Market Commentary

 

Ideas001

 

By Zahira Osman – Portfolio Manager

Global Overview

Developed Markets: Easing momentum, a more dovish stance and Brexit developments

Following the resurgence of global growth in 2017, we saw the latter part of 2018 showing signs of a slowdown, indicative that the global economic cycle had peaked.  This has continued into the first quarter of 2019 with global industrial production (IP) declining since October last year, symptomatic of lowered activity levels.  There has also been growing uneasiness due to trade tensions between the United States (US) and China, which have further weighed on global capex and trade.  Trade negotiations have intensified uncertainty, impacting exports from both economies.  Any US-China trade resolution will provide a much needed boost to global sentiment.

The pace of expansion in the US is likely to moderate even further with the result that the Fed looks to be pausing its interest rate hiking cycle this year, as signalled in the most recent Federal Open Market Committee (FOMC) meeting.  Fed funds futures are even pricing in a cut in 2019.

The latest Eurozone Purchasing Manufacturing Index (PMI) print fell to its lowest level since April 2012, primarily driven by manufacturing in Germany.  At its March meeting, the European Central Bank (ECB) also announced that it would hold policy rates this year, with rate normalisation only likely in 2020.

In the United Kingdom (UK), the economy continues to face challenges post the prolonged volatility of the Sterling due to Brexit developments.  Brexit events have taken centre stage this quarter, with a series of votes being tabled in parliament.  Theresa May’s proposed Brexit deal saw a 149 vote defeat during the second meaningful vote, increasing the risk of a no deal.  As per the request of the UK, the European Union (EU) has granted a deferral beyond the end of March.  Currently, a number of indicative votes are underway to assess views on the UK leaving and alternate Brexit models.

Uncertainty and fears of a global turndown have seen risk-off trades in favour of bonds this quarter, with circa 20% of global investment-grade debt now once again negative yielding.  Whilst an imminent recession is not on the cards, the global economy is likely to see growth fading, with the result that bolstering economic activity is fast becoming a central bank imperative. 

Commodities: Continued momentum

In spite of waning growth, the commodity price rally seen in the final quarter of 2018 has extended into 2019.  A trade war resolution is likely to benefit commodity prices further.

After the Saudi-led supply spike and subsequent collapse in oil prices late last year, brent crude prices have recovered +27.1% this quarter as the Organisation of the Petroleum Exporting Countries (OPEC) and Russia have recommenced their disciplined supply curtailment.

Within the precious metals basket, the palladium-platinum divergence persists. Since August 2018, palladium has surged 80% as it continues to experience dwindling inventories.  This quarter saw a +9.5% increase, despite a sharp pullback in March.  As China adopts stricter emissions standards, increased platinum group metals (PGM) loadings is likely to keep the market tight.  Gold performance was marginal this quarter.

Iron-ore prices were boosted during the quarter following the Vale tailings dam failure in January, and the ensuing production stoppages.

Emerging Markets:  Underperforming developed market peers

Given the global uncertainty this quarter, general risk-off sentiment has benefitted safe haven assets, with the result that emerging markets (EM) have lagged their developed market counterparts.  In US dollar terms, the MSCI EM was up +9.6%, trailing the MSCI World Free which was up +12.6%.  Within EM, South Africa (SA) continued to underperform in US dollars (+5.4%) on the back of weaker economic growth, which has been exacerbated by load shedding concerns.  Year-to-date (YTD) SA equities have seen outflows of $2.3bn, offset somewhat by bond inflows of $0.5bn.  Negative sentiment towards EM remains amidst Turkey’s recessionary pressures. 

SA Overview

SA growth under pressure, aggravated by load shedding, but credit rating maintained

Key economic indicators and energy pressures have led to a downward revision to growth expectations.  Notably, poor vehicle and retail sales have highlighted the frailty of the consumer.  Alongside a weak consumer, lower inflation expectations and global dovishness, the South African Reserve Bank (SARB) kept rates unchanged.

Given this backdrop, credit downgrade concerns have been abound, with the Moody’s review scheduled at the end of the quarter.  One of the key risks to our rating has been the fiscal deterioration over recent years.  Softer economic growth, coupled with a growing debt balance, has considerably widened the budget deficit despite attempts by government to stimulate growth and reign in expenditure.  The recent onset of widespread load shedding has also impacted the growth and investment outlook.  Eskom faces operational challenges as well as immense financial constraints due to its unsustainably high debt levels.  Continued disruption to power supply will have far-reaching negative repercussions in an already distressed economy.   Whilst providing limited relief for consumption expenditure, the budget went some way to address some of these issues through fiscal austerity and energy reform.  Notwithstanding the poor economic backdrop and load shedding struggles, Moody’s has made no changes to our outlook. 

Given the precarious state of the economy and the lack of global risk appetite, it is not surprising that the Rand weakened -0.9% and -18.3% respectively relative to the US dollar over last quarter and year ended March 2019. 

Local Market Review: Resources continue to outperform

Despite EM pessimism, SA equities posted a strong quarter (+8.0%), ahead of SA bonds (+3.8%), SA property (+1.3%), and SA cash (+1.7%). 

Equity performance was once again led by resources, which gained +17.8% during the quarter.  This was underpinned by robust performances from the industrial metals (+54.9%), platinum (+49.7%) and general mining (+22.4%) sub-sectors.  Platinum continues to surge, posting a +117.8% return for the year ended March 2019.  During the quarter, Impala Platinum (IMP) increased +66.3%, followed by Sibanye (SGL) +57%, Northam Platinum (NHM) +46.8% and Anglo American Platinum (AMS) +38.2%, underscored by an increase in PGM basket prices.  Since January 2018, rhodium and palladium prices having meaningfully outperformed most industrial commodities.  Including jewellery and investment demand, the 3PGM basket is in structural deficit which should continue to support prices.  With palladium and rhodium markets tight, any switch into platinum should provide further impetus to the sector.

Industrials posted a quarterly return of +7.4%, driven by a strong rebound in tobacco and beverages.  Following a very weak performance in 2018 (-39.3%), British American Tobacco (BTI) advanced +29.5% this quarter.  Valuation became extremely attractive towards the back end of last year and some of the regulatory concerns were lessened with the exit of the US Food and Drug Administration (FDA) head.  Furthermore, the business is operationally sound and margin enhancement remains on track, supporting superior cash generation and a growing dividend.  Anheuser-Busch Inbev (ANH) ran +26.7% on solid numbers and a beat on EBITDA.  Despite Chinese gaming regulation and Tencent’s growth slowing, index heavy-weight Naspers (NPN) posted a +18.8% return.  NPN, however, saw a limited price action towards the end of the quarter when it announced its intention to separately list the international internet businesses. 

Investor concerns about the initial overhang from Multichoice (MCG) from the international shareholder base were short-lived, as the counter gained +14.9% during March after its unbundling and listing on the JSE in February.  Large asset managers in SA have also since been building sizeable positions in the counter, which ranks well on quality and management.  Assuming management can successfully execute on their growth and subscriber acquisition strategy, the investment case in Africa is particularly attractive, barring any macro shocks.

On the downside, pharmaceuticals and biotech lost -28.2% during the quarter, as Aspen (APN) continued its fall from grace (-31.0%).  The market has increasingly focused on their deteriorating earnings quality and inability to manage the high level of indebtedness.  General retailers also took a hammering this quarter (-14.2%) as festive season trading disappointed.  Apparel retailers Mr Price (MRP) and Truworths (TRU) shed -23.0% and -18.4% respectively, whilst Woolworths (WHL) and Massmart (MSM) lost -14.0% and -21.9% respectively.  WHL continues to bear the brunt of its poor capital allocation decisions, having taken the decision to forego the dividend from the Australian business until debt obligations are reduced.  MSM has suffered slowing top-line and margin pressures.  Prospects for the sector remain subdued owing to constrained consumer spending, employment headwinds and low confidence levels.

Financials were the laggard this quarter, recording a paltry -0.4%.  Banks and life insurance retreated -0.8% and -5.5% respectively.  As with retailers, banks are facing top-line pressures given the lacklustre domestic outlook with the market wary of higher impairment charges and corporate defaults in the near-term.  Most banks have missed slightly relative to consensus expectations during the latest results season.  Standard Bank (SBK) outperformed its peers this quarter gaining +3.6% compared to Nedbank (NED) -8.5% Absa (ABG) -6.0%, and FirstRand (FSR) -4.0%.   FSR continues its underlying operational momentum delivering best in class returns.  The rest of Africa division in SBK has assisted in cushioning the slowdown in SA.  As a result of the revenue pressures, management across the sector have indicated that cost to income ratios will be a key focus going forward.  Life insurers also regressed this quarter, with Discovery (DSY) -13.8%, Liberty Holdings (LBH) down -8.2% and Sanlam (SLM) down -7.6%.  DSY delivered a weak operational result, missing its ROE target due to increased costs and investments associated with new initiatives.  Investors have become increasingly concerned with cash flows.  Both LBH and SLM also saw full year results disappointing.

Property was the worst performing asset class this quarter, returning 1.3%.   Fortress Reit (FFB) was one of the worst performers in the market, falling 20.3% on the back of negative growth in its dividend per share (DPS), lowered full year guidance and the failed proposed asset swap with Resilient (RES).  Shares with a large exposure to retail assets have come under severe pressure, not least due to the weaker consumer environment, but also as a result of Edcon’s 41% rent reduction for 2 years.  Within SA, Hyprop (HYP) is most exposed at 9.6% of retail gross lettable area.   HYP lost -8.8% this quarter.

Data Sources:

Bloomberg, Factset, SBG Securities, Avior