Market Commentary – July 2020




2Q20 Market Commentary

By Mila Mafanya – CEO, Head of Equities

Bulls overpower Bears

The 21.6% rally in local equity markets in the second quarter showed a significant reversal of the investor pessimism that resulted in equity markets plunging 16.7% in the first quarter and entering the first bear market since the Global Financial Crisis (‘GFC’) in 2008.

Since the onset of the COVID-19 crisis the fortunes of the market have largely been driven by investors’ fixation with tracking the trajectory of global corona virus active cases as well as monetary and fiscal responses from global policy makers aimed at softening the economic fallout from this health crisis.

During the first quarter, as the COVID-19 crisis escalated from an epidemic originated in China that soon spread to a pandemic with epicenters in Europe and the United States (‘US’), investors fled risk assets which created heightened volatility and led to one of the swiftest equity bear markets on recent record. Towards the end of March, as equity markets approached valuation lows last seen in the GFC, the raft of monetary and policy stimulus packages announced by central banks and governments put a floor on equity market levels triggering the current bear market rally. 

As government-imposed lockdowns began to flatten the COVID-19 active cases in mid-April, largely driven by active case declines in China and Europe, the equity market rally was given more fuel as investors became more risk seeking. While technology, healthcare and consumer staples were defensive in the bear market contraction from late February through to the third week of March, these same stocks also led the market out of the initial market rally in late March and early April. This renewed investor enthusiasm soon spread to more cyclical sectors which propelled the equity market rally through to early June. The impending threat of a ‘second wave’ of COVID-19 is visible in rapidly rising active cases in Latin America and a resurgence of active cases in the US in particular. This threat kept a lid on markets for the latter part of June as equity markets largely traded side-ways.

Wall Street trumps Main Street

The second quarter has also shown a growing divide between equity markets, colloquially referred to as Wall Street, and the real economy, which is informally known as Main Street.

Wall Street has taken its cues from an expectation that the worst of the COVID-19 health crisis is behind us and an appreciation that the stimulus packages committed by policy makers are visibly inflating asset prices. Whilst equity markets plunged 36% from peak levels prior to COVID-19, equity market valuations have re-rated from the trough levels seen in late March 2020 to an equity market level which is now only 10-15% off levels prior to COVID-19.

Main Street on the other hand is still to be dealt its fate, as the full effects of the economic crisis induced by COVID-19 are still unknown. The two main considerations in assessing the economic effects of the crisis centre around passing judgement on the extent and duration of the economic fallout from COVID-19.

The consensual view has been that the extent of the economic contraction is likely to far exceed the recession experienced in the GFC crisis and is probably more comparable to the Great Depression of the 1930s. Asian countries, whose economies were afflicted by government-imposed lockdowns in the first quarter, have already released their first quarter economic prints in the second quarter, confirming the deeper than GFC levels of economic contraction. The rest of the world, whilst impacted by linkages to Chinese supply chain disruptions in the first quarter, only began to be economically impacted in a meaningful way in the second quarter with economic releases only due in the third quarter. Soaring unemployment levels in the US in the second quarter point to an economic contraction that also confirms a worse than GFC economic contraction.

The duration of the economic contraction is a more debated topic as the path to economy recovery will depend on the risk of second waves of COVID-19 infections , time elapse before a vaccine is found or herd immunity is reached for the virus and enduring economic effects of the health crisis. Early indications from Asian economies indicate that the recovery 3 months after the lifting of lockdowns has been to around 85% of the economic activity levels prior to COVID-19. While the shape of the recovery remains uncertain many economists expect that the global economy is likely to recover to 2019 economic levels only in 2021 to 2022.

SA romps ahead of the pack

SA equity markets delivered strong US dollar returns of 27.5% in the quarter which were 2nd best returns in emerging markets and comparable with the best performing developed markets.  

For local investors SA equities notched up impressive returns of 21.6% in rands, which are the best quarterly returns since 2000. From an asset class lens the asset class performance in the quarter reflecting the risk-on environment with equities outperforming property, bonds and cash which delivered 20.4%, 9.9% and 1.5% respectively.

The sector performance of SA equities also demonstrated the risk-seeking nature of the market; with resources as a more cyclical sector delivering returns of 41.2% which significantly surpassed the 16.2% returns generated industrials, which are a mix of defensive and cyclical sub-sectors. The performance of these two sectors was a reversal of the performance seen in the first quarter where resources led the down-leg of the market with industrials proving more resilient. Financials recorded returns of 12.9% for the second quarter, maintaining their laggard position for two consecutive quarters as they remain out of favour.

At a stock level the outperformers in the quarter were largely characterized by a resurgence of shares that had been casualties of the bear market correction in the previous quarter.

Sasol (‘SOL’), which was the biggest underperformer in the previous quarter having fallen 80%, staged a remarkable recovery as the price surged 258% confirming its position as the top performing share for the quarter. The share price reacted to the strong resurgence of the Brent crude oil price by 81% to $40.9 per barrel by quarter end and the announcement of a restructure, assess disposal and recapitalisation plan to address the onerous debt load on the balance sheet.

The platinum mining index, which had retraced 44.1% in the previous quarter, rose 62% in this three- month period in a broad-based rally across the sub-sector. The market concerns over COVID-19 induced auto demand declines partially dissipated with the re-opening of the global economy with a renewed expectation that palladium and rhodium markets could return to price supportive deficits in 2021.

General miners advanced 31.9% in the quarter as iron-ore price gained further momentum and copper prices reversed some of their prior quarter losses. The iron-ore and copper price support is courtesy of supply disruptions at large mines in Brazil and Chile respectively, as the COVID outbreak in Latin America continues to accelerate. African Rainbow Minerals (‘ARI’), Kumba Iron-Ore (‘KIO’), Exxaro (‘EXX’), Anglo American Group (‘AGL’) and BHP Group (‘BHP’) all caught the bid of the supportive iron ore and copper prices with ARI’s return of 67.8% leading the way for the general miners whilst BHP was the laggard amongst the sub-sector with a market beating return of 31.5%.

The notable exceptions to the outperformers stock thematic was the performance of gold mining shares and the Naspers (‘NPN’)/Prosus (‘PRX’) stable. The gold mining index increased 68% in the quarter, remaining amongst the top 5 performing sub-sectors in the market for two consecutive quarters. Year-to-date gold mining shares have rallied 75.8% prompted by its safe-haven appeal in the uncertain economic backdrop and conducive loose global monetary policy that has ensued from COVID-19. The NPN/PRX stable continued its contribution to market leadership with their delivery of returns of 30.3%/23.9% respectively. The NPN/PRX stable benefited from the continued outperformance of global technology shares which has buoyed their associate ownership in Tencent and the anticipated inclusion of PRX in Europe’s STOXX50 index for the June index rebalance which has been deferred to September.

The largest underperformers for the quarter were a mix of defensives shares in the industrial sector, which had proved resilient in the previous quarter. Hospital shares fell 6.0% in the quarter as preparations for COVID-19, cessation of elective surgeries and non-COVID-19 patients’ anxiety to be admitted to hospitals gave rise to a significant drop in admissions and bed utilisations. Food & drug retailers and food producers retraced -2.0% and -1.6% respectively in the quarter amidst an environment of slowing food inflation and government imposed caps on essential food items during the lockdown period.