Market Commentary

 

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4Q19 Market Commentary

By Zahira Osman, Portfolio Manager

 

Global Overview

Developed Markets: Improved outlook for industrial production as trade tensions ease, but heightened geopolitical tensions

2019 saw a slowdown in global GDP to +2.7% (from +3.2% in 2018) with estimated industrial production (IP) below historical norms at +1.5%.  Global trade volumes languished due to trade war uncertainties and were further impacted by exceptional declines in global auto sales.  Recessionary fears led to a broad-based easing monetary stance, with both the Federal Reserve (Fed) and European Central Bank (ECB) cutting rates post their hiking cycle and asset repurchase programme in 2018.

After almost two years of prolonged trade war volatility impacting global economic growth and sentiment through multiple tariff increases and policy uncertainty, a “Phase One” deal has finally been agreed in principle. The deal, which is meant to be signed on 15th January 2020, is expected to roll back the tariffs and aims to bolster Chinese purchases of manufactured goods, agriculture, energy and services from the United States (US).  Furthermore, the deal is likely to address intellectual property protections and the stability of the Yuan. This greatly enhances the outlook for global IP momentum which should be positive for risk assets in an all-important US election year.  Coupled with a trough in IP and more supportive monetary policy, we should see a global industrial recovery into 2020.

In the US, the pace of expansion moderated in 2019 as business confidence and investment was hampered by trade volatilities.  Consumer spending however remained robust with household balance sheets and labour markets remaining strong.  Fed policy is likely to remain on hold during 2020 given the balance of risks and the inflation outlook.  The 2020 election is likely to add some uncertainty, especially as members of the House recently voted to impeach President Trump (Trump) on abuse of power and obstructing Congress.

The Euro region saw slower growth over the past two years due to global trade headwinds affecting exports as well as challenges in the auto sector.  The latter was affected by falling production amidst stricter emission standards.  A recovery in global IP and trade should strengthen Euro growth in 2020, with demand underpinned by looser monetary conditions and low policy rates.

The election of Boris Johnson’s Conservatives has meant that protracted Brexit uncertainty has reached finality with a prospective orderly Brexit Withdrawal Deal seeing the UK exiting the EU by end January 2020 and a transition period until year-end to agree an exhaustive trade deal.  The Sterling strengthened +7.5% relative to the US dollar during the quarter, reflective of the friendlier Brexit outcome.  The UK economic backdrop saw a difficult 2019 due to Brexit and trade war fears but should see a rebound on fiscal stimulus and improved global trade.

Whilst tensions have eased between the US and China, escalating geopolitical pressures between the US and Iran post the 2019-year end could dampen global sentiment in the short-term.  Relations between the two have been frosty since Trump’s withdrawal from the 2015 Iran nuclear deal and the imposition of severe sanctions.  The situation deteriorated immensely when the US ordered the assassination of General Qasem Soleimani, Iran’s most important military leader.  The retaliatory toing and froing has continued since between both parties.

Commodities: PGM prices continue to soar

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

Brent crude prices rose +22.7% for the year, spiking post year-end due to the US-Iran conflict, trade war resolution and the Organisation of the Petroleum Exporting Countries’ (OPEC’s) recommencement of supply curtailment.

Palladium and platinum commodity prices rose +50.0% and +21.5% respectively during the year.  The platinum group metals (PGM) basket had a strong start to the year, recently hitting multi-year highs with this momentum set to continue due to tight supply and demand dynamics, especially in the wake of recovering auto demand.

Gold prices remained resilient last year, climbing +18.3% as a hedge against the ongoing trade dispute.  Risk-off sentiment should continue to buoy prices as US-Iran tensions intensify.  Investor appeal should remain given accommodative monetary conditions, elevated equity valuations and uncertainties around Brexit and the US elections towards the latter part of 2020.

Iron-ore prices rallied sharply during the former part of the year following the Vale tailings dam failure and ensuing production disruptions.  Recent months however saw a retracing of some of these gains as the market expects to shift into surplus on supply recovery.

Emerging Markets:  Underperformed developed market peers, but outlook improved

Emerging markets (EM) lagged their developed market (DM) counterparts during 2019.  In US dollar terms, the MSCI EM was up +18.9%, trailing the MSCI World which was up +28.4%.  Within EM, South Africa (SA) continued to underperform in US dollars (+10.7%) due to investor concerns around much needed sustainable structural reforms.  Notwithstanding SA bond inflows of $1.0bn in 4Q19, the year saw SA equities and bond outflows of $8.7bn and $1.4bn respectively.

As the financial stresses in Turkey and Argentina lessen, EM economic activity should stabilise or improve.  De-escalating trade uncertainties, diminishing global recessionary fears and looser financial conditions should support growth.

SA Overview

SA in need of major structural reforms; credit rating at risk

Weak GDP growth persisted for much of the year.  Consumers continue to face headwinds with unemployment at stubbornly high levels and a deceleration in private sector wage growth.  The outlook remains precarious as corporate SA downsizes, suggesting little to no incentive to invest.  Furthermore, IP has been unrelentingly weak and has been exacerbated by the relapse of power outages during the year. Consumer and business confidence therefore remain depressed.

2019 saw some of SA’s most challenged state-owned enterprises (SOE’s) in the line of fire due to bloated debt balances and an inability to operate sustainably.  The SA government took decisive action by placing South African Airways (SAA) in business rescue whilst providing Eskom with a bail-out and inviting private sector power generation submissions.

The onset of the unprecedented Stage 6 load-shedding occurrence in early December 2019 and the resumption of rotational blackouts in early January 2020 once again highlighted the huge operational and financial issues faced by Eskom.  Even with financial assistance and new management at the helm, it is unlikely that these challenges will be resolved in the short-term due to structural flaws at the new power stations and increased stoppages at older ones, where maintenance has been less than adequate.

The above has resulted in large fiscal and external imbalances, making it difficult for government to address the weak growth environment through meaningful investment, both of which are increasing the risk of a credit downgrade by Moody’s.  The South African Reserve Bank (SARB) maintained a cautious view on policy rates in 2019 relative to global peers given these considerations.

Despite the poor growth outlook and looming credit downgrade, the Rand appreciated by +2.6% against the Dollar during 2019 and was the best performing EM currency during 4Q19, advancing +8.2%.  Local bond yields appear to be discounting the poor fundamentals and more challenging fiscal outlook.

Local Market Review: Resources continue to outperform

During 2019, SA equities (All Share Index) delivered a solid +12.1%, ahead of SA bonds (+10.3%) and SA cash (+7.3%).  SA property was the worst performing asset class, returning a paltry +1.9%, following a dismal 2018 (-25.3%). 

Equity performance was once again led by resources, which advanced +28.6% during 2019. This was underpinned by robust performances from the platinum (+202.9%), gold mining (+107.7%) and industrial metals (+56.9%) sub-sectors.  During the quarter, Sibanye Gold increased +71.1%, followed by Impala Platinum +50.6%, Northam Platinum +48.7% and Anglo-American Platinum +43.2%, underscored by improved fundamentals and a resultant increase in PGM basket prices.  Since January 2018, rhodium and palladium prices having meaningfully outperformed most industrial commodities.  Including jewellery and investment demand, the PGM 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 an annual return of +8.9%, driven by a strong rebound in tobacco and beverages.  Following a very weak performance in 2018 (-40.0%), British American Tobacco advanced +36.2% this year.  Valuation had become extremely attractive and some of the regulatory concerns were tempered with the exit of the Head of the US Food and Drug Administration.  Furthermore, the business is operationally sound and margin enhancement remains on track, supporting superior cash generation and a growing dividend.  Anheuser-Busch Inbev increased +23.8% during 2019 given improved fundamentals and underlying trends in key markets as, well as improved balance sheet strength with a target of less than 4x leverage in their next financial year (FY20).  Index heavy-weight Naspers (NPN) posted a +20.0% return for the year despite having a flat quarter (-0.2%) post the separate listing of the international internet businesses through Prosus (PRX).  The unbundling thus far has been a disappointment as it has not led to a re-rating of the PRX assets or a narrowing of the NPN holding company discount.  The PRX share price also came under pressure as it increased its offer of Just Eat, a food delivery company, multiple times in response to a competing bid from Takeaway.com.

On the downside, fixed line telecoms regressed massively during the second half of the year following a strong first half.  For the quarter Telkom (TKG) regressed -49.9% as they contend with high gearing amidst slower growth and increased capex and spectrum requirements.  If mobile network operators are indeed forced to reduce data prices, the TKG investment case becomes increasingly unsteady.

The travel and leisure sub-sector also took a hammering this year (-23.8%), reflective of the downturn in the local economy.  City Lodge regressed -40.9% on disappointing results as occupancies across both SA and Africa continued to deteriorate.  Coupled with below inflationary room rate increases, top-line was under pressure.   General retailers ended the year down -18.4%.  Apparel retailers Truworths and Mr Price shed -40.8% and –23.0%, whilst Massmart and Woolworths lost -49.5% and –8.5% respectively, as they too struggled with top-line pressures.  Prospects for the sub-sector remain subdued owing to constrained consumer spending, employment headwinds and low confidence levels.  We currently await their Black Friday and festive trading updates, which will ultimately drive their full year operational outcomes. 

Financials were the laggard this year, recording sub-par growth of +0.6%.  Banks saw a flat performance for the year (+0.2%), whilst life insurance retreated -3.0%.  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.  Nedbank fell -17.3% during the year, underperforming sector peers on investor fears around their commercial property exposure to Rebosis (REB) and Delta Group and hence a potential blow-out in bad debts.  Within the life insurers segment, Discovery (DSY) retraced -23.2% during the year.  Whist DSY posted encouraging full year results, investors have become increasingly concerned with cash flows and policy assumptions.  Returns on capital remain subdued due to the increased investments associated with new initiatives.

Property was the worst performing asset class during 2019, returning +1.9%.   Overdevelopment in the retail and office segments has led to increasing vacancies and negative rental reversions.  Coupled with ballooning administered prices, distributable income has come under increasing pressure. REB was one of the worst performers in the market, falling -88.1% due its failed UK investment, asset write-downs, excessive loan-to-value and inability to grow net property income, which saw distributable income falling -71.4%. 

Sources:

Bloomberg, Refinitiv Datastream, SBG Securities, Avior, Macquarie, Credit Suisse, MRB Economics