Download MARKET REVIEW - Markets pare early Quarter gains as Strong

MARKET REVIEW - Markets pare early Quarter gains as Strong Dollar weighs late
September:
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The JSE All Share recorded its worst quarter in three years and shed 2.58% in the
month of September alone.
For the Third Quarter, SA Listed Property was the star performer, returning 7.1%, the
All Bond Index rose 2.2%, Cash gave you 1.5% whilst SA Equities lost 2.1%.
SA Listed Property surprisingly leads the year to date returns at 13.9%, whilst
the All Share has given you 9.5%, All Bond Index 5.7% and Cash at 4.3% against CPI
inflation of 6.4%.
External reasons for this weakness include: uncertain prospects out of China,
worrisome economic reports from Europe prompting fears of the Eurozone dipping
back into recession, and lastly commodity prices in particular being aggravated by the
very sharp rally in the US dollar.
Add to this a weakening local outlook given a record August trade deficit of
R16.3bn and signals from the Monetary Policy Committee of a tightening bias for
local rates despite a weakening economic growth outlook. Our currency remains the
key upside risk to inflation which continues to appear vulnerable given SAs
deteriorating current account deficit, falling commodity prices and tenuous foreign
portfolio flows funding the shortfall.
Q3 PERFORMANCES
TOTAL RETURN IN ZAR
14-Sep
Q1
JSE All Share Index
TOP 40
MID CAP
SMALL CAP
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Q2
Q3
YTD
4.33% 7.22%
9.55%
2.55%
2.07%
4.72% 7.43%
9.34%
2.57%
2.80%
1.78% 6.10% 1.81% 9.95%
2.84%
4.55% 6.03% 1.88% 12.95%
0.28%
Data sourced from Bloombergs, total return calculated on Gross Dividends
reinvested. Global returns based upon widely-used proxy indices
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Data sourced from Bloombergs, total return calculated on Gross Dividends
reinvested. Global returns based upon widely-used proxy indices
ASSET ALLOCATION – SA Equities capitulate, Global & Local Property take the
lead
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Data sourced from Bloombergs, total return calculated on Gross Dividends
reinvested. Global returns based upon widely-used proxy indices
Q3 SECTOR PERFORMANCES – Broad-based weakness
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On a sector view, weakness has been broad-based with all the major indices ending
lower. Although marginally lower, Financials have outperformed, with insurers
benefiting from a low claim season due to favourable weather, wealth managers
reaping the benefits from positive returns, compounding effects and banks have
reported relatively stable earnings. African Bank obviously blots the sector’s record,
the demise of the micro-lender impacting many of SAs Money Market funds in
particular.
Industrial counters have been pressured by lacklustre earnings, particularly in the
retail industrials. The SA consumer is noticeably under pressure which is weighing on
the SA retailers.
Resource counters have once again taken a pounding in response to a confluence
of reasons – fears over Chinese demand while the surging US dollar further pressured
commodity prices and the effects of the prolonged strike action filtering into the
earnings reporting season.
Top sector performances came from Fixed Line Telecoms, Healthcare and Real
Estate.
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Bottom sector performances were from Platinum, Personal Goods, Golds, Auto and
Industrial Transport.
CURRENCIES, COMMODITIES and EMERGING MARKETS - suffer the Strong
Dollar & Over-Supply
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The rand has depreciated1% against a surging US dollar over the quarter, although
held ground against a weak Euro, gaining 2.1%.
South Africa recorded a mixed quarter from foreign portfolio flows – a R10.7bn
equity inflow was offset by R12.4bn of outflows from bonds.
The sharp rally in the dollar also translated into weak commodity prices, notably
gold, platinum, iron ore and other metal prices, especially with more speculative
investors dumping their exchange traded funds in the metals. This selling has more
than offset any increase in demand from the global car industry which was just
beginning to show signs of improvement.
The platinum price has slumped 12.4% in dollar terms in the last 3 months to a 5year low and remains in this down-trend spiral that started in 2011 at $1915 compared
to the current price around $1200, prices last seen in 2006/7.
The outlook for iron ore also appears jaded with BHP Billiton forecasting the
increase in iron ore supply to continue to outstrip demand from the steel industry over
the next 2 years, meaning the iron ore price could remain pressured, even after
tumbling 41% in the year to date.
The oil price fell close on 16%, its biggest quarterly decline since 2012. Strong
supply was the main culprit as North American and OPEC production surged and
Libyan ports and oil fields were reopened.
SA has not been in isolation - the MSCI Emerging Markets Index fell 7.4% in
September and places Developed equities back in the lead for 2014 on a return of
4.4% against the ytd MSCI Emerging Market return of 2.6%.
In US dollar terms, the worst quarter returns amongst the emerging markets came
from Russia -15.1%, Turkey -11.8%, Brazil -8.4% and the South Africa -6.6%.
Both India and China recorded small positive dollar returns in Q3.
Amongst developed markets, the S&P500 hit new closing highs in each month of the
quarter and breached the 2000 mark in September before succumbing to profit taking
late in September. The US performance certainly stands strong against the weak UK
and European markets.
Commodity Prices and Emerging Market Currencies take a beating:
MAKING SENSE OF THE QUARTER AND LOOKING TO THE FUTURE – 2 Steps
Forward, 1 Jump Back:
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In developed markets we are beginning to see significant decoupling of business
cycles and monetary policy prospects, with the US in particular approaching peak
inflection point, the UK hot on its heels, while the Eurozone and Japan lag
significantly behind.
Most fund managers continue to believe that the US offers the greatest
opportunities with US earnings forecast to rise approximately 10% in 2014 and close
to 15% in 2015. Earnings strength helps buffer shares against the worries about Fed
tightening and possible geo-political issues that may arise. Another positive read from
the US is that US corporates have bought back $338billion so far of their own shares
in 2014, the most in 7 years.
From a top-down perspective, again the US appears to be the global beacon of hope
with respect to global growth although credit creation in the US is still well below
average. Consumers continue to pay down their debt, even though mortgage yields
have fallen to record lows.
Unleveraged growth means the developed world is unlikely to spring into boom times
and we’re likely to make slow yet irregular progress.
The world economies are still feeling the effects of excessive debt and commentators
believe that the deleveraging will take longer and possibly see negative real rates
(inflation higher than official interest rates).
The breather seen across global equities in the last couple weeks has been welcomed
whilst the long term bull market trend, albeit temporarily hindered, remains intact. We
caution however that market commentators believe there may be more pain to follow
across equities but the consensus call is to stick with equities over bonds.
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The consensus outlook in US Treasuries is fairly neutral with the risk of a
significant sell-off relatively low given the world of overabundant savings. When
faced with an over-savings scenario, bond yields traditionally fall to stimulate
spending. Excess savings in Europe remain large and growing. Meanwhile the strong
US dollar will dampen the pricing power of the US economy, drive down inflation
expectations and compress bond yields even lower.
The outlook for China remains worrisome and described as “two steps forward, one
step back” as authorities try to juggle both reform and growth at the same time. In
Japan, the spurt of nominal growth has stalled and another dose of stimulus is needed
to sustain reflationary momentum. Furthermore, Japan’s demographics remain poor
with the labour force contracting at 0.5% per year.
Europe is the other big worry and seems headed for stagnation as credit growth
continues to contract. Banks are reluctant to lend and businesses and consumers are
loathe to borrow.
Economists are also warning that an ongoing strong US dollar will possibly reverse
the strong capital flows into Emerging Markets – another cause for concern across
local equities.
For South Africa there is significant cause for concern and most fund managers are
expecting some Fourth Quarter weakness. Valuations amongst the Top40
heavyweights, in particular amongst the consumer industrials, are stretched and we
are beginning to see a noticeable search for value amongst the smaller and mid-caps.
This trend is likely to continue into Q4.
On the PE basis, the JSE All Share is trading just below 17x earnings down from
its peak of over 19x in June. The current level is the lowest since July 2013 but still
above the long term average of 14.7x. Again the disparity is evident amongst the
industrial conglomerates with the likes of SAB trading on a PE of 29x and Naspers a
massive 85x.
JSE PE Ratings – Industrials appear stretched
THE DOMESTIC MACRO ENVIRONMENT AND OTHER NEWS – not a pretty
sight:
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South African Macro highlights for the Third Quarter and month of September
remain weak:
o The MPC kept rates on hold although continued to signal a tightening bias.
o The SARB marked down the growth outlook to 1.5% (from 1.7%) for 2014
and 2.8% (from 2.9%) in 2015 with risks skewed to the downside. The
inflation outlook was lowered to 6.2% and 6.3% for the next 2 years on a more
benign food inflation trajectory. However, the MPC did single out the
currency as a key upside risk to inflation although also highlighted concerns
around a wage-price spiral and elevated wage demands.
o Governor Gill Marcus announced that she is stepping down as her term
expires ahead of the October MPC meeting. The deputy governor, Lesetja
Kganyago was announced as her successor.
o Headline inflation unexpectedly ticked higher in August as food inflation
picked up and core inflation also rose. The August report disappointed as food
inflation climbed to 9.5% driven mainly by a 1% rise in meat prices (meat
inflation at 10.1%) and a 1.5% gain in dairy products (dairy annual inflation at
12.7%).
o Core inflation rose to 5.8% partly due to base effects, but also a rise in vehicle
and personal care costs.
o SA’s current account deficit widened to 6.2% in 2Q14 from 4.5% in the first
quarter, and attributed to the impact of the platinum strikes. Weak domestic
demand will continue to limit growth while the removal of supply side
constraints should favour export growth and hopefully see a slight
improvement in the current account deficit in the third and fourth quarters.
o The trade deficit widened to 2.8% of GDP, from 2.1% previously, due to the
impact of the platinum strikes filtering through the system as well as weak
external demand.
o The Purchasers Managers Index recovered to 50.7 in September from 49 in
August, rising above 50 for the first time in the past five months, indicating a
slight improvement in manufacturing activity.
o A slowdown in Consumer Spending was reflected in the SARB’s 2Q Bulletin,
as well as a concerning drop in fixed investment. Household spending
softened further as real disposable income growth fell to just 1.3% partly due
to wages lost during the strikes as well as more modest real wage gains in
most sectors.
o It was announced that Medupi is likely to cost the state R35bn more than
original estimates placing the final figure now over R105bn, according the
Public Enterprises Minister Lynne Brown. The first unit of Medupi is expected
to be synchronised to the grid by December and come into full operation in
1H15.
o In corporate news, the SARB put African Bank into curatorship and begins
restructuring the ailing business. It undertook R17bn of the bank’s bad loans at
a cost of 41% of face value. This left R26bn of good loans (after provisioning)
which is to be recapitalised by way of a R10bn rights issue underwritten by7
major financial institutions – Firstrand, Std Bank, Nedbank, Absa, Investec,
Capitec and the PIC. African Bank JSE listed instruments, debt and equity
were suspended on August 11th, and the good bank holding company will list
in due course.
THE GLOBAL MACRO ENVIRONMENT – US the “Global Beacon of Hope”:
US
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The US Fed reduced its asset purchases by $10bn in each month over the quarter
with “QE” set to conclude in October.
The focus of this quarter turned to the timing of a Fed rate hike, though FOMC
commentary continued to look for a “considerable period” between the end of QE and
the first hike.
2Q14 GDP expanded at an annual rate of 4.6% quarter on quarter, the highest rate
since 2006 as growth bounced back from a 1Q contraction of -2.1% caused by poor
weather conditions.
Nonfarm payrolls underwhelmed and the unemployment rate was unchanged at 6.1%,
whilst the participation rate held steady at 62.8%.
Consumer confidence firmed over the quarter with the Univ of Michigan survey
rising to a 14 month high of 84.6 in September, up from 82.5 in June.
Purchasers Managers Indices also rose sharply, the Manufacturing PMI rose to
59.0 in September from 55.3 in June, whilst the non-Manufacturing Index rose to 59.6
from 56.0.
China
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China’s Central Bank announced in September that it would provide
RMB500bn of liquidity to five major banks for a period of three months.
Housing conditions continued to deteriorate over the quarter with house price
declines reported across most Chinese cities.
GDP growth in 2Q14 was 7.5%, up slightly from 7.4% in 1Q14.
CPI inflation eased to 2.0% year on year in August compared to 2.3% in June. PPI
deflation continued, running at -1.2% year on year in August from -1.1% in June.
The Manufacturing PMI fell over the quarter to 50.2 in September from June’s read of
50.7.
Credit data was soft over the quarter with new bank loans totalling 703bn yuan in
August compared to 1079bn yuan in June.
UK
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The UK economy remains in expansion mode, growing by 0.8% in 2Q14. A more
balanced growth profile looks set to be underpinned by a solid housing market,
strengthening corporate confidence and investment and a slowly improving export
performance, as indicated by the quarter’s business surveys.
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However official wage figures remain alarming and the BoE is cautious on the
economy’s ability to withstand rate increases. Comments by the UK governor of
the BoE, Mark Carney, caused investors to push back their anticipated timing of
interest rate hikes.
Europe and Japan
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Economic reports across Europe were weak over this past quarter. Both Italian and
German GDP shrank in 2Q14, with Italy returning to recession. France’s economy
also failed to return to growth over the period. Germany however, surprised with
record employment figures and rising wages.
Consider this: An economic region where GDP growth is stagnating, retail sales
are weak, unemployment is floundering at 11.5% and industrial output is sluggish.
Worst of all, the region’s inflation rate has declined throughout the first half of 2014
to a mere 0.3% in August, its lowest level since 2009 and well below the target rate of
2%.
The response from Eurozone bond investors becomes more positive the worse the
news gets - short term government bonds have drifted into negative yield territory, the
10year German Bund yield moving firmlybelow the 1% mark. As Europe stagnates
and the risk of deflation increases investors are becoming more and more confident
that the ECB will be forced to intervene and undertake further quantitative easing
action to counter the weak inflation and aid the region’s recovery.
Following the subdued inflation prints and stubbornly high unemployment, the ECB
President, Mario Draghi, finally announced a much anticipated 10bp reduction in the
interest rate corridor and confirmed that purchases of asset-backed securities will
begin in October.
Japan’s economy is also under threat, and recorded a contraction of 1.7% in 2Q14.
The Japanese current account fell into deficit for the first time in five months in June.
Eurozone deflates
A WORD FROM THE WISE… Guide to CGT
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Capital Gains Tax (CGT) is triggered when an asset is sold at a higher value than
that of its base cost. When an investor rebalances their portfolio back to a strategic
weight, in order to ensure consistency of risk in their portfolio, CGT may be triggered
resulting in lower returns. If one were to compare the effects of realising capital gains
on an annual basis as opposed to ‘once off’ at the end of the investment term, it is
found that the difference is dependent on client circumstances, time horizon, size of
investment and expected capital return.
In Conclusion Capital gains and the tax associated with it is inevitable for taxable
portfolios. In our opinion, the risk control and higher risk adjusted returns associated
with regular rebalancing compensate the client for the tax paid over time. Triggering
capital gains associated with rebalancing in order to meet long term objectives at a
higher probability and lower risk is good investment practice. This also adjusts your
base cost going forward which lowers the Rand value of CGT payable in the future.
However, we would prefer to be able to make fund switches within structures that will
not trigger CGT where possible. If an existing investment already has substantial
capital gains, this should not deter the investor from making the correct investment
decisions (i.e. switching into a more efficient portfolio). CGT will ultimately have to
be paid somewhere along the line and it is important to remember that a portion of
your investment will always be owned by the government. Realising CGT on an
ongoing basis is often favourable particularly if the exclusion is available.