A year in review – what local and international markets taught us this year and what to expect in 2020
As we approach the end of 2019 it’s a good time to reflect on the year that’s past and look ahead to 2020.
The local economy has really been battling the doldrums this year. Despite an uptick in second quarter growth numbers that surprised on the upside, it all came back to earth with the third quarter decline in GDP of -0.6%. This leaves the unadjusted real GDP growth number at just 0.1% year on year.
SOE’s remain a key challenge for government, and the recent placement of SAA into voluntary business rescue is hopefully a sign of commitment to dealing with these issues going forward. Sentiment is key to confidence in markets, so these actions are extremely important.
Tax revenue has also been a challenge in 2019, so it was good to see an improvement in collections in October. On an annual basis, gross tax revenue collection increased by 8% y/y in October, following a 6.6% y/y increase in September. This is the first time since September 2018 that gross tax revenues have grown at 8% or more.
Getting the South African economy going is vital to dealing with the current record unemployment. The solution doesn’t lie in the public sector (as we can see from the difficulty government is having reducing the wage bill) and restoring confidence back into the private sector is key. We need corporates to begin using the cash on their balance sheets to invest into our economy, and they will only do that when they are confident of the long-term prospects of these investments. The cost of doing business needs to reduce and we need policy certainty.
Looking at markets, the JSE All Share has returned just over 13% over the last 12 months. However, YTD (since 1/1/2019) the picture is not quite as rosy.
All indications are that the bond market has already priced in the expected downgrade by Moody’s to sub-investment grade in March next year. Currently, despite having a ‘junk’ rating, Russia and Brazil’s bonds are nevertheless trading at lower yields than their South African counterparts.
Source: Old Mutual
Real 10-year bond yields
Source: Old Mutual
This data seems to indicate that the local currency and bond markets will hold up reasonably well if the expected downgrade is announced post the February Budget Speech. If confidence returns and we somehow manage to hold onto our investment grade rating, this will have a positive effect on bond prices (bonds prices react inversely to interest rates i.e. rates down = prices up and vice versa) as well as the currency.
Looking at some of the local unit trust sector returns year to date, it’s clear that offshore equity funds have been the place to be in 2019. Looking at the 5-year numbers, it’s clear why we are seeing a move from our local multi-asset funds (which in recent years attracted the highest inflows) to more conservative interest-bearing money market and income funds. However past returns tell us very little about the future and trying to time the market is generally a fool’s errand. See this article for an analysis of the dangers of trying to time the market.
Another observation of the unit trust sector this year, is how much active managers have battled to keep up with passive strategies. I suspect this is also due to the sentiment driven nature of current markets (very difficult to price sentiment).
South African unit trust returns per sector
For last few years the US economy has been the engine driving worldwide growth. The current bull market began in March 2009, when the S&P 500 bottomed after the global financial crisis, and so is a little more than 10 years old. That makes it the longest in history.
The US housing market firmed a bit more than expected in September, up 0.4% m/m (as measured by the Case Shiller Composite 20 Index). Over the last year, however, prices are only up by a modest 2.1%. Should the ongoing employment increase trend continue, this should underpin house price growth in 2020.
The 2020 Presidential may lead to greater than usual policy uncertainty in the US next year. This, and the weakening US economy, will put pressure on Donald Trump to come to an agreement with the Chinese on the current trade dispute. As seen in 2019, markets are currently largely sentiment driven, and a deal with the Chinese would likely be supportive of US, Chinese and world markets in general.
If this results in a ‘risk-on’ trade worldwide, we would expect the US dollar to weaken from its current level, and for EM markets (such as South Africa) to benefit from increased investment flows. Certainly, as detailed above, the SA bond market is well positioned to benefit from such an event. It would also be supportive of local equities.
The current view seems to be that a win for the Democratic candidate would usher in a significant shift away from pro-business Trumpian Republicanism and towards a redistributionist, environmentally friendly, anti-big business stance.
For the moment it looks likely that Elizabeth Warren will stand as the Democratic candidate, although things change fast in US politics!
The UK will be holding elections on the 12 December 2019, as it struggles to find a way to implement Brexit. Weak growth in the UK and Europe is pushing both sides towards a Brexit resolution, which is lowering the risk of a ‘no-deal’ UK exit from the European Union.
International Bond Markets
These really are the elephant in the room. Despite it being almost 11 years since the Global Financial Crisis, the US Federal Reserve has not yet managed to ‘normalise’ policy. At the same time European and Japanese interest rates remain negative. In fact, about 25% of government and corporate debt worldwide offers sub-zero nominal yields.
At some point in the future, interest rates in developed markets need to normalise. Currently worldwide inflation is benign, despite the amount of quantitative easing that has taken place since the 2009.
The worldwide macro-economic outlook is certainly cloudy, however this has reduced the tail risks that have dominated headlines for the last few months. Locally it would seem that most of the potential bad news is priced into our markets, and any turn in sentiment could have a positive effect on valuations. Offshore, the risk of a very damaging outcome from the US-China trade dispute and a ‘hard’ Brexit is also reducing. Once again, improving sentiment is likely to buoy markets worldwide, particularly EM markets that have lagged the developed world since 2009.
It’s still vitally important to ensure your portfolios are suitably diversified. Besides diversifying between asset classes both locally and offshore, diversifying investment styles between passive and active strategies can also yield benefit. Understanding the time horizon of your investments is also crucial to ensure you have the appropriate asset allocation strategy in place.
As we get deep into December, volumes traded on markets will decline as everyone goes on holiday. Markets should largely trade sideways until January. All of us at Cornerstone Asset Management wish you all the best for the holidays and the New Year.