South African Market:

Now that’s entertainment! February started with the annual SONA bun fight and ended with …cringe!… the Oscars debacle. You would be forgiven for thinking both were theatre productions fresh from the fringe of an avant-garde arts festival. Sadly, they were not. Meanwhile, the Rand continues its winning streak, and we dedicate a large part of this month’s update to our beloved currency.

For years WellsFaber have been strong advocates of diversification through offshore exposure. However, when the Rand goes through a period of strength, the performance of offshore portfolios in Rand terms looks relatively bleak. A case in point is the past year’s performance of the MSCI World Index which returned 18.8% in USD, a great return by any standard. However, as a result of the Rand’s strength, in Rand terms the MSCI World Index delivered a less impressive 2%. We do not concern ourselves with the impact of this short term Rand strength when looking at performance of our offshore portfolios, as we think about offshore portfolio returns in foreign currency terms. However, we are concerned with the level of the exchange rate when it comes to advising clients to take funds offshore. One measure we pay attention to when making this decision is the long term fair value of the Rand, using a Purchasing Power Parity calculation. Using this measure, the fair value for the Rand is currently around R12 to the US Dollar and R19 to the Pound. Taken on its own this indicates that the Rand may still strengthen somewhat against the US Dollar, but is expected to weaken against the Pound over time. This goes some way to explaining the recent Rand strength – at R16 to the USD it was clearly oversold. However, when reading analysts’ views on the reason for the change in the Rand’s direction Ian Le Roux, the Old Mutual Investment Group Chief Economist, gives a most sensible account. Ian listed the likely reasons for the Rand strength as follows (i) the rise in recent months in the prices of a number of our key commodity exports, such as coal and iron ore. (Indeed SA’s four largest commodity prices rose by about 30% in US Dollar terms from late in 2015 to the end of January 2017) (ii) positive sentiment from the better recent performance of a few key emerging market currencies, including the Brazilian Real, Russian Rouble and Malaysian Ringgit (iii) the perception that the economy has finally turned the corner. (It should be noted that Old Mutual are of the view that GDP growth will rebound from 2016’s estimated 0.4% pace to little under 1.5% in 2017) (iv) the narrowing deficit on the current account of the balance of payments.

We would add that the risks to the current positive trend is “Zuma politics” resulting in a cabinet reshuffle, removal of Pravin Gordhan or a credit rating downgrade. Rising US interest rates, especially if quicker than anticipated, could also put pressure on the Rand.

When it comes to the decision of when to take money offshore, it would appear that a window of opportunity is opening.

A notable point on the local market performance in February has been the decline in resource shares which lost 9.9% for the month. This follows an exceptionally strong month in January.

Global Market:

At the time of writing the Dow Jones is at an all-time high having completed a run of 12 “up” days in a row for the first time in 30 years! Love him or hate him, the markets are clearly backing Trump’s ability to Make America (economically) Great Again. 

The US market and consequently the MSCI World Index continued their Trump inspired rally in February. Both indices are now showing one year returns of 20% and 14.7% respectively. Furthermore, emerging markets returned 3% for the month, resuming the rally that started at the beginning of 2016.

Our sense is that global sentiment appears to be tilted towards the positive. The risks that have dominated headlines for a number of years, have gradually receded. Regularly sited concerns used to include the sustainability of the US economic recovery; the possibility of a “hard landing” in China and deflation in Europe, among others. These risks have become much less of a concern today, but have been replaced with heightened political risk across the world. It is arguably the first time since World War II, that global political events are the number one (evident) risk to markets. With the Dutch election to be held on the 15th March and the French election on the 27th April, some of these risks will play out by the time we write our next market update. It will be very interesting to see what happens thereafter.

This year we expect to see a continuation of the gradual return to normal interest rate levels in the US. The market is expecting two US rate hikes in 2017. The increase of interest rates is important. If increases turn out to be faster than anticipated, this may result in the US Dollar rising further which implies lending rates could move higher. On the other hand other currencies, particularly those in emerging markets, would be likely to fall, negatively impacting those countries with significant US Dollar debt and US Dollar based costs. Mohamed El Erian, ex CIO of the world’s largest bond manager, Pimco, believes a strong US Dollar is the most significant economic risk to markets in 2017 for these very reasons. Interestingly, the US Fed left rates on hold in February, although Janet Yellen did comment that the US is getting close to its employment and inflation targets. The market interpreted these comments as meaning that US interest rate hikes are imminent.