Q1 2018: A new dawn for SA but global trade wars loom

Economic and market review

The beginning of the year saw global stock markets stumble 1.3% with US equities experiencing their first quarterly decline since almost two years, suffering from a volatility-induced whiplash. With President Trump on the rampage, volatility spiked after a benign 2017. In addition, the punch and counterpunch of a trade war left global markets dizzy and tethering to find their feet, while the US Federal Reserve (Fed) continued to hike rates.

Most international economic data confirmed that the global upswing remains intact. News out of the US was positive. Retail sales picked up pace in February and consumer confidence and job gains remained strong with a greater number of jobs having been created versus consensus expectations. The unemployment rate remained at a 17-year low of 4.1% while wages rose at close to 5.0% year-on-year. The Fed raised its target range for the benchmark interest rates by 0.25% to 1.5 – 1.75% in its first meeting under new Chair, Jerome Powell. In the Euro area, the European Central Bank left interest rates unchanged and admitted that its bond buying programme will need to end soon. Growth remains upbeat and this has seen significant slack in the economy being taken up. China’s economy remained robust with both industrial production and retail sales growing at a faster pace in the first two months of 2018 than was the case towards the end of 2017.

Back home the first quarter of 2018 saw the nation let off a collective sigh of relief as a number of key political and macroeconomic events turned out more favourably than many had previously anticipated. After Cyril Ramaphosa’s close win in the ANC presidential elections in December, his first objective was to convince former president Jacob Zuma to relinquish the presidency of the country. This he managed to achieve, while averting a feared political crisis. The State of the Nation Address delivered by the new president was largely well-received. The next important event was the Budget Speech, where significant fiscal measures were announced in order to address the country’s budget deficit and growing debt burden. These included the first increase in VAT in 25 years (from 14% to 15%), as well as strict expenditure ceilings.

These measures, and the prevailing mood of political certainty that accompanied them, saw Moody’s maintain the country’s long-term local debt rating at investment grade, while improving its rating outlook to ‘stable’. A long-feared exit of the country’s local currency bonds from the Citi World Government Bond Index and the accompanying likely sell-off in domestic bonds were thus averted.

The country’s morale received an unexpected boost when real GDP growth for 2017 printed at 1.3%, higher than even the most optimistic forecasts, and well above the figure of 0.6% seen in 2016. The main contributors to this growth were agriculture, the trade sector and manufacturing.

Further cheer was added to the markets by the decision of the South African Reserve Bank (SARB) to cut its repo rate by 25 basis points (bps) to 6.5% at its March meeting. However, with the increase in VAT being applied from 1 April, as well as higher petrol prices (from higher crude oil prices and fuel levies), the positive impact of the rate cut on consumers is somewhat muted.

While the above developments provided support to the rand and fixed-income assets in the quarter, the equity market failed to come to the party. For the quarter to March, the FTSE/JSE Shareholder Weighted Index (Swix) gave up 6.8% quarter-on-quarter with all major equity sectors off their December levels. The JSE was also rocked by a human tragedy as a listeriosis crisis originating from a meat factory owned by Tiger Brands led to some 189 deaths. Tiger Brands (neutral) was down 17.6% in the past quarter. Heavyweight Naspers come under pressure with a decline of 16.2% after delivering solid returns in 2017. Naspers decided to reduce its holding in Chinese Internet giant Tencent by 2% for some US$10.6 billion. The market was disappointed that none of the cash raised would be returned to shareholders but would rather be reinvested in the business and that the rest of the Tencent stake is now subject to a three-year lock-up.

The local property sector especially saw a very severe sell-off, with the SA Listed Property Index declining by 19.6%. The rand strengthened from R12.38/$ to R11.85/$. Nominal bonds returned 8.1%, inflation-linked bonds were 4.0% higher and cash delivered 1.7%. On the international front, the MSCI Emerging Markets Index was 1.4% firmer in US dollar terms and the MSCI World Index declined 1.3%.

Our positioning

On an effective level, we added to our position in conventional bonds as the asset class offers an approximate 3% real yield, which is attractive when compared to the domestic bonds of most other emerging markets.

On the international front, we prefer equities and property over fixed-income assets. According to most valuation metrics the US equity market has rerated to expensive levels. This is despite the significant reduction in US corporate tax rates. Within global equities, we maintain our overweight position in European equities, which trade at a relatively low P/E ratio as well as price-to-book ratio. We believe global sovereign bonds are unattractive due to the low or negative prospective real yields on offer. As the US Fed hikes the federal funds rate, bonds become less attractive on a relative basis.

Given estimates of earnings growth, the local equity market is now fairly priced with the one-year forward price-to-earnings (P/E) ratio at 14.5x. Aggregating the individual company valuations of SIM’s analysts, the market appears attractively priced, but this is mainly due to Naspers, which we believe is about 45% undervalued from current levels. We believe the SA equity market to be selectively attractive, offering fair upside from current levels. Our approach is to focus on company fundamentals and seize opportunities where quality companies are being sold off on pessimistic sentiment and to sell stocks which are attracting all-time high ratings in order that we stay the course of continuing to add value in the long term.