Global Market

The first two weeks in February set hearts racing, and unfortunately it had nothing to do with Valentine’s Day. Between the 26th January and 9th February 2018, global equity markets had fallen 10%. However, by month end, the MSCI World Index, which tracks the performance of global shares, had recovered most of its losses ending down – 4.3% in February.

Volatility is Emotional

For seasoned investors, volatility is part and parcel of achieving long-term investment goals. For others it can be anxiety inducing. It always triggers emotion. Our role at WellsFaber, is to assist our clients in keeping both eyes firmly on the long-term investment process and to ensure that volatility does not sew doubt nor distract from the objective. This is often our most challenging role as financial advisors.

Why Equities Fell 10% & Why it May Happen Again

In last month’s update, we mentioned that US inflation and US interest rates were key indicators to watch out for in 2018. No sooner had the ink on our update dried, then fears of higher interest rates in the US were triggered by reports of wage inflation. The key number to watch is the benchmark measure of US interest rates, the ten-year US treasury yield which is currently 2.85% (and is reported each month in this update). This yield was 2.4% at the beginning of the year and has been increasing. The question is, how far does it have to increase before investors start switching out of equities into lower risk US treasuries? We had insight into this in a recent report by Overberg Asset Management. Consensus appears to be a yield of between 3.0% and 3.5% before equity investors get twitchy. As US treasury yields move up and down from current levels, gyrations in global equity markets are likely to occur because of this.

US Q4 Earnings Reports Look Good

With the valuation of the US stock market somewhat elevated, another key indicator investors are watching closely is US corporate earnings, which are reported at the end of every quarter. Equity markets are more likely to continue rising if corporate earnings grow above expectations. A recent report by Earnings Insight, on US corporate earnings in the 4th quarter of 2017, noted that the earnings growth rate for companies in the S&P 500 was 14.8%. If 14.8% is the final number for the quarter (some companies are still to report), it will be the highest earnings growth since Q3 2011 (16.8%). It seems that for now the momentum in the US and global economy is providing the anticipated tail wind to keep growth of US company profits on track.

US Dollar Weakened -10% in 2017 and -2% in 2018

The US Dollar has lost a further 2% in 2018 (against a basket of six other currencies), following a 10% decline in 2017. Although much of the Rand strength has been attributed to the positive political developments in South Africa, it has clearly been exacerbated by weakness in the US Dollar. The “weak US Dollar trend” is still in-tact, providing a temporary headwind to those invested in US markets.

Reasons for US Dollar weakness have been attributed to an improvement in Europe’s economy and therefore a preference for the Euro, as well as political dysfunction in the United States.

South African Market

The attention in 2018 has been on the Ramaphosa victory, Steinhoff collapse, and the Budget. However, at the same time, the SA Property Index has lost -18% in two months, and SA Bonds have gained +7%.

Equity Market

The All Share Index was down -1.1% in February, reflecting negative returns for those parts of the market with a Rand Hedge component, i.e. resources and industrials, and positive returns for financial shares, which are benefiting from a more positive outlook for South Africa.

Property Index Is Down -18% in 2018

The SA Property Index is down – 18% since the beginning of the year. The reason for this has been a fall of between 40% and 50% in the share prices of four listed companies that are part of the Resilient stable of property companies, namely Resilient, Nepi Rockcastle, Fortress and Greenbay. The fall is due to concerns emerging about the corporate structure of the group, as well as perceived excessive buying and selling of shares in the underlying group companies by directors of Resilient. In addition, three local investment houses have recently released reports raising these concerns. On a positive note the companies are backed by hard property assets, and therefore will not “melt-down”, however investors need clarity and in this regard, are looking to reports from the Financial Services Board and Resilient’s Internal Audit Committee before making their next move.

Bonds Rallied 13% Since November 2017

Contrary to property, South African bonds as measured by the BESA All Bond Index (ALBI) were up 3.9% in February. This reflects the positive sentiment following Ramaphosa’s election, Zuma’s resignation, the Budget Speech and the cabinet reshuffle. Since November 2017, leading up to the ANC elective conference, bonds have delivered a capital gain in excess of 13%. Balanced Funds, and lower risk Stable and Income Funds typically hold a percentage of their assets in bonds, although exposure has been measured whilst South Africa faced the prospect of ongoing credit rating downgrades. Now that South Africa is back on the high road, investors are adjusting their positioning in the bond market, and increasing their exposure to the asset class, as the outlook for growth, inflation, the Rand and our credit rating, improves.

Low SA Inflation

The South African Inflation rate was reported at 4.4% in January, confirming the current lower inflationary environment. Our long term historical annual inflation rate is 6%. Lower inflation is supportive of lower interest rates going forward, and some expect a rate cut soon, however the prospect of rising interest rates in the US is expected to dampen this somewhat.

One impact of lower inflation is the expected returns of certain funds that target a return of Inflation + X%. As long-term inflation has been 6%, a return target of inflation plus 3%, converts to an expected return of 9% per annum over the long term. However, with a current inflation rate of 4.4%, a fund is delivering on its target if it delivers a return of 7.4%. Whilst this is somewhat of a technical nuance, it is something to keep in mind when evaluating short term performance, particularly of lower risk funds such as income funds, or stable funds. Over the longer term, returns are expected to meet the long term historical inflation benchmarks.

Compiled by Mike Moore, Wealth Manager