Market Commentary

 

Ideas001

 

By Mila Mafanya – Head of Equities

2018: A year to forget for emerging markets

In 2018, equity markets suffered the worst year-on-year performance since the aftermath of the global financial crisis, which began in March 2009.  Developed equity markets fell 8.2% in US dollars (‘US$’), recording their worst annual return since 2008, the year they registered a fall of 40.3%. Similarly, emerging markets declined 14.6% in US$ in 2018, closely mirroring the 14.9% correction that manifested in 2015, when emerging markets were shaken by the headwind of a materially strengthening US Dollar (USD) exchange rate.

In the case of emerging market equities, 2018 was in many ways reminiscent of 2015, with strength of the USD exchange rate and slowing global growth providing a challenging backdrop for performance. To compound matters, global markets also spent the better part of 2018 preoccupied with US President Donald Trump’s inspired trade war with China, which caused periodic spikes in volatilities which, in turn, catalysed a few equity market pull backs during the course of the year.

Notwithstanding all these impediments, the US Federal Reserve (‘Fed’) was unwavering in its path of hiking interest rates by 25bps at each quarterly meeting, which pushed the US 10 year government bond yields (‘US 10 year yield’) above the psychological 3.0% level for the first time since 2014. The incessantly higher US 10 year yields kept equity markets in negative territory for the majority of the year, with a brief reprieve notable in equity markets in November when US Fed Governor Jerome Powell hinted that the hiking cycle was nearing its peak.

Landmines shatter local equity returns

On the local front, in the early part of the year the South African Rand exchange rate (‘Rand’) benefited from the euphoria surrounding the election of Cyril Ramaphosa as President of the ruling political party, the African National Congress, in December 2017 and his subsequent ascendency to the Presidency of South Africa (‘SA’) in February 2018. As a consequence, the Rand strengthened sharply from December 2017 to the end of the first quarter of 2018. The stubbornly strong USD, SA’s deteriorating fiscal position and SA’s second quarter recession experienced in the middle of 2018, saw the first quarter’s gains in the Rand more than wiped out in the second quarter, with the Rand finishing the year 13.7% weaker versus the USD.

Notwithstanding that over 60% of the earnings of the Johannesburg Stock Exchange (‘JSE’) are generated offshore, local equities saw little benefit from the weakness in the Rand as investors were consistently peppered by a slew of bad corporate news that triggered a number of sizeable stocks losing significant value during 2018. Combined with the global equity market backdrop, it is no surprise that less than a third of the largest 100 shares on the JSE generated positive returns which led to local equities declining 10.9% in 2018. In the midst of equity market volatility, bonds and cash were the standout winners of 2018 delivering returns of 7.7% and 7.3% respectively. The poor performance of equities was overshadowed only by property shares which dropped by 25.3% in the year.

Resources bucked the trend in 2018, as strong commodity price growth in 2017 carried through to good earnings momentum in 2018.  South African investors were drawn into the attractive valuations of the sector whilst the weakening Rand drove the resource sector 15.0% higher during the year. The sector’s performance was attributable mainly to good showings by the general mining, platinum and gold sub-sectors which delivered returns of 26.8%, 14.4% and 6.3% respectively. General miners were led by the performance of global diversified miners, Anglo American (31.1%) and BHP Billiton (27.5%), which benefited from the conducive environment for the mining sector. Platinum leadership was provided by the JSE’s best performing Top 100 share, Anglo American Platinum, which rallied 54.3% on the back of a higher platinum basket price and restructuring efforts to focus on its highest quality mines. AngloGold Ashanti rose 41.9% during the year due to prospects of an easing mining regime in Tanzania and the appointment of former Barrick Gold president, Kelvin Dushnisky, as Chief Executive Officer. Glencore was the most notable laggard in the sector (-12.7%) as the US Department of Justice launched a subpoena related to Glencore’s conduct in Nigeria, The Democratic Republic of Congo and Venezuela.

Industrials was the worst performing sector in 2018 as many of the sector’s Rand-hedge, heavyweight stocks featured amongst the poorest performing stocks on the JSE. Aspen Pharmacare lost half its value (-50.3%) as the company released disappointing full year results, which cast doubt on the sustainability of the growth priced into the share with the market increasingly focused on the deteriorating earnings quality and their inability to manage their high level of indebtedness. The British American Tobacco share price dropped 43.4%, as the US Food & Drug Authority detailed plans for a menthol ban on cigarettes which impacts a significant portion of the profits in its US subsidiary Reynolds. Mediclinic International’s share price was down 42.2% on increased regulatory pressure in Switzerland and a weaker than expected recovery in the Middle East. Tigerbrands fell 40.5% due to the impacts of the listeriosis outbreak along with deflationary pressures which were driven by an intensely competitive landscape and weak consumer environment.  MTN declined 34.8% as Nigerian regulators laid a claim for $10bn related to alleged improper repatriation of dividends from the West African country. Naspers retraced 16.6% as a consequence of their Chinese associate company Tencent which came under pressure as Chinese gaming regulators suspended the release of any new games in the early part of the year.

Financials were also a casualty in 2018, declining 8.8% for the year, largely attributable to the dismal performance of real estate which plunged 32.2%.  The real estate sub-sector was largely impacted by Resilient stable of companies (Resilient REIT, NEPI Rockcastle, Fortress Income Fund and Lighthouse Capital) which lost circa 40-60% in value as a result of damning governance allegations which included share price manipulation and insider trading. Also contributing to the underperformance of property was the UK listed names: Intu Properties, Hammerson and Capital & Counties, whose share prices dropped 43.7%, 27.9% and 18.9% respectively. Over and above a weak UK retail environment which weighed on UK property share prices, Intu Properties sold off aggressively following a number of failed takeover bids for the company. Holding company Brait continued its share price decline from the previous year (-28.0%), as their investee company, New Look, continued to feel the brunt of the UK retail environment which necessitated a restructure plan.