Monthly Market Update
October saw the JSE All Share rally by 3.1%, led by resources and financials. Industrial shares had a tough month finishing down -1.4%. The beleaguered local property sector also has a good month, finishing up 1.9%. The dour Mid Term Policy Speech has a negative effect on the local bond market, with the ALBI finishing the month down -0.4%.
Looking offshore, the MSCI World Index finished the month 0.7% up in USD. The S & P 500 in the US was up 1.7%. Japan has a good month, with the Nikkei up 2.8%. The FTSE 100 in London fell -2.2% as a solution to Brexit continues to be sought. The Chinese Shanghai SE index was down -6.2%.
South African unit trust returns per sector
A better month for investors in the South African unit trust market, with pretty much all the illustrated sectors outperforming CPI for the month. Over the longer term however, it’s still been a challenging time for South African growth assets which have lagged the offshore equity and property sectors, as well as local cash and fixed income markets.
As per the above extract from the Morningstar 2019 Q3 fund observer, funds have started leaving the SA Equity and Multi Asset/ Flexible sectors and moving largely into fixed interest funds based on this recent history. This is clearly a reaction to the poor returns emanating from local equity and property sectors over the last few years. However, there are risks for these investors. They could miss out on a recovery in these markets if the October numbers become a trend. South Africa’s credit rating is also at risk of a downgrade (given Moody’s recent change of our outlook to ‘Negative’) which would not be positive for bond markets. Unfortunately, it’s a cycle that repeats, which is why investor returns in unit trusts and mutual funds tend to be below returns of those actual funds over time.
The Mid Term Policy Speech
The MTPS on the 30th October clearly illustrated South Africa’s worsening Fiscal position. The combination of a weak economy, tax revenue falling short of expectations and the continued need to fund SOE’s have all contributed to the current situation. The budget deficit is now 5.9% of GDP, while gross debt has risen to the record level of almost 61% of GDP. In 2009 gross debt stood at only 29% of GDP.
It’s clear South Africa needs to somehow increase economic growth (and subsequent tax revenue) while at the same finding a way to reduce government spending. With the government wage bill having grown to such a large portion of the budget, this is not going to be an easy task. A solution also needs to be found for the SOE’s currently draining the fiscus, particularly Eskom.
Moody’s recently kept South Africa’s credit rating at investment grade (Baa3) but downgraded the outlook from stable to negative. This was largely expected by the market, and therefore assumed to be ‘priced in’ to our bond and currency prices already. It was interesting to note the Rands reaction to the change, it initially devalued from about R14.60 for the USD, to over R15. It has since strengthened back to below R14.80, which seems to imply that it was, in fact, priced in.
The government and the Reserve Bank are going to have a difficult time convincing this rating agency to keep South Africa on an investment grade credit rating at the next review in 3 months’ time. Should they be able to do so, the writer expects this will be a surprise outcome for markets and could therefore result in boosting both local markets and currency.
Analyst opinions are currently divided on what the effect of a downgrade will be. Two views seem to prevail: 1. The downgrade is priced in, and any currency or bond market volatility will be short term in nature, and falling out of investment grade indices will be largely offset by inclusion in ‘junk’ indices or 2. The downgrade will have a negative effect on both bond and currency markets, South Africa being excluded from investment grade indices resulting in a significant outflow of capital.
The FNB/ BER Consumer Confidence Index has fallen to its lowest level since 2017. The index fell from +5 to -7 during the 3rd quarter of 2019. Factors attributed to the decline include rising unemployment (29.1%), a decline in per capita income, the announcement of a R59 billion bailout for Eskom and the reoccurrence of xenophobic violence.
The report indicates that while consumer sentiment declined across all income groups, it was especially poor among high income consumers (earning over R14, 000 p.m.) This could potentially lead to declines in luxury items, such as new car sales, furniture, jewellery and household appliances. It’s also likely to constrain pricing power of retailers in general over the festive season.
October finally gave patient investors a bit of a reprieve from the difficult markets we have endured for the last 3-5 year.
On the positive side, local inflation is likely to remain contained over the medium term (currently 4.1%p.a.), with further repo rate cuts having the potential to lower financing costs. However, many challenges remain, including serious fiscal challenges, high unemployment, poor performing SOE’s and rising socio-economic discontent.