard times ahead of us as politicians are urged to consider implementing much needed policy reforms which be necessary for an improvement in the health of our economy.

Despite the rather negative outlook, asset managers are aware of the dangers and they are positioning themselves accordingly whilst balancing the compelling opportunities which present themselves to a patient investor.

“The correct forecasting of complex global macro outcomes is almost impossible (as recent events bear testament to). Even if it were, positioning an investment portfolio precisely for such an outcome is even more challenging. We therefore do not believe it appropriate to position the portfolio for any single event. Rather we maintain a balance of exposures which offers protection against a range of potential outcomes. As always, we remain unwavering in our commitment to growing your capital in a judicious and discriminate manner.”
Ninety One (formally Investec Asset Management): Positioned for a range of outcomes

OFFSHORE MARKETS IN A NUTSHELL

Global markets have recovered from the first quarter crash with the MSCI World Index gaining 19.54% in USD over the second quarter of 2020. Governments and central banks are doing everything they can to provide relief as well as stimulating their economies. The market has responded positively to this supportive sentiment.

The graph below represents the World Equity Index over 5 years in dollar terms.
World Equity Index over 5 years in dollar terms

The recovery over the quarter has seen mixed results as the US lead the recovery with 21.76% led by the large tech stocks. The UK had a modest recovery of 8.17% with the EU recovering by 13.40%.

To the East, Japan gained 11.57% while China gained 15.33%.

“OPTIMISTIC YET CAUTIOUS”

Upon reviewing the views of various asset managers and research houses, we see a surprisingly consensus view pointing to being optimistic about the future and yet cautious about the unknown unknowns.

Now that we have seen a strong recovery from the March lows, what’s next for global markets?

In short, the answer to the question is mirrored by one word – uncertainty.

The sentiments of various institutions could be summarised into the following points:

  • We may have seen the worst: This is of course subject to a scenario where economies don’t regress into another hard lockdown which could cause further severe economic distress.
  • The economic recovery is likely to be U shaped: little economic recovery is forecast for the remainder of 2020. The U shape is indicative of a large fall in economic activity followed by a period of stagnant economic activity and thereafter an economic recovery.
  • Positive economic data is coming out: As economies reopen, we are starting to see an increase in economic activity as well as a reduction in the unemployment rates in developed countries.
  • Optimism and caution: There is a lot to be optimistic about going forward. However, exogeneous events such as a large-scale resurgence in infection rates, heightened geopolitical tension (US – China) and the outcome of the US election provide reason for caution.
  • There’s no playbook for a recession such as this: This time may be different. Several asset managers have commented on the fact that there is no playbook for a recession where the global economy grinds to a halt at the speed, magnitude and length at which we have seen in the second quarter of 2020.

In order to illustrate the views of the various institutions, we have quoted both optimistic and cautionary comments.

Institution Optimism Caution
Fidelity

Jurrien Timmer
Director of Global Macro for Fidelity Management & Research Company

Historically, what we see in the S&P 500 today—big price gains combined with a large retracement after a decline, and strong market breadth—has nearly always indicated the beginning of a bull market. I am sticking with my thesis that the lows are in, but that the market is not a layup from here. While a repeat of the Great Depression seems unlikely, it is good to at least be aware that the strength of the rally so far does not guarantee a continued bullish outcome.
BlackRock – Taking Stock

Tony DeSpirito

Chief Investment Officer,
U.S. Fundamental Active Equity
We see equal reasons for caution and optimism as we enter the second half of 2020. The economic and market metrics are now trending in the right direction While we are unlikely to retest the March lows, the market has moved very far, very fast. It is prudent to prepare for further volatility.
Pimco – Building Resiliency Amid Uncertainty

Erin Browne
Portfolio Manager, Multi-Asset Strategies

Geraldine Sundstrom
Portfolio Manager, Asset Allocation

Under the optimistic scenario, the rapid development of a medical treatment for the virus would enable economies to re-open and normalize more quickly than is currently anticipated. The pessimistic scenario involves a strong and widespread second wave of the virus that forces governments to renew social distancing policies. This could lead to a double-dip recession and result in permanent business closures and job losses.
Capital Group – Mid-year outlook: Navigating volatility on the road to economic recovery

Martyn Hole

Equity investment director Based in London

Peter Becker, CFA
Fixed income investment director Based in London

“This is different than the 2008 financial crisis — we can see the other side of the valley, what recovery can look like when policies are relaxed, and that to me is reassuring.” Risk assets should be well-supported by the monetary stimulus but could be vulnerable if we get a second wave of the coronavirus with new shutdowns.
UBS – Reset for the recovery

Chief Investment Office Global Wealth Management Investment Research

Now is the time for investors to “reset for the recovery.” Although financial markets have recovered the majority of their losses, we have entered a new paradigm.
We see further upside for stocks in both our central and upside scenarios.
We expect higher volatility to continue, and see it as a challenge for investors at a time when traditional portfolio hedges have such low yields.
A key long-term cost of elevated volatility is that it can trigger indecision and leave investors stuck in “safe” but low-yielding assets for extended periods. But volatility can also present opportunities provided investors act with discipline.
Schroders – Why we think the recovery will be U-shaped &
Global market perspective

Keith Wade

Chief Economist & Strategist

Tina Fong, CFA
Strategist

Some of the data suggests we are past the worst. Q3 should see something of a bounce in activity, albeit to a lesser extent than we had previously anticipated. On a global basis, activity in the second quarter is likely to be as bad if not more severe than in the first quarter, as the lockdowns extended through April into May.
In terms of the likelihood of risks to our central view, we see the W-shape recovery as the greatest concern. This involves the return of the virus later in the year leading to a second wave of lockdowns such that there is a double-dip of global activity.
Franklin Templeton – Midyear outlook: Risk, recovery and
new market realities
The low point has probably passed for many economies.
Despite a heightened level of uncertainty, we believe expectations have largely caught up with the true depth of economic damage that had been suffered.
However, the pace and nature of recovery remains more uncertain than usual.

We anticipate a more drawn-out gradual recovery.

BCA Research

Mathieu Savary
Global Strategist, BCA Research

As a result, while the souring Sino-US relationship could cause a correction, it is unlikely to be greater than -5% to -10%. A re-test of the March 23 bottom is a low probability event. The expected growth of long-term cash flows embedded in the S&P 500 price is still extremely depressed.
T. ROWE PRICE – Insights
2020 Midyear Market Outlook:

Robert W. Sharps
Group CIO and Head of Investments

Justin Thomson
CIO, Equity

Mark Vaselkiv
CIO, Fixed Income

Looking ahead to the second half of 2020, investors should expect more gradual recoveries in risk assets—not a continuation of the powerful rallies that lifted markets off their March lows, the three T. Rowe Price leaders say. Thomson says he is relatively optimistic about the second half outlook, although markets could be “choppy” at times. With much of the anticipated benefits of stimulus already priced into risk assets, economic fundamentals will have to take over for broad markets to move higher, Sharps says. “I think the going will be tougher from here.”

What does this mean for your portfolio?

Acknowledging an uncertain outlook going forward, it’s important for us to acknowledge that the fund managers within one’s portfolio are in the best position to navigate these unprecedented times.

FORWARD OUTLOOK (OFFSHORE)

The forward outlook for offshore assets is uncertain. On one hand there is significant potential for a strong recovery in several industries which have been resilient to the global shutdown. Other sectors of the global economy are likely to continue to suffer in the wake of the virus.

Several factors may come into play over the coming months which could either have a negative or positive effect on GDP as well as the return on the stock market. The search for a vaccine is underway however finding a vaccine is one thing, mass producing it and distributing it to the global population is another.

There is a consensus view that governments and central banks around the world, are likely to continue to be supportive in their policies which is a good thing for the local economy and the local stock market, at least for the next several years.

The commonly held concern which is at the forefront of the discussions with various asset managers is the effect the virus can have on the global economy should we see a large scale second wave and a series of hard lockdown which haven’t been priced into the market. The world seemingly accepts the fact that we will see a second wave of infections. However, there seems to be a lack of soberness when it comes to taking precautions in the fight against the virus. There has been a rise in anti-mask movements is the US, UK and indeed parts of Africa.

There is likely to be consistent volatility going forward. We define volatility as “the measure of the day-to-day percentage difference in the price of the commodity such as stocks.”

As stated in the quote below, the global economy has declined rapidly to perhaps rival that of the Great Depression. Just as we saw from the Dotcom Bubble and the Global Financial Crisis, the global economy will have to take a steady yet purpose-driven trek to regain the lost ground.

“The economy rode the elevator down but will have to climb the stairs back up”
Federal Reserve Bank of Richmond President Thomas Barkin

Decisions that are made in the short term based on fear or greed and not sound financial planning principles, could lead to poor long-term outcomes. Stay the course and adhere to sound financial planning principles.