Global Market

For the most part, market movements in May were an extension of the themes that have dominated our updates for most of 2018: Trump, Trade Wars, Geopolitics, US Interest Rates and Global Growth. However, two new strands to these stories have grown in prevalence in May – risk is rising in Emerging Markets as well as in Europe. Concerns in both areas resulted in the MSCI World Index (developed markets) returning 0.3% and MSCI Emerging Markets Index returning  3.8%

What is Causing Emerging Markets to Wobble?

Emerging markets have outperformed their developed market peers over the past 24 months. In May however, emerging markets sold-off as investors sold emerging market assets to switch into investments in the markets of the developed countries. Part of this sell-off has been created by events such as Argentina having increased interest rates three times in eight days to 40%, as well as the Turkish Lira collapsing 25%, so far, this year. The reason for these shifts are multifaceted however, they have coincided with a gradual strengthening of the US Dollar since March, which can be notoriously troublesome for emerging markets.

A Strong US Dollar impacts Emerging Market Countries

The US Dollar hit a low of just over $1.25 to the Euro in February and has since appreciated by 6.6%. The reason for this is the relative strength of the US economy and gradual rise in US interest rates.

Over the past six years, the amount of US Dollar denominated borrowings by emerging market countries has doubled, due to the near zero percent interest rates that have prevailed. For countries that borrow in US Dollars, especially emerging market countries with large deficits, an increase in the value of the US Dollar, or a decrease in the value of their domestic currency, directly impacts the cost of their interest payments, which are made in US Dollars. This in turn puts these indebted countries under financial pressure. South Africa is relatively well managed in this regard as, relative to many other emerging market countries, we have low levels of foreign debt. However, a strong US Dollar is notoriously challenging for emerging markets in general, and so many investors are keeping a wary eye on these developments, as issues in one country can lead to contagion in others.

Italy is Back on the Front Pages

Politics is once again creating volatility in European markets and, consequently, the world. If ever you feel bad about South African politics – it always helps to look at what the Italian politicians are up to. After the Italian elections resulted in a hung parliament in March, Italy’s populist parties (which put in a strong showing) have not been able to form a government. Markets are concerned that this is now likely to mean fresh elections in July, which ultimately could lead to populist parties winning, and consequently a referendum on Italy’s future in the Euro. In other words, the risk of Ital-Exit has risen!

Trumponomics: Tariffs, Kim Jong Un, Iran

Keeping up with Trump is proving to be a challenge for financial markets. Whilst progress is being made on the tariff issue as trade talks with China progress, Trump is playing a similar game of “hot and cold” with South Korea’s Kim Jong Un. After referring to him as “short and fat” last year, Trump managed to turn things around to the point where the 12th June 2018 was the date on which a summit between the two countries was to be held. Unfortunately, a disagreement on what is meant by the term “denuclearisation” has derailed the planned discussions

South African Market

The JSE All Share Index continued to frustrate investors in May as it returned – 3.5% for the month. Once again resource shares performed well, whilst the broader market was down, led by financial shares which were down -6.5%.

Why was the JSE Down in May?

The South African equity market was caught in a double whammy of global events. Initially the market was impacted by the tailwind of negative sentiment affecting emerging markets. At month end however, the market was affected by issues emanating from the developed world as, markets worldwide reacted to concerns about Italian politics.

S&P Maintained SA’s Credit Rating & SARB Kept Rates on Hold

There were no unexpected comments in S&P’s statement on South Africa’s credit rating in May, however, what was of interest was the following reference to land expropriation: “We could also consider lowering the ratings if the rule of law, property rights, or enforcement of contracts were to weaken, undermining the investment and economic outlook.”

In the SARB’s comments on interest rates, it appears the Governor is entrenching expectations of a below 5% inflation outlook for South Africa. This is material in a country with a long-term average inflation rate of 6%. This is particularly relevant for investors in funds that target returns of inflation + X %, as the absolute return number in future may be less than one has been anticipating.

Progress on State Owned Enterprises (SOEs)

Pravin Gordhan made significant steps last month to shore up our wobbling SOEs. He appointed new boards at SA Express Airways, Denel and Transnet and appointed a new Chairman at Eskom. These appointments are positive as they improve the perception of governance at SOEs, and consequently the chances of market participants funding them. Evidence of improving sentiment in SOEs in 2018 comes in the form of Sanral’s ability to raise R 500m of non-government guaranteed debt for the first time in six years, as well as Eskom’s ability to raise R 5bn in bridging finance from the GEPF and then to secure a R 20bn facility from local and global financial institutions.

Property Shares Drop Again

After recovering of 8% in April, the SA Property Index lost its gains in May, ending the month down 5.9%. Property shares are down -18.6% since the beginning of the year, due to a fall of between 40% and 50% in the share price of the four listed companies that are part of the Resilient stable of property companies and this makes up 40% of the property index. This occurred after concerns were publicly raised by certain asset managers. The company has effectively admitted that it was wrong and announced that it would unwind the offending cross shareholdings and restate its 2017 financial statements. The latter announcement was made during May, and this effectively ended the shares’ April recovery, driving them back to their previous lows. Hopefully, this huge volatility in the Property Index is coming to an end and we can begin to move forward from the current base.

Compiled by Mike Moore, Wealth Manager