Equity markets across the world sold-off in October, with no region escaping the downturn. There is no single identifiable cause of the correction – more like a resetting of equity market levels, given global economic and political circumstances.
How Have Equity Markets Been Affected?
The sell-off has effectively removed this years gains in the US stock market, which is now showing a 12‑month return of 7.3%. Having said this, the US remains the best performing major world stock market over the last 12 months compared to other major market indices which, for example, have performed as follows: FTSE: -5.1%; Japan -0.4%; Germany: -11.6%. The MSCI World Index, which represents an aggregation of the world’s developed stock markets, has returned -0.7% over the last 12 months and the MSCI Emerging Markets index has returned -14.6%.
What Caused the October Sell-Off?
Regular readers of the WellsFaber Market Update are well-aware of the main themes that have dominated investor concerns in 2018: (i) The US Fed’s consistent increase in interest rates (ii) Trump’s trade tariffs (iii) Ructions in emerging markets (iv) The strength of the US economy and the sustainability of US corporate earnings. All of these appear to have weighed sufficiently on the forward-looking minds of market participants’, resulting in October’s equity market retracement.
What Should I Do?
Volatility is normal and unavoidable. To prove the point, Jill Mislinski, a research director at Advisor Perspectives, recently published a chart showing that this sell-off is the 23rd time the S&P has sold-off from a new record high, by more than 5%, since 2009. Whilst it may not feel like it now, over time, equity markets do deliver the highest returns of all the asset classes, but they do so with the most volatility – achieving those returns requires patience. When markets are going up, we tend to feel like we invested too little, too late. When markets are going down, we tend to feel that we invested too much, too soon. As long as your investments are spread across geographies and asset classes appropriately, the volatility we are currently experiencing is best ignored.
How is the US Economy Doing?
The US economy remains robust. According to Earnings Insight, an organisation which tracks US quarterly company earnings, 48% of the companies in the S&P 500 have now reported results for the third quarter of 2018. 77% of them have reported earnings above forecasts, and 59% have reported sales above forecasts. US economic strength will, of course, not simply carry on ad‑infinitum and perhaps this is what markets are anticipating in this late stage of its economic cycle. As we have highlighted regularly in these monthly updates, investors watch the major economic indicators and themes closely, in an effort to anticipate when they will impact the growth in company earnings. As views change, markets adjust, which equates to volatility.
What is the Biggest Risk?
According to a Bank of America Merrill Lynch survey of fund managers, the most prevalent of these concerns is an escalating and sustained trade war. This view is also supported in the IMF’s “World Economic Outlook” a report published in October, which says that “In the United States, momentum is still strong as fiscal stimulus continues to increase, but the forecast for 2019 has been revised down due to recently announced trade measures, including the tariffs imposed on $200 billion of US imports from China”.
There is some progress on this front. The Office of the United States Trade Representative begins trade talks with the EU, the UK and Japan soon. And in term of the big issue, China, Donald Trump and China’s Xi Jinping are set to meet on the side-lines of the next G20 meeting.
Betting on how this particular risk will play out is a fool’s errand, as we cannot know. For this reason, we remain invested, confident that our appointed fund managers are weighing-up the balance of risks, and positioning their funds to avoid catastrophic consequences, whilst still positioned to take advantage of markets when they once again rise.
The JSE All Share Index followed global markets lower in October, losing 5.8% during the month. On the 25th October the index of Top 40 shares closed 20% below the high reached on 17th November 2017, meeting the official definition of a bear market.
Bear Market – An Opportunity for Active Managers to Shine!
The JSE is now in bear market territory. Bear markets are characterised by emotions of pessimism and regret. Feelings of “I should have waited before investing”, “I should have kept my money in cash”, “I knew this was going to happen!” are typical during times like these. For the professional investment community however, these are the truly exciting times. The fund managers responsible for managing your money are like shoppers three days before black Friday (which, incidentally, is on 23 November this year) – they are rubbing their hands in anticipation of finally being able to invest in those gems that they have been patiently waiting for over the years, at prices they consider to be bargains! On the other hand, the same fund managers, by remaining patient, have avoided some of the companies responsible for bringing the market down 20% since its peak, as they considered them to be too expensive. They will have protected their investors from the full force of the JSE volatility. Actively reducing the impact of market corrections, and actively buying shares in companies that have been oversold by market participants, is how active fund managers have an opportunity to shine, over their passive (ETFs) counterparts.
Asset Managers Agree: There is value in the South African Equity Market
Since 2010, South African asset managers have warned that we should not expect the South African stock market to deliver the type of returns we became accustomed to in the preceding two decades. They regularly commented that offshore shares of developed markets offered better value i.e. South African shares were relatively more expensive. Indeed, looking back we can see that their view has indeed played out as offshore developed equity markets have outperformed the local equity market.
The latest round of updates by SA’s asset managers, (which were before the pull-back in October!) have seen a turn-around in that view – the story has changed.
For example, Coronation Asset Management have increased their long-term return expectations for South African equities, property and bonds for the first time since 2013. Prescient Investment Management released an update on 24 October saying “we’ve upgraded our view on South African equities from neutral to moderate overweight today. The recent sell-off has led our valuation to turn 180 degrees from negative to positive. We now do see value in SA equities in a period where global growth remains solid, financial conditions continue to be supportive and we expect the negative sentiment around emerging markets to turn positive, soon, as well.” Stanlib published a note with a slightly more exasperated tone, saying: “All-in-all our market is overdue a big bounce/rally. We are all overdue some good news after many months of dismal stuff, day after day, week after week (typical of a bear market)”.
Markets may continue to test our patience, but in the current economic circumstances, we expect to see SA managers increasing their exposure to SA shares, should markets stay at these levels, or decline further.
Positive News from the South Africa Investment Conference
Kevin Lings, Stanlib’s chief economist, attended the South Africa Investment Conference which was held on 26 October. In his report back, Kevin pointed out that approximately 1000 delegates attended of which 30% to 40% were from overseas and they included CEOs from most of SA’s listed companies. Kevin highlighted two points as standing out. Firstly, a list of companies and their commitment to the expansion of current operations or investment in new operations was presented. This list surpassed expectations, totalling R 290bn of planned investment in the next five years. Secondly, cabinet members responsible for the identified key growth industries shared a stage with business leaders and among others it was notable that they emphasised and committed to achieving policy certainty in these critical industries. In conclusion Kevin also noted the presence of Alibaba, Amazon and Naspers at the conference, as positive.
Compiled by Mike Moore, Wealth Manager