After two calendar years of weaker returns (5% in 2015 and 2.6% in 2016), market prices produced a respectable 21% in 2017. Despite this move up in prices, the 5 year compounded return for the JSE All Share index is only up to 11.9%. Nevertheless, this is an approximate 6.5%real rate of return on this asset class.
The JSE All Share index ended the year just shy of the 60 000 level, which it managed to reach early in 2018. Few investors would have predicted a 20% plus return on the local listed shares, given the issues that the SA investor faced over 2017,including:
- The year started off on a firm footing, but soon became unstable when political risk was heightened with a cabinet reshuffle by President Zuma in March, with Finance Minister Pravin Gordhan ousted
- This was followed in April by two of the major rating agencies downgrading SA local and foreign debt to sub investment grade
- Quarter 1 saw SA slip into a technical recession, which rebounded in quarter 2.
- Midyear, the ANC policy conference made calls to nationalise the SA Reserve Bank
- In November, rating agencies made a further downgrade to SA debt
- In December, Steinhoff (Top 40 share) crashed over 90% after admitting accounting irregularities and delaying publishing its annual financial statements.
Naturally, there were many positives for investors, which outweighed the negative sentiment, resulting in the following :
- The rand appreciating versus the weaker US dollar by close to 10%
- The All Share index gaining 21% and the Top 40 23% – 35% in USD dollars
- The industrial metals sector gaining 90% on the back of firmer base metal prices
- The bond market up 10.2%
- Listed property up 17.2%
- Money market up 7.5%
Local market prices were boosted by Naspers, which accounted for approximately half of the market gains. Late into 2017, banks rallied on the firmer rand, ending the year up 31%.
It is evident from Chart 1 (below) that returns from both listed property and shares only came through in the second half of the year. As is the nature of risk asset prices, returns are lumpier (unlike lower risk returns from money market).
Following the global financial crisis in 2008/2009, monetary authorities, led by the US Federal Reserve (the US Fed) undertook an experiment by lowering short term interest rates to essentially zero in the hope of driving investors out of fixed income investments and back again into risk assets.
Since then, in each calendar year since 2008, US equities have posted a positive year and global equities were only negative in 2011 and 2015, with 2017 proving to be a bumper year, both for developed markets and emerging market risk assets as evidenced by the 23.9%gain from the MSCI All Country index.
In 2017, the bulk of the return from global markets came from growth in earnings; this means that valuations in general are not necessarily more stretched than a year back, despite gains of over 20% for many global shares.
The question that investors are now asking is “have we now reached the end of the easy monetary experiment, or is there still more to come from risk assets?”
While at this stage, there is no sign of a recession, these do typically occur after there has been significant monetary tightening from central banks in their enthusiasm to rein in rising inflation.
Therefore, one of the key areas to focus on in 2018 will be US inflation and further tightening of interest rates by the US Federal Reserve. The market is pricing in 3 or 4 further rate hikes, but if inflation picks up more than expected, this will be cause for concern.
For the time being our view is to maintain close to maximum exposure to global equities. But this will be tempered with an ongoing higher weight to global quality companies, with reasonable valuations and a steady reduction in allocation as prices rise (i.e. taking some profits off the table).
Seed Local Review
Equity December 2017 was a volatile month, with politics playing a huge part in investor sentiment. The election of Cyril Ramaphosa as head of the ANC was considered positive for SA and the rand gained ground against the USD, trading near 10% firmer for the month. This put strain on the JSE returns, which are heavily weighted to rand hedge shares. The Steinhoff decline was also a contributing factor. These factors combined resulted in the JSE Top 40 index falling by 1.3%. While earnings have come through, the price gains mean that valuations remain elevated above long term averages. Pockets of value appear in local focused shares, and stock picking, as opposed to buying an index, is going to be more important in 2018.
Property Listed property shares were strong, gaining over 4% in December following the outcome of the ANC elective conference. This resulted in property shares gaining 14.5% since mid-2017 and 17.2% for the year. Over 2017, shares with a greater focus on local assets underperformed those with a more global focus. In December, gains were dominated by heavyweight shares (Growthpoint, Hyprop and Redefine). The listed property market has a one year forward income yield of around 6.5%, appearing expensive in relation to the local bond yield (trading at 8.5%). Approximately 50% of the index is now exposed to global properties, where the equivalent bond yields are much lower. A property portfolio with a one year forward yield of over 10% can still be constructed, which is attractive when compared to the prevailing bond yield.
The December gain of 5.7% for local bonds SA bond yields was an indication of the risk premium investors, both local and foreign, were pricing in for the political situation in SA. With the ANC elective conference bringing in Ramaphosa, a large portion of this premium was removed, and yields on bonds fell from 9.4% to 8.7%, resulting in a strong gain. For the year bonds produced a 10.2% gain but proved to be a reasonable investment, outperforming money market returns (with higher volatility). Valuations are not as attractive following this price gain and given a possible further downgrade by Moody’slater in 2018.
The level of inflation has continued to remain under the upper band of 6%. The November inflation rate came down from 4.8% to 4.6%. Higher fuel prices will put pressure on inflation into the end of the year, but the much firmer rand price into December is positive for the inflation outlook. Reasonable expectations are that inflation should end the year around 5.3% as compared to 6.4% for 2016. This means that cash generating investments continue to provide a relatively high real return compared to long term history, at least before tax. For this reason cash and near cash investments remain attractive.
Seed Global Review
The rand surprised many investors in 2017, given the materialisation of risks. December saw a sharp turnaround, resulting in an appreciation of the rand against the USD (around 10%) and the Euro. The rand gained 10% against the USD for 2017, which was slightly weaker relative to some of the majors, gained 1.5% against the GBP, and was approximately 2.5% weaker against the Euro. Hence, one month made a big difference. The strong gain meant that on a purchasing power parity basis, the rand appears to be reasonably valued against a trade weighted currency basket. Further gains may come from a greater normalisation of the politics and ongoing firm commodity prices.
Global equity markets have had a huge 2017 with virtually all markets making gains. This has been supported by a synchronised global growth story. At a broad level the MSCI All Country index gained 1.6% in December and 24% for the full year in USD terms. Because price gains have mostly been supported by firmer earnings growth over the year, valuations have not necessarily become more stretched. At the same time investor sentiment is more positive and therefore the strong momentum is likely to continue. The risk lies with the easy monetary policy starting to turn into a tightening one and therefore a headwind. For now, though, we remain fully invested, but cognisant of the these risks.
The US 10 year treasury bond yield traded relatively sideways in December closing at 2.4%. Into January, it has weakened to 2.5%. In the UK the 10 year bond trades at 1.3%. As generally expected, the US Federal Reserve increased rates again at their December meeting. The market is expecting at least 3 rate hikes in 2018 as the monetary authorities try and stay ahead of the inflation curve. Many market commentators believe that we are slowly going to unwind the 30 year bull market in bonds and that the 1.3% seen in mid 2016 was the high point, while others remain convinced that there is still value as the yield creeps up. In our view valuations in global government bond markets remain too expensive.
Other asset classes that can sometimes be considered include private equity, direct real estate, commodities, and hedge funds and can provide investors with uncorrelated returns. In an environment where starting yields are at historical lows these traits are highly valued. These assets can perform a useful role in multi asset portfolios as they help provide more consistent returns. Generally rising yields however will be a constraint on valuations.
Source : Seed Investments (31/12/2017)