API Third Quarter Summary 2020

LOCAL MARKETS IN A NUTSHELL

The South African stock market was up over the quarter led predominantly by resource stocks. The JSE All Share Total Return Index gained 1.75% over the quarter.

Chart: Performance of the FTSE/JSE All Share Index over the past ten years (2009/07/01 – 2020/09/30)
Chart: Performance of the FTSE/JSE
Source: Trading economics

The third quarter of 2020 saw a modest recovery on the local stock market on the back of the strong performance in the second quarter. As the local economy attempts a “push start”, aided by a low-interest-rate environment and normalisation of both imports and exports, more action seems to be needed in order to generate investor confidence which will see capital inflows into the market.

Worrying albeit expected economic data has been released regarding the reported job losses in South Africa. According to an article by Christi Nortier of the Daily Maverick “unemployment is now at over 50%, with youth unemployment specifically sitting at around 70%.”

The chart below shows the devastation in the employment rate as we reach levels which we were at in 2008
Chart: Lockdown Produces Unprecedented drop in employment.

Experts say that the worst is now behind us by way of COVID 19 infection rates, however, we now need to rebuild our economy, labour force and healthcare sector. All eyes are on the government as they scramble to find a credible action plan to bolster employment. This comes in the context of trade unions who are planning a one-day strike over job losses.

The economic recovery may be harder than experts initially anticipated.

“The chances of a V-shaped recovery [economic recovery] are probably out of reach and the South African economy will need some form of further stimulus.”
Nedbank economists Busisiwe Radebe and Nicky Weimar

Chart: Sector Performances.

Returns on the local market are likely to come from non-South African companies

Although South Africa has been praised by the WHO for how it has handled the pandemic, we have made more than our fair share of mistakes, which we will pay for going forward. Now that we have flattened the curve, we can start to prioritise our economy which was far from the centre stage over the course of the year. As the cartoon below illustrates, what we did to flatten the curve had an imminent and detrimental effect on the economy. Something which was largely unavoidable, yet further exacerbated by poor decisions.

Chart: COVID Comic.

As the government tries to reignite the economy, companies which derive most of their earnings from non-South African operations (commonly referred to as rand hedged stocks), offer more diversification from the concerns related to the local economy.

Many managers are holding defensive assets such as gold and hedged equity to reduce risk in the current environment.

“While SA equities appear cheap, the medium-term outlook for the SA economy is fraught with uncertainty. In other words, the large margin of safety currently priced into SA equities is well deserved. Commodity producers have a large margin of safety priced in too, but the current global recovery and still weak rand are likely to provide significant support to their share prices, in our view. Within the SA equities universe, we have a clear preference for commodity producers over SA Inc shares.
Rapid global money supply growth raises the possibility of higher-than-expected global inflation down the line. We expect that gold will prove an effective hedge should this play out, while also providing a hedge against a possible increase in SA-specific risk.” Investec Global Investment View, Quarter 3, 2020

All eyes will be on the Finance Minister as he delivers his mid-term budget speech in October. The budget speech is expected to further outline the steps that will to be taken to create jobs and bolster growth. The mid-term budget speech could be an important driver of business confidence, however, the implementation of policy reforms may prove to be a mammoth task to implement.

South Africa’s default trajectory is that of a failed economic state!

“Should I take my money offshore?” A question which is often asked by investors who are fearful of the South African deterioration. Without digressing into a lengthy analysis of the pro’s and con’s of offshore investing, lets rather consider the facts which relate to the underlying issues within the question

The graph below shows the government wage bill (government employees only) as a percentage of the country’s total wage bill (private + public). 30% of the country’s wage bill goes towards paying government employees.

Chart: Government Wage Bill as % of Total SA Wage Bill.

South Africa is quite literally borrowing money to pay its public sector employees. Although the finance minister noted in his February budget speech that government will tackle its bloated public sector wage bill, nothing has been done as a result of the pandemic.

The chart below shows South Africa’s local GDP (growth) since 2013, as well as the forecasted GDP at the end of 2019. The sad reality is that the pandemic has set us back several years by way of lost GDP. As every South African well knows, this is on the back of an already stagnant period of growth in the years leading up to 2020.

Chart: GDP Will Be 5% Below Pre-Recession Levels End 2021.

As an emerging market, the odd wobble every now and then is to be expected when it comes to both business confidence and consumer confidence. As the chart below shows, these things come in cycles. The problem with where we currently sit is that we have never before seen such pessimism in our 26 years of democracy. Without meaningful intervention from government this time may be different?

Chart: SA's Confidence Crises.

Despite the bloated wage bill the chart below is the most worrying for South African Investors. It doesn’t take a mathematician to see that the country has had declining real GDP (growth) since 2011.

Chart: South African Real GDP.

In a Business Times interview with Duncan Artus (the new Chief Investment Officer of Allan Gray), Duncan expresses his concern around the ability of good companies to operate and thrive in a failing economy.

“Over the longer term you can’t have successful companies in a country that fails. The cost of our 10-year government debt is higher than our economy is growing. Just do the maths; it can’t carry on like that. Unless we make some brave economic decisions, it won’t be long. We’re running out of time.”

These comments highlight the concern around the already widely debated questions around holding too much of one’s retirement savings on the local market given the dangers of what may happen if the current status quo is not address.

The government’s actions over the next 6 – 18 months could determine the economic future of the local economy in the following 10 -15 years. Needless to say, the mid term budget speech is going to be vital to our economic outlook going forward.

“After climbing a great hill, one only finds that there are many more hills to climb.”
Nelson Mandela

OUTLOOK (LOCAL)

The outlook for local equities is dependent on several factors not least of which is the US election, a continued recovery in China as well as geopolitics which could affect sentiment around emerging markets. Managers are holding onto defensive rand hedged companies (local listed companies with predominantly foreign earnings) as well as safe haven commodities such as gold and mining companies.

The local economy is in bad shape and in need of desperate reform. The mid term budget speech is going to be a vial starting point not only to pledge addressing immediate issues but to also indicate a timeline of when and how these issues are going to be addressed. Unfortunately, one can’t see exponential growth in companies which operate in an environment where the economy has failed.

Investors need to ensure that they know what their financial plan is and how it is positioned in order for the investor to have confidence to stay the course.

If you don’t know where you’re going, any road will get you there.
Lewis Carroll

OFFSHORE MARKETS IN A NUTSHELL

Global markets have recovered from the first quarter crash with the MSCI World Index gaining 8.05% in USD over the third quarter of 2020. The market is being led predominantly by the large US technology companies which are more commonly referred to as the FAANGM’s (Facebook, Amazon, Apple, Netflix, Google and Microsoft).

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

At the end of the second quarter parts of the global economy gradually started to reopen. Fortunately, the trend has continued throughout the third quarter with further positive economic activity. There have however been questions around “where to from here” with further US stimulus being required.

Money continues to be printed and deployed into the global system by central banks around the world as a short-term fix, whilst long-term economic policies need to be successfully implemented to further support the global recovery.

The threat of a second wave has remained a concern around the world with minor spikes being reported in a number of countries such as the US, UK, Germany, Italy, Russia whilst significant increases have taken place in countries such as France, Spain and India.

THE US ELECTION IS AT IT AGAIN

The US election is at it again and it promises to be a bumpy ride! From Clinton to Biden, the Democrats certainly can’t be forgiven for their more recent track record of selecting presidential candidates. Unfortunately, given what Biden has suggested by way of policies which he would like to implement, the market sees more questions than answers. Needless to say, he doesn’t strike a great deal of confidence as the alternative to Trump.

Its hard for people to sieve through the “Trump Rhetoric” that employs psychology, mentalism and doubt to manipulate opinions, however, what do the numbers suggest? The charts below show the comparison between the Obama and Trump presidency by way of several important metrics that is often used in political rhetoric.

US Quarterly GDP (Growth Rate)

US Employment Rate

US Balance Of Trade

S&P 500 Performance 2006/10/07 – 2020/10/07

US Consumer Sentiment 2006/10/07 – 2020/10/07

We can see that Trump has been a beneficiary of a growing US economy and a declining unemployment rate which continued through to the end of 2019. The Coronavirus has created an extremely difficult environment for economies around the world. The next US president has an extremely tough job ahead of them over the next presidential term. This fact is well known to the market and thus its prudent for investors to be mindful of the risk of increased volatility in the fourth quarter of 2020.

Regardless of who emerges triumphant as the next US president, markets will digest the news and forge ahead as they have always done.

“Using volatility as a measure of risk is nuts. Risk to us is 1) the risk of permanent loss of capital, or 2) the risk of inadequate returns.”
Charlie Munger – Berkshire Hathaway.

UNCERTAINTY AT ITS BEST! MOST MANAGERS REMAIN NEUTRAL

When reviewing the positioning of offshore multi-asset funds, it becomes apparent that many of them are positioned according to a more neutral stance with few managers taking any high conviction asset allocation calls. In other words, many multi-asset managers are neither overly cautious nor are they overly aggressive.

The two biggest immediate risk factors over the short-term appear to be a second wave of infection and the upcoming US election.

A Second Wave

For the time being a second wave appears less threatening than most people previously anticipated. Treatments have become more effective with most people continuing to utilise masks whilst regularly sanitising their hands. As the global economy began to open, a resurgence in the infection rates was to be expected. The lock down strategy was not intended to eradicate the virus but to rather slow the rate of infection.

The market’s fears revolve around the possibilities that countries may need to go back into lockdown which will further destroy economic activity and thus company earnings.

The news on a vaccine development is promising with experts expecting that a vaccine will be approved before April 2021.

The US Elections

The US elections could have a major impact on the markets over the short-term. If the US election result is contested, we could see a major decline in the US market.

At this point its no wonder that most multi-asset managers are holding onto precious metals such as gold and platinum as a defensive hedge against the numerous risk factors.

The previous article titled “THE US ELECTION IS AT IT AGAIN” discusses the implications of the election in further detail.

Avoiding high conviction calls going into the fourth quarter makes sense.

Some industry experts believe that once we have the US election behind us, we should have more certainty around the matter of a second wave of infections.

At the time of writing, the US congress is in negotiating the latest stimulus deal. If/when approved the stimulus bill is likely to provide further relief to the market.

FORWARD OUTLOOK (OFFSHORE)

The remainder of 2020 is likely to be extremely eventful and potentially extremely volatile, particularly as a result of the US election. For the most part, economies around the world have reverted to levels of economic activity which in some cases is on par with where they were before the pandemic hit. Particular sectors such as airline industry, are still trying to recover but as the graph below shows, the world equity index has largely recovered to its previous high on the basis of low interest rates, large stimulus packages not only in the US but around the world as well as aggressive printing of money.

MSCI World Index

The question of where to from here particularly after the recovery in the world equity index, leaves the market susceptible to poor sentiment or negative market news which could see markets fall from the current levels. Its important to note that sentiment moves markets over the short-term. However, the price of a company inevitably follows its earnings growth over time.

Many managers are holding defensive assets such as gold and hedged equity to reduce the effects of poor sentiment which may manifest over the quarter head.