Global Markets:

Emerging markets gained another 1.1% in September with Developed markets gaining a subdued, 0.3%. Perhaps it should be no surprise that the countries in the world that continue to have normal monetary policy and normal interest rates (emerging markets) are becoming a preferred investment destination.

The rally in emerging markets was initially supported by the turnaround in commodity prices earlier in the year. We are now seeing this turnaround in other emerging market sectors, as earnings more broadly are forecast to show modest growth next year. Valuations are lower than those of developed markets and so funds are finding their way into emerging markets as company prospects are expected to improve. An interesting point is that financial stocks are the largest component of the MSCI Emerging Market Index. Unlike their developed market peers, financial companies do not face the same negative interest rate environment faced in developed markets and so have a relative advantage in this respect.

We had a sense of déjà vu this month as banks were back in the headlines for the wrong reasons. Deutsche Bank scared investors as the US authorities imposed a fine of $ 14 billion on the struggling bank. This intensified the focus on the European financial sector where concerns are heightened due to negative interest rates, weak economic growth and tightening regulation. A concern is that Deutsche Bank’s clients will lose confidence. This would be a major set-back for markets, and is an addition to the growing list of risks that our investment managers need to take into account.

The US interest rate merry-go-round continued this month. The US Fed once again kept interest rates on hold. Janet Yellen commented that the case for an increase had strengthened, but that they would wait for further evidence of growth before lifting rates. Market expectations for an increase before year end remain in place. This appears to be likely as long as the employment levels in the US continue to gradually improve, and inflation steadily increases, as has been the trend.

Finally, Theresa May has provided a deadline by which the UK will trigger the two year withdrawal process to start Brexit – March 2017. This announcement has added to a renewed bout of Sterling weakness and general uncertainty. A recent conversation with an asset manager that runs a global equity fund summed up the extent of the concern. Their view is that whilst there may well be opportunities, there is simply too much risk for another bout of Sterling weakness to justify exposure to UK companies at the moment.

South African Market:

The JSE ended September down 1% having been down as much as 3.5% mid-month. Since March 2015, the All Share Index has traded sideways, punctuated by periods of volatility. This implies that equity returns have not come easily over the past 18 months, and portfolio performance should be viewed with this in mind.

Fund managers continue to warn that current markets are among the toughest they have encountered, as global risks remain high, asset values continue to be distorted by global central bank intervention, and the changing political landscape is creating more uncertainty than ever.

Each month WellsFaber’s investment committee meets to review matters affecting our clients’ investments. One of the areas we focus on is the allocation of funds offshore i.e. the percentage of a portfolio that should be allocated offshore and when money should be taken offshore. A short term risk we have tracked carefully in this regard is the potential for a sovereign rating downgrade. This has been hanging over our market for some time now. This month, fixed income manager Futuregrowth announced that they have stopped new loans to State Owned Enterprises (SOE). In researching views on this matter we would like to share with you the following comments from leading fixed income manager, Prescient Investment Management who said “the biggest impact [of the Futuregrowth decision] on the state of the SOE finances and the funders’ unwillingness to lend is the effect it could have on government finances and a potential downgrade. In terms of the pricing of SA bonds that would result from a downgrade, we can observe that SA BBB- bonds are currently priced in line with Turkey and Russia BB+ bonds. This implies that junk status has been priced in already. On announcement date the SA bonds would likely sell off but will present a relative value play to other emerging markets. The flow of funds into emerging market bond funds as an asset class is a massive force and does tend to dominate local sentiment in the target investment countries.” In summary, we agree that whilst there may be an initial knee jerk reaction to any downgrade announcement, there will not be a sustained sell off in South African bonds, and by implication, the South African Rand.

Finally with a touch of sadness we say goodbye to JSE stalwart SABMiller in October. The exit of SAB has profound implications for our local market. One such implication is the resulting change in the make-up of the All Share Index, of which SAB was the second largest constituent. For passive investors this means that their portfolios will effectively change without any of the flexibility and thought provided by an active portfolio manager. Whilst we believe there is a role for both passive and active management in a portfolio, the benefit of having an active manager consider and adapt to the implications of such a change within a portfolio, is healthy.