Cinnabar Insights
Investor Behaviour in Volatile Times
Investing is all about cycles. Business cycles, interest rate cycles, commodity cycles, risk-on vs. risk-off cycles and even political cycles. The nature of a cycle is in the name: circle – whatever the metric or factor, it goes in a long circular route from beginning to end and then back to the beginning. These direction changes are often not smooth and result in rapid sentiment change for investors.
Currently, SA investors are in the midst of a few different cycles which are affecting sentiment. Both a rate cutting cycle and an increasing risk-on (by offshore investors looking to invest in emerging markets) have sought to lift the SA investors’ sentiment and this has helped to buoy our equity and bond markets to new heights. Unfortunately contrary to this is the
local political cycle which is driving business and investor con dence to its lowest level in a decade.
Although the equity market is still trending upwards, the trend is far more muted than investors have become used to in the past. The All Share Index saw an almost 400% increase in the 10 years to mid-2014, this is a 17% average return per year. The problem is that over the last 3 years the ALSI has only seen a 7.4% cumulative return or just 2.4% annualised.
This shift in equity performance over the past 3 years has resulted in traditionally lower risk portfolios generating greater returns than more risky portfolios in the short term. This is evident in the 1 year numbers to end of July where the average money market fund returned 7.2%, the average balanced fund returned 4% and the average equity fund only returned 2.3%.
Over 3 years this trend still exists, however, sanity prevails over periods 5 years and longer where the more risky portfolios have provided higher returns. This lower return phenomenon is due to the SA equity market having come to the end of a long bull market.
The reasons for this can de nitely be blamed partially on the depressing political climate in SA and consequently the slump in the economy which has entered a technical recession.
Investors seeing the poor returns of the local equity market over the past 3 years are likely to think that they should ignore growth assets entirely and move more into xed interest asset classes and cash because there are better returns to be had and there is safety away from the local equity market which they believe could fall if the SA political environment worsens.
The reality is that this may be true for the short term, however, if they make these changes to their long-term investments which are there to provide for their retirement in decades to come, they could be making a catastrophic mistake. It is a reality that growth assets like equity do return much more returns than lower risk asset classes over time (approximately 7 years or longer).
Not holding enough growth assets is, in fact, a much larger (opportunity) risk than the short term market volatility. A further reason for not going completely into local xed income assets only when investing for retirement is that xed income assets, in particular, SA cash is totally correlated to the rand and hence the SA political situation, while SA equities being dominated by many multi-national companies that earn much of their revenue outside of SA offer a great hedge to a potentially weakening rand.
Market Insights
United States
President Donald Trump tweeted “Excellent jobs number just released – and I have only just begun”, as he also hailed the $1.6 billion investment by Toyota and Mazda to build a car plant in the US creating 4,000 jobs. In mid-July, this year, the FED revised the federal fund rates and have hiked the rates up by 25bps from 1% to 1.25%.
United Kingdom
After the general election and the Brexit negotiations began, the services and manufacturing PMI’s dipped in June and consumers grew uneasy in response to the political instability.
The governor of the Bank of England warned that uncertainty over Brexit is already weighing on the economy, as the Bank cut its growth forecasts for this year from 1.9% to 1.7%, citing a slowdown in business investment. The jobless rate has been reduced to 4.5%, which is the lowest it has been since 1975.
In ation has decreased slightly from a year high of 2.9% in May to 2.6% in June. Whilst the Bank of England decided to maintain the current bank rate at 0.25%.
China
The economy expanded 6.9% annually in Q2, matching the result in Q1, showing good stimulus ahead of their Communist Party Elective Conference in October. This has been achieved in spite of a reduction in the exports and not reaching the expected level of local consumption.
The unemployment rate in the country has not changed signi cantly since the last quarter. It moved from 3.97% to 3.95% within this period. The interest rate has been preserved at a level of 4.35% as the in ation has risen slightly to 1.5% in June.
Europe
The euro crept up 9%, even though there have been concerns over a European Union breakup followed by a victory in the French elections.
The growth rate has persisted, with Spain contributing the most, as the level of unemployment dropped to 9.1% in June. In ation has remained unchanged from the previous month, at 1.3% and monetary policy remains unchanged with interest rates at effectively 0%.
South Africa
South Africa is out of tune with the rest of the world. What has gone wrong here is politics undermining con dence depressing both Business and Consumer con dence. This downward trend in con dence has caused a slowdown in momentum.
The unemployment rate has climbed from 26.5% to 27.7% quarter on the quarter. The current in ation rate is sitting at a 5.1%. Since the in ation rate is within the acceptable range, the South Africa is out of tune with the rest of the world. What has gone wrong here is politics undermining con dence depressing both Business and Consumer con dence. This downward trend in con dence has caused a slowdown in momentum.
The unemployment rate has climbed from 26.5% to 27.7% quarter on the quarter. The current in ation rate is sitting at a 5.1%. Since the in ation rate is within the acceptable range, the SARB announced a 25bps reduction in the repo rate to 6.75%.
The next 6 months outlook revolves around politics and the ANC electoral conference in December, who will decide on a new ANC president and overall, the next president of South Africa. In spite of a government debt downgrade, the bond yield on the 10-year government bond has shrunk from 9% to 8.5%.
Investors have spiked their risk appetite towards emerging market bonds. The net foreign buying of these bonds jumped to US$38bn in the rst ve months of this year from $250m in the same period last year. There is a strong possibility that Moodys and S&P will downgrade South Africa’s domestic and foreign ratings to junk status in mid- December which could have a gloomy effect on the local markets.
There is a chance that the further downgrades are averted, but the government will have to act quickly to reform and engage with labor and the private sector. If the downgrades come to pass certain mandates – that do not invest in junk status bonds – will withdraw funds from the South African market and it would remove SA bonds from the domestic investment grade- bond tracking index, Citibank’s World Government Bond Index, which is by far the largest of this form of an index.
Global Bond Market
There has been positive corporate bond performance and relatively stable interest rates led positive global bond returns in the rst half of 2017.
Despite uncertain central bank actions, unsettled political con ict around the world and unclear U.S. policies regarding tax, trade, and foreign relations, the overall risk sentiment remains optimistic.
At the end of this last quarter credit premiums fell since corporate issuance remained strong and new issue concessions were modest as deals continued to be met with strong demand.
Credit valuations are less attractive than they have been in recent years, although balance sheets and cash ow prospects are generally robust, and the economic backdrop appears to be steady. Low-interest rates in major developed economies persisted, despite prospects for reductions in central bank asset purchase programs.
Insights
