South African Market

Seemingly out of the blue, the JSE ended the month at a record high on the last day of July. This is the first time since 4 April 2015, that the JSE has been above 55,000 points, bringing the return for the year to date up to a respectable 9%.

The JSE finally moved out of its two-year sideways movement with a 7% rally in July. This rally was led by resource shares, which were up 13.3%. The rally in resources shares appears to be due to a combination of factors, including the suspension of the proposed changes to the mining charter, firmer commodity prices, and good results from Anglo American, who will resume paying dividends six month earlier than expected. The impact of this will be mostly felt by the “value” managers, who have been leading the performance tables for the past year, as they tend to have higher exposure to this sector. It will have less of an impact in funds with a “quality” or “growth” approach to investing, as they tend to avoid resource companies due to the unpredictability of their earnings, and their reliance on strong global growth. Financial and Industrial shares also contributed to the market’s performance returning 5.6% and 4.9% respectively. The former benefited from a 6% rise in bank shares, following a surprise cut in interest rates, while the latter was driven partially by a 12% rally in Naspers, which makes up around 17% of the FTSE/JSE All Share Index.

The Reserve Bank surprised the market with its decision to cut the repo rate by 0.25%. The recession combined with the Rand’s current resilience in light of much negative news flow, as well as an expectation that inflation will remain contained within the Reserve Bank’s target of 6% were factors supporting the decision.

The Rand was slightly weaker during the month. Although our currency appears to have been resilient given our current political and economic backdrop, it has lagged other emerging market currencies, such as such as Poland, Turkey and the Cech Republic that have similarly attractive interest rates, but lower political risk.

Emerging markets were up 5.5% for the month, outperforming developed markets as measured by the MSCI World Index, which was up 2.3%. This brings emerging market performance for the year to 22%, whilst developed markets have returned 13.9%. Whilst these returns are impressive, the impact when measured in Rand terms is dampened due to the impact of a stronger Rand over the last 12 months.

Finally, we note that positive sentiment in the US continued to be supported following the reporting of company earnings in the second quarter. More than 80% of the S&P 500 companies reported higher-than expected profits.

Global Market

“While any investment forecast is dangerous and flawed, the current dynamics influencing the direction of global equity markets are particularly hard to predict.” Tony Gibson, Founding Member of Coronation Asset Management, July 2017.

At WellsFaber, we are extremely aware of the unpredictability of the current investment environment. Partly, this heightened uncertainty is due to the seemingly contradictory circumstances we read about every day. For instance, the value of stock markets in some regions, such as the US, are stretched, whilst in other regions, such as the Euro Area and Emerging Markets, they are not. Another such contradiction is the improving investor sentiment we read about as growth picks up globally. Yet this is overshadowed by geopolitical worries, as Trump and the Brexiteers appear to lurch from one issue to the next.

These opposing forces lie on top of unknowns which stem from the global financial crisis. The latest phase of central bank action involves the US Fed moving out of the crisis management role they have played for the best part of the last decade, gradually raising interest rates back to normal levels, and preparing investors for the process of unwinding the impact of years of quantitative easing. There is no precedent to look to for insight as to how this might play out.

There are also the consequences of the latest trend to invest in passive funds that track the market indices to consider. There has been a massive shift of capital into passive investments over the past decade, particularly in the US. What does this mean for the major market indices, should there be a correction?

So how do we manage this uncertainty, because whilst there is always risk in the system to worry about, there are many arguments supporting an extended rise in markets.
The first thing we take cognisance of are the lessons history has taught us, and from this we know that not being invested in the market, is the riskiest strategy of all. Coronation Asset Management recently put out a report covering this issue. The period from 1995 to 2017 consisted of 5 468 business days. If you were invested in the South African stock market for that period you would have returned 15% per annum. If you had missed the 25 days during that period with the highest returns, you would have returned 8.5% per annum. If you had missed the 100 days during that period with the highest returns you would have lost – 3.0% per annum. So, despite how uncertain the market feels, we do know that staying invested is critical for long term success, and sitting in cash is not an option.

However, to manage the unpredictability, it is essential that two aspects of an investment portfolio are managed correctly. The first is that asset allocation, and particularly, the amount of exposure to volatile assets like equity and property, is appropriate for your personal circumstances. The second is to strive for solutions that offer as much diversification as is reasonably possible as diversification reduces the impact of market downturns, whilst taking advantage of different sources of return to support gains. This means ensuring that investments are diversified across the traditional local and offshore asset classes of equities, property, bonds and cash. More recently, we have researched the diversification benefits of less mainstream asset classes such as corporate bonds, infrastructure assets, private equity and market neutral funds. These too can be included in, or alongside, traditional unit trust portfolios, bringing tremendous diversification benefits.

In the short term, we do not know where this market will take us, but our focus is on appropriate asset allocation and well considered diversification to create portfolios that are robust and ready for the unpredictability of the current climate.