Global Market Overview
After the severe shock in March, markets rebounded strongly in April. COVID-19 continued to spread globally, but some countries saw daily new infection rates start to fall and are now planning to gradually reopen their economies. Governments and central banks introduced very significant stimulus measures to reduce the damage caused by the economic shutdown, restoring some positive sentiment to markets.
Volatility declined from extreme levels. Developed stock markets outperformed emerging markets and growth stocks outperformed value. The S&P 500 index returned 12.8% (USD) and has recovered close to 60% of its prior decline. Fixed Income markets rallied as central banks committed to purchase more government and corporate bonds.
US oil prices turned negative for the first time in history in April amid the deepest fall in demand in 25 years. A flood of unwanted oil in the market caused the West Texas Intermediate (WTI), the benchmark price for US oil, to plummet to almost –$40 a barrel after the fastest plunge in history. That meant producers were paying buyers to take oil off their hands. The price of oil has been steadily falling across global markets since coronavirusfirst broke out in China at the end of 2019. Since then, the shutdown of major economies and travel routes to curb the spread of the virus has wiped out oil demand as transport has ground to a halt. But oil producers have continued to pump crude from their wells, causing a catastrophic imbalance between oversupplied oil and the biggest slump in demand for 25 years.
Despite April’s market rebound, considerable uncertainty remains over the trajectory of global growth over the coming quarters. A lot will depend on the extent to which economies can successfully reopen. For this reason, investors should remain prudent and expect further volatility.
Management of the epidemic in the US has inevitably become a political battleground with the election due later this year. The US economy contracted at an annualised pace of 4.8% in the first quarter of the year. Fiscal stimulus measures launched by Congress have been enormous, but more may still be required. The number of jobless claims has increased by 30 million in the last six weeks, how many of these layoffs end up being temporary will be key for the outlook. The extent of the economic deterioration due to the shutdown was evident in the April Flash composite Purchasing Managers’ Index (PMI), which plunged to 27.4. Retail sales also fell 8.4% in March.
The Federal Reserve’s (the Fed’s) response has been dramatic in both size and speed. The US central bank has committed to unlimited government bond purchases. It will also now buy investment grade corporate bonds and high yield bonds (provided that the issuer had an investment grade rating prior to 22 March). In addition, the Fed will purchase corporate bond exchange-traded funds (ETFs), including some high yield ETFs. The action of the central bank contributed to a sharp decline in investment grade and high yield spreads, and kept Treasury yields low despite the massive fiscal stimulus being provided.
The Flash PMI indicators for April followed a similar trajectory to Europe, with the composite business survey falling to 12.9. Retail sales in March fell by 5.1% month on month (-19.4% excluding food).The FTSE All-Share index underperformed most other equity markets in April due to the exposure to the energy sector and closed with a return of 4.9% over the month.
In Italy, the initial epicentre of the outbreak in Europe, the number of new cases is decreasing and a gradual business re-opening will take place. Germany has already relaxed some restrictions. The eurozone’s real GDP contracted 3.8% in the first quarter of the year and the second quarter is likely to show a faster decline. The composite April Flash PMI indicator for the eurozone fell to an all-time low of 13.5, confirming a substantial hit to businesses. The International Monetary Fund estimates a drop in 2020 GDP of over 7%, with a significant increase in deficits and debt levels.
The European Central Bank (ECB) continued its quantitative easing programme, applying some flexibility by putting an increased emphasis on purchases of government bonds of those countries with the greatest need due to the virus, including Italy and Spain. The ECB also eased collateral requirements to include high yield securities in order to support lending to small and medium-sized enterprises.
The Eurogroup launched an emergency support plan of EUR 540 billion and the European Council also announced a recovery fund, although the details will have to wait for further discussion in May.
China’s economy has been gradually reopening. First-quarter real GDP declined by 6.8% year on year (-5.2% for the service sector). But since March, there has been a recovery in production, retail sales and investment. The China Urban Survey unemployment rate fell to 5.9% in March from 6.2% in February.Despite the pickup in economic activity, it is premature to expect a rebound that rapidly undoes all of the prior decline in output. Much will depend on the success of exit strategies globally.Demand for Chinese goods from Europe and the United States, where social distancing measures are still in place, could remain weak. Moreover, to prevent a second wave of contagion, China may have to maintain social distancing, particularly in some sectors, such as sports, cinema and restaurants, leading to a softer recovery.
The People’s Bank of China increased its monetary stimulus, cutting the one-year targeted medium-term lending facility (TMLF) rate by 20 basis points (bps) to below 3% and the one-year and five-year prime rate loans (PRL) by 20bps and 10bps respectively. Social financing data showed an acceleration in loan issuance, reducing liquidity risks.With the rebound in April, the year-to-date drop in the CSI 300 index was sharply reduced to -4.5%, thanks to its high exposure to domestic consumption dynamics and the limited index weighting in energy compared with some other indices. Markets are also optimistic that, while severe, the pandemic does not derail China’s positive structural growth outlook.
A number of emerging market central banks cut rates to support their economies, including South Africa and Turkey. Rate cuts contributed to weaker currencies, which reached new lows against the dollar.
Following one of the shortest, sharpest selloffs in financial market history, there was a strong rebound across most asset classes in April. Global financial markets have been supported by record monetary and fiscal stimulus measures, along with an improvement in the infection rates in the developed world. The South African government, although constrained on a fiscal standpoint, has provided a R500bn economic package. At this point, these measures are only expected to partially offset the slowdown in domestic economy thanks the reprioritization of the budget from intrastate spend to consumption. The real question on everyone’s mind is a) how long it will take for the economy to re-open and b) will there be adequate, investor friendly structural reforms that could trigger a meaningful recovery. The latter is something the market has been expecting since Ramaphosa took the helm more than 2 years ago now but has thus far been disappointed.
Economic data released in April has revealed the extent of the economic slowdown. For example, new vehicle sales fell 30% YoY, electricity consumption was down 8%, PMI data remains depressed, and the SARB’s leading indicators suggest a Q1 GDP contraction. This should not come as too much of a surprise considering that the economy was on a verge of another economic dip coming into the year, but now a recession is a certainty. It is incredibly difficult to estimate the extent of the contraction, but the Bloomberg consensus forecast for 2020 GDP growth is between -1.9% and -9.5% (average of -4.5%). The pressure on the fiscus is enormous and the market anticipates the budget deficit to blow out to somewhere between 7% and 12% (of GDP) in 2020.
Bond investors have welcomed the recent CPI print, in which core inflation fell to 3.7%. The weakness in the oil price despite a weak rand was the biggest contributor, but rental holidays and weak consumer spending will likely keep this figure at the bottom of the SARB’s target range for the foreseeable future. Although we have already seen 200bps worth of emergency cuts by the SARB since the COVID-19 epidemic unfolded, further rate cuts remain on the cards.
The highly anticipated downgrade by Moody’s turned out to be somewhat a non-event, as did the rebalancing of the WGBI which took place on the last day of April. Either, the SARB’s bond buying program was enough to soak up the sale by foreign investors, or the index funds were prepositioned going into the rebalancing. Since the March lows, yields on South African bonds have fallen dramatically. The ALBI delivered a return 3.9% in April, but the curve has steepened since the start of the crisis, thanks to the governments funding requirements.
Local investors enjoyed the broad-based rebound in risk assets in April, in which the FTSE/JSE All Share index gained 14%. The resource sector (+22%) was buoyed by a strong rebound in the Sasol share price, along with some impressive returns from the gold miners and the PGM producers. Financials performed quite well but the there was a wide variance in returns, especially from the local banks. For example, Standard Bank was only up 5% but Nedbank gained 39%. The main reason for the wide variance in returns over this period lies in the nature of their respective loan books. Nedbank for example is highly exposed to the property market (compared to Standard Bank), and therefore is expected to have a higher beta in this environment. Nedbank is still down 47% year-to-date while Standard Bank is down 36%. The best performers in this highly volatile period (other than the gold miners), are those companies that can deliver digitally (like Naspers +31%/Prosus +25%), or have defensive business models, like some of the food retailers. Demand for mobile data has also been supportive for telecommunications provider Vodacom which is up 7% this year.
The country’s lockdown has brought the ailing property sector to its knees. Many tenants are now in a position where they cannot afford their rental obligations and the distributable earnings of the REITS is under severe pressure. We have already seen some of the major players in this space have either deferred or cancelled their dividends payments, these include Redefine, Hyprop and Grit. The sector delivered 7% in April but has a long way to go to recover its losses. Year-to-date the sector is down 43%.
If we turn to analysts’ estimates, US corporate earnings are expected to fall 20% this year and improve by 30% in 2021. These earnings estimates are, however, based upon a steady lifting of lockdown measures across the globe which should see a return to much more normal economic environment as we head into the third quarter. However, we would caution that the return to normal could be a drawn-out affair, with lingering effects on consumers and corporates alike. At first glance, the sharp rally in stock prices since their March lows is profoundly inconsistent with the awful economic reality today: Business activity around the world has imploded as a result of economic lockdowns from Europe to Asia to the Americas. Asset prices should have been way down to reflect this grim reality. They were in March, but stocks are also forward looking. Unprecedented policy supports, both monetary and fiscal, have stabilized market expectations as they will more than plug the economic hole, thus bridging the gap between the current economic fallout and the expected economic recovery 6 to 10 months out. In fact, a major rally in stock prices almost always occurs when a recession is at its worst spot. This was true in the 1990 S&L crisis, the 2001 dot-com bust and the 2008 Global Financial Crisis. Thus, it is not unusual for stocks to rise much earlier than the economy recovers. Of course, the COVID-19 crisis has caused unprecedented economic contraction and there is always a question whether policy support is enough to fill the economic hole. Our sense is that the fiscal packages launched so far are not only enough to stabilize the economy, but may even over-compensate the actual loss in output. Combining monetary and fiscal expansionary efforts, U.S. fiscal and monetary authorities are pumping over US$7 trillion into the economy. With this in mind we continue to advocate the need to remain invested and well diversified with the sharp selloff and rapid recovery proving that trying to time the market is very dangerous.
Fund and Portfolios Overview
April was a strong month for all the portfolios. Not only did the Iza Global Balanced portfolio preserve capital during the selloff in March but captured the majority of upside on offer when markets recovered. This was as a result of a combination of strong alpha generation from Scottish Mortgage (up over 15% for the month) and the decision to rebalance Lindsell Train back to at weight late March, thereby increasing our capture rate on the rebound. Even our gold allocation added to gains as it rebounded from the sell off in March due to margin calls and forced selling. The long term picture remains healthy for gold due to the potential for a weaker dollar, continued economic uncertainty and low rates.
Additionally, we are pleased to say that all portfolios outperformed their respective peer benchmarks. As at the end of April on a year to date basis when converted to ZAR the Iza Global Balanced fund is not only number 1 in the ASISA Global Multi Asset category, but also bested all the funds in the ASISA Global Multi Asset Medium and High equity categories as well (See table below) . We know the rankings can change quickly but to take this top spot over a period like this speaks to the overall process and composition of the portfolios. Not resting on our laurels, we are continuing to evaluate opportunities from the increased volatility and have just recently made a small allocation to China via the China Prescient Fund.