Global Market

Last year delivered outstanding offshore equity returns with the MSCI World Index returning 20.1%, led by the US and Japanese equity markets. 2018 has started positively with the MSCI World Index adding a further 5.2% in January. The returns of 2017 are going to be hard to beat – what should we look out for in 2018?

At WellsFaber we started the year inundated with asset managers’ views for the year ahead. Having already met with a few investment teams, we took inspiration from Sanlam Private Investments, who neatly summarised the key global issues for 2018, as follows:

Company Valuations and Earnings

Valuations of shares in developed countries, particularly the US, are certainly elevated when one compares them to historical levels. However developed economies are in a period of sound economic growth, which could support the profitability of global companies. In addition, Donald Trump’s drive to reduce US Corporate Tax from 35% to around 20%, is likely to enhance company profitability further. Investors will watch carefully each quarter, as US companies report their earnings, to see that they are growing their profits in line with expectations, thereby justifying these elevated valuations. Any earnings disappointments will be a cause for concern and any disappointing trends are likely to cause market gyrations. Companies meeting or exceeding expectations will keep the mood buoyant.

Inflation & Higher Interest Rates

During the past two years, developed economies have steadily emerged from the hangover of the financial crisis and are now growing soundly. This growth has been led by the US which is operating at full employment with much of the developed world approaching the same. This is an indication that developed countries are now in the latter half of an economic cycle that started with the great recession of 2008. Typically, this stage of the cycle is characterised with increases in inflation, however to date inflation has remained unusually low. If inflation picks up unexpectedly fast, or sharper than markets expect, this will be of concern as central banks are likely to respond to increasing inflation with increases in interest rates. Since the financial crisis, government debt, corporate debt, and household debt has increased to unprecedented levels. China’s corporate debt, and the US Government’s debt are particularly noteworthy. Increases in interest rates make debt repayments higher, and this can lead to financial strain. Inflation and interest rates will continue to be areas of intense scrutiny.

Geo Political Risk

Finally, although we are growing accustomed to the geo political turmoil that arose in 2016 and 2017, the risk that it poses remains. Donald Trump has three more years in power and continues to create uncertainty among allies and enemies alike. The implications of Brexit are no clearer than a year ago. Furthermore, rapid technological developments in the areas of artificial intelligence mean we are entering a new era of industry disruption together with jockeying for prime positions at country, industry and company levels. The potential for a misstep having a ripple effect is therefore high.

We will track developments in these three key areas and keep you updated of any changes.

South African Market

The close of 2017 brought with it an early Christmas present for South Africans as Jacob Zuma finally lost his grip on the country, and Cyril Ramaphosa was elected leader of the ANC. Unfortunately, President Zuma and his merry men weren’t the only ones struggling to digest their Christmas pudding – the demise of Steinhoff gave many asset managers the same problem.

Although the South African equity market performed exceptionally well in 2017, delivering 21% for the year, it is important to note that Naspers delivered 12% of the 21% return. Excluding Naspers, the rest of the equity market delivered a more modest return of 9%. Few asset managers are brave enough to hold Naspers in their portfolios at the 20% weight that Naspers represents in the index. However, a few more are brave enough to have no exposure to Naspers whatsoever. It is therefore likely that although the JSE had a good year, most domestic portfolios have delivered sound, but more modest returns than the equity market’s 21% would suggest.

Although Cyril Ramaphosa has inherited what can only be referred to as a “mess”, his impact has been immediate. With the wheels of justice beginning to turn, and credible appointments being made at state owned enterprises, there is good reason for optimism. Hopefully, 2018 will see a return of the business and consumer confidence which evaporated during 2017. The immediate effect of his appointment has been an improvement in the Rand, bonds and the share prices of interest rate sensitive companies such as retailers and banks. If sentiment improves, those companies that earn their income predominantly in South Africa are expected to benefit.

The recent strengthening of the Rand, whilst positive for the country, does cause some concern as it puts short term pressure on offshore portfolios in Rand terms. This is particularly relevant to investors who took funds offshore last year to protect against the fast growing political and economic risk during 2017. We can be quick to forget how serious the political situation was and how close South Africa came to the point of no return, and having adequate offshore exposure is prudent. Another point to bear in mind, is that although the strength in the Rand was triggered by Ramaphosa’s victory, it has been substantially supported by a weak US Dollar, which is now trading at a three-year low against a basket of currencies.

Ahead of us we have the annual budget speech to look forward to in February. Moody’s is the last major ratings agency that rates South Africa as investment grade. They are set to deliver their revised rating after the budget, and the key factors they are watching out for are reduced government expenditure, higher revenues, and lower borrowing projections. Sufficient progress with the reform of state-owned enterprises is also key. We expect increased commentary about the potential impact of Moody’s announcement in the weeks to come, which may affect the value of currency.