So the local government elections have come and gone. Yes, I appreciate they took place in August, and this is a market recap of July, but I’m so buoyed by the maturity of our democratic processes that it wouldn’t feel right if I didn’t kick off with a review of the events of early August. Irrespective of your political beliefs or party loyalties, as South Africans we can collectively celebrate the success of a peaceful and transparent electoral process. Of course it’s the results that capture our attention. But let’s not forget that it’s the absence of headlines about vote rigging, intimidation or any other number of transgressions that allow us the luxury of applying our minds to the important outcomes. We should never take this for granted. A strong democracy will continually test our resolve and patience. We are genetically predisposed to disagreeing and arguing and our constitution provides the platform for the natural ebb and flow of politics. But time and again it’s the snaking queues of patient, engaged South Africans that demonstrate to the world that the future remains as bright as ever here on the tip of Africa. I feel proud to have been part of this process.
As I write this, we still do not know who will govern many of the major metros. What we do know is the age of coalition politics has dawned in South Africa. No longer do the ANC’s liberation credentials give it an automatic right to govern. Its significant role in the history of our country can never be questioned, but these election results send a very clear signal to its leadership. It’s no longer enough to rest on your reputation. It’s about actual service delivery. And a strong opposition, perhaps born out of unusual coalition partnerships, only augers well for the country. I don’t think we could have wished for a better result. Any greater loss by the ANC may well have triggered political instability and violence. Majority victories for the DA in any of the metros would have closed the door for collaborative coalition talks. Larger national support for the EFF would have prevented it from recognising that radical political rhetoric can only get you so many votes. Whatever the coalition outcomes, it’s abundantly clear that the DA will need to focus much more attention on the poor (perhaps even at the expense of some of its traditional white affluent support), the EFF will have to soften on some of its radical pronouncements and small political parties will have a meaningful role to play. And the ANC? Well, if it doesn’t start transforming itself from liberation movement to transformative government, then I fear the trend evident in the Western Cape will slowly drift northwards and make the party irrelevant in decades to come. It’s a fascinating period in our political history. All set on the backdrop of huge political uncertainty globally. As a nation we’ve come a long way from the depression of Nene-gate in December last year. Of course, it won’t take much to trigger another self-inflicted crisis, but hell, it feels good to be a South African in August 2016.
While our political landscape was meandering along, investment markets continued on their merry way. While the numbers for July 2016 in themselves are not that remarkable, it’s interesting exploring some of the trends evident this year. I will do so below, but first, to provide some context, here are the summarized numbers for the usual key indicators in July 2016:
||Local listed property
|Rand / Dollar
|Rand / Euro
|Rand / Sterling
The most obvious trend to examine is the continued strength of our currency. The rand has endured a rollercoaster ride for many years. I’ve often stated that the vagaries of our currency are possibly the single biggest determinant of national psyche. Not even the performance of our national sports teams have as much impact on how we feel as a nation. A steeply declining currency is akin to that Monday morning post Carte Blanche feeling – on steroids! And of course, when it comes to thinking about the currency in our investment portfolios, it’s the area where we repeatedly commit all the behavioural finance mistakes. Ask any retail investor to predict the direction of the rand in December last year and you would have struggled to find anyone predicting significant strengthening. Yet that’s what has been happening. From 1 January 2016 to 31 July 2016 the rand has strengthened 11.7% against the USD, 8.3% against the EUR and a remarkable 23.4% against the GBP. There are many reasons for this. Some domestic. Some beyond our control. But the net result has seen a strong inflow of foreign investment and solid returns from some of our local asset classes. Similar to the currency, very few investors would have opted to invest in local bonds in late December. Concerns around state capture, an imminent debt downgrade, elections looming all pointed to staying away from our local bond market. Yet, year to date, local bonds have been the best performing asset class delivering a 13.7% return. It’s worth putting that into some context. Reflect back on December last year. The popular thinking was to take all your money offshore. Those who were brave enough to avoid the emotive decisions and look to invest in cheap assets (like local bonds) would have generated a 7 month return of 25.4% in US Dollars. That's simply remarkable. Luckily, the diversified nature of our client portfolios means most of our clients would have some exposure to this thinking although in varying degrees based on personal mandates.
For those interested, local equities delivered 5.5% for the 7 months to the end of July, while local listed property did 13.2% and cash 4.1%.
Regular readers will recall that I always lead any discussion on investment markets and currencies by reflecting on the foreign drivers first. Although it’s easy to always pick on some domestic factor for the direction of stock markets and currencies, this often ignores the obvious impact of global investment forces. It’s these international factors that are a bigger determinant of direction and returns. So what’s happening in the rest of the world? Well the same trends are emerging. Previously unloved sectors (the ones that did the worst in 2015) have seen the most favourable returns. Emerging Markets have delivered 12.0% for calendar year 2016. Compare this to the 6.3% of the S&P 500 and the -3.3% (in US Dollars) of the FTSE 100. For obvious reasons it’s the equity market that always grabs the headlines. The equity market is the brash, good looking popular brother who captains the rugby team with poor grades. The bond market is the ungainly, red-headed sister who plays the violin and ends up working for NASA at age 17. And it’s the red hot bond market that requires some serious analysis. To give some perspective on this discussion, analyst opinions of global bonds fall into one of two schools of thought.
The first view the global bond market as the next big investment bubble. Their position is partly premised on the fact that yields in government treasuries are all at multi-decade lows. While some are still providing a positive yield, many, including German, Swiss and Japanese bonds are in negative yielding territory. Add to this the high single digit returns delivered by global bonds for the 7 months to July and they claim you have a toxic combination of overpriced, expensive assets that have artificially low yields. They see an inevitable uptick in inflation as the death knell of this pricing anomaly.
The second maintain that bonds offer the only safe haven from an overpriced equity market that has benefitted from an unprecedented amount of monetary stimulus and which will have to decline in value for long term valuations to normalise. They point to the elevated PE ratio of most markets and the lack of any inflation evident in developed market economies. They forecast further deflationary forces driving yields even lower.
The challenge for investors and advisers alike, is deciding which point of view is correct. And this is no easy decision, because arguments from both camps are equally compelling. Despite the obvious potential threat of buying an overpriced bond market, investors in the US have poured $60bn into US Fixed Income ETF’s for the 7 months to July. This exceeds the total inflows for the whole of 2015, and it is only for 7 months in 2016. This scramble for yield is a direct consequence of central banks continuing to drive interest rates lower in a never ending push for economic stimulus. The problem is there is simply no economic growth of any consequence in many developed markets. By comparison, inflows into US equity ETF’s have declined by 85% and total just a fraction over $15bn year to date. So while it’s the good looking, intellectually challenged older brother grabbing the headlines, the emergence of the bright, yet awkward younger sister seems to be emerging as the biggest threat to investment market stability. Ultimately, bizarrely enough, the one relies on the other and both will struggle to unwind almost 8 years of central bank manipulation of interest rates without some degree of economic pain.
Where does this leave the world of monetary stimulus and low interest rates? Eric Lonergan penned an excellent article in the FT Weekend summarising it nicely (Interest rates are a spent economic force, FT Weekend, 13 August 2016).
‘In standard economic theory, interest rates are the price we pay for instant gratification: lower rates induce us to spend more and save less’ he states. This is exactly what monetary stimulus seeks to do. By lowering central bank interest rates, monetary authorities are forcing the banking system to pass on the benefits to consumers. These consumers will, in turn, hopefully use the low interest environment to consume more goods and services thereby stimulating the economy. Quite simple really. However he continues: ‘But evidence from financial markets strongly suggests the shift to negative rates is indeed undermining the performance of the financial sector….. Since the rise of economic liberals such as Margaret Thatcher…. and Ronald Reagan… this rule of thumb has gone unchallenged. Given recent market and consumer behaviour, it looks less convincing.’ Could it be that what is effective at higher interest rates at some point becomes ineffective the lower you go? He continues: ‘The idea that lower interest rates raise demand is based on the view that households attempt to smooth their consumption over time. This assumed relationship has little empirical support and there are good reasons, particularly when rates are extremely low or negative, to doubt it…. And what of savers? Lower rates have a depressing effect on household incomes, through reduced interest on savings and pensions. It is likely that in relatively wealthy economies – with rising healthcare costs, increasing longevity and uncertainty over pension funding – households respond to lower income on their savings by trying to save more. If this outweighs the reduced incentive to save, the actions of central banks are self-defeating. The relationship of spending to lower interest rates may well be the reverse of that assumed by policymakers.’ If this is all in fact correct, we may well be chasing our monetary policy tails.
He concludes: ‘For central banks to continue playing a role in preventing recession and raising growth, they will need to rethink the entire premise of monetary policy and aim their firepower directly at consumer spending and corporate investment. Expecting further cuts in interest rates to work is wishful thinking. The scattergun approach is not hitting the target.’
I do not think the investment climate is currently conducive to exposing your portfolios to extreme asset allocation weightings. This is not a time when aggression will be obviously rewarded. Yes, the odd brave soul will spot an opportunity to dip their toe into what may appear to be a massive mispriced opportunity. But for the average investor, this is a period where a low yield, low growth world deserves some respect. The continued stimulus should continue to prop up investment markets and in the absence of real return alternatives, equities do still offer the most attractive alternative. But at some stage the stimulus taps need to be turned off and just how markets will react is unknown territory for all of us. Remain diversified, liquid and patient, but above all do not succumb to emotional decision making.
For a full breakdown of fund and individual share movements, kindly click on the links above to access the July 2016 Local and Offshore Watchlists.