It’s been an extremely challenging period for global markets. As 2018 came to a close investors were disillusioned and their all-seeing, all-knowing portfolio managers had been humbled. But looking back on the past year is vital when it comes to navigating the next raft of uncertainties awaiting investors.
It tells you something about the bemusement in investing circles that a chart highlighting the JSE All Share Index’s ‘fallen giants’ in 2018 has been so widely circulated over the past few months. It shows that a manager whose style maintained a bias toward the large-cap sector of the Johannesburg Stock Exchange was more than likely to suffer negative returns over the year, regardless of their superior selection decisions.
In 2018, giants such as MTN Group, Aspen Pharmacare and Tiger Brands have seen declines around the 40% mark over the year-to-date, while a few other well-regarded names fell within the >30% range – such as British American Tobacco, Mediclinic International and Woolworths Holdings. At the time of writing, Naspers itself was down 23% since the beginning of the year and, to add insult to injury, not even the well-liked property sector provided much reprieve, also recording a 23% drop for the year.
Given this backdrop, it may be useful to take a step back and examine the environment we’ve just survived and to take a dispassionate view of the uncertainties that persist.
The global situation
From a global economic perspective, it seems that the United States (US) found the last remaining chair at the party. Growth outperformance from this region, while keeping up with a tightening monetary policy stance, resulted in pressure increasing in other corners of the market, particularly in emerging markets. The prospect of rising US bond yields with little-to-no inflation risks (yet) has meant that the US provides real returns of close to a percent – a situation that has not materialised since shortly after the global financial crisis of 2008. Given the lofty levels of company price-earnings (PE) ratio multiples over the past few earnings’ cycles, 2018 has been the year in which investors began to appreciate the lower risk-adjusted returns earned from bonds than from equity markets.
In China, the slowdown in growth indicators seems set to continue into 2019 as the relatively minor ‘targeted easing’ measures seen so far appear to have had little effect. Furthermore, one cannot talk about Chinese economic growth without referring to trade and what has been quite strong – and improving - data. We, however, remain watchful and would regard improving indicators as tariff ‘front-running’ across broader Asian markets and would caution for a notable reversal in the first quarter of 2019. While 2018 saw US President Donald Trump and Chinese President Xi Jinping sitting down during the G20 Summit in Argentina, it would be advisable to wait and see if any potential trade deals are reached or not.
Although emerging markets had an extremely turbulent year, with the MSCI Emerging Markets Index shedding 24% in dollar terms for the year-to-November, there are some early signs that the worst may be behind us. By December 2018, oil had fallen by 32% from US$86 per barrel to under US$60 a barrel, a development that should boost heavy oil-importing countries such as India and South Africa. Another boost came in what appears to be a change in mood by the United States Federal Reserve over the future trajectory of its interest rate policy. If the Federal Reserve hikes rates less than expected in 2019 then this should translate into a slightly weaker US dollar, which should boost emerging market currencies and help support the carry trade.
South Africa’s mixed picture
Having come through multiple years of declining growth and rising risks to SA’s sovereign rating, SA equity markets bore the brunt of an emerging market basket facing significant pressures (given the global picture painted above). As it stands, foreigners have been net sellers of SA equities since 2015 and turned net sellers of our bond markets in 2018 on a year-to-date basis. This compares to an emerging market peer group that has enjoyed net inflows in equities over recent years, with net outflows being recorded in 2018 for the first time in many years. On valuations, the MSCI SA ex-Naspers Index is trading on forward PE multiples of around 11.6x, levels not seen since May 2012. Some have even argued that current levels are reflective of an equity market that is fully pricing in recessionary conditions in the economy.
So, what then are our expectations for SA in 2019?
In the first instance, we are keenly aware of the prevailing difficulties faced by both government and the private sector in stimulating economic growth. The October 2018 Medium Term Budget Policy Statement highlighted the extent of the deep fiscal challenges facing South Africa; reiterating that only evidence of reform will boost confidence and yield higher private sector investment. It is our expectation that economic growth will likely remain constrained to below 2% until then. Having said this, we also note other macro indicators that should provide some respite, providing a good basis for an acceleration in economic reform:
- A competitive currency
- A stable inflationary outlook
- Household balance sheets that were repaired in the tough times
- A reform package of R290 billion and the creation of an infrastructure fund that leverages the private sector for implementation.
For SA it is time to admit that the exuberance and over-optimism that we shared as a nation at the start of 2018 overshot the reality. We overestimated the pace of reform and ignored the realities of unemployment, the fragility of our state-owned entities and the many policy mis-steps taken in the past. Despite this, the deliberate reforms and positive judicial processes put in motion in 2018 are hard to overlook. Many anticipate that South African President Cyril Ramaphosa needs to move through the upcoming 2019 election before cementing his ideal cabinet and fully enacting his vision for reform in the country. At Ashburton Investments, we would only revise our growth estimates at each incremental change of the journey.
Given the deep declines in some of our mainstay stocks, together with a slightly better mood evident in SA than has been the case in in previous years, we would support positioning for a recovery in returns when considering the risk asset classes. This approach is notwithstanding the various risks on the horizon, from trade wars to land expropriation without compensation.
Other articles in this issue of Global Perspectives
- Dust yourself off…
- A world still in transition
- Rainbow and reform: What lies ahead for SA?
- Emerging market trends to watch
- Oil market sets up opportunity on the horizon