It has been an extremely challenging period in markets. Investors are disillusioned, while their portfolio managers have been humbled. A manager whose style maintains a bias toward the large-cap sector of the JSE likely suffered negative returns regardless of their selection decisions. Giants such as MTN, Aspen and Tiger Brands declined by over 40% during 2018, while a few other well-regarded names fell more than 30%. Naspers lost about a fifth of its value since the beginning of the year and even the ever popular property sector fell by a similar amount.
Given this backdrop, it may be useful to take a step back and examine the environment in which we have walked through and the uncertainties that persist.
From a global economic perspective, it seems that the US found the last remaining chair at the party. Growth outperformance from this region, while keeping up with a tightening monetary policy stance, resulted in pressure increasing in other corners of the market, particularly in emerging markets. The prospect of rising US bond yields with little-to-no inflation risks (yet) has meant that the US provides real returns of close to a percent – a situation that has not materialized since shortly after the Global Financial Crisis of 2008. Given the lofty levels of company price/earnings (PE) multiples over the past few earnings’ cycles, 2018 has been the year in which the investors began to appreciate the lower risk-adjusted returns earned from bonds than from equity markets.
In China, the slowdown in growth indicators seems set to continue into 2019 as the relatively minor ‘targeted easing’ measures seen so far appear to have had little effect. Furthermore, one cannot talk about Chinese economic growth without referring to trade and what has been quite strong data and improving. We, however, remain watchful and would regard improving indicators as tariff ‘front-running’ across broader Asian markets and would caution for a notable reversal in Q12019.
Although emerging markets had a very turbulent year, with the MSCI EM Index falling by about a quarter, there are some early signs that the worst may be behind us. Oil erectly fell by around 30%. This should boost heavy oil-importing countries such as India and South Africa. There also seems to be signs of a mood change by the US Fed over the future trajectory of their interest rate policy. If the Fed hikes less than expected, this should translate into a slightly weaker dollar, thereby boosting EM currencies and helping along the carry-trade once again.
Having come through multiple years of declining growth and rising risks to South Africa’s sovereign rating, SA equity markets took in the brunt of an emerging market basket that faced significant pressures. As it stands, foreigners have been net sellers of SA equities since 2015 and turned net sellers of our bond markets in 2018 on a year-to-date basis. This compares to an emerging market peer group that has enjoyed net inflows in equities over recent years, with net outflows being recorded in 2018 for the first time in over 4 years.
On valuations, the MSCI SA ex-Naspers Index is trading on forward PE multiples of around 11.6x, levels not seen since May 2012. Some have even argued that current levels are reflective of an equity market that is fully pricing in recessionary conditions in the economy.
So, what then are our expectations for 2019?
In the first instance, we are keenly aware of the prevailing difficulties faced by both government and the private sector in stimulating economic growth. The Medium-Term Budget Policy Statement (MTBPS) highlighted the extent of deep fiscal challenges facing South Africa and evidence of reform will be necessary to boost confidence and yield higher private sector investment. We note however macro indicators that should provide some respite, providing a good basis for an acceleration in economic reform:
- A competitive currency
- A stable inflationary outlook
- Household balance sheets that repaired in the tough times
- A reform package of R290bn and the creation of an infrastructure fund that leverages the private sector for implementation
Indeed, we should admit to ourselves the exuberance and over-optimism that we shared as a nation at the turn of 2018, over-estimating the pace of reform and ignoring the realities we face in unemployment, State Owned Entities and many more policy mis-steps taken in the past. Despite this, the deliberate reforms and positive judicial processes currently underway are hard to overlook. Many anticipate that the President needs to move through the upcoming 2019 election before cementing his ideal cabinet and fully enacting his vision for reform in the country. We would only revise our growth estimates at each incremental change.
Essentially, given the deep declines in some of our mainstay stocks together with a slightly better mood in the country than previous years, we would support positioning for a recovery in returns when considering the risk asset classes, notwithstanding the various risks evidenced on the horizon from trade wars to land expropriation without compensation.