Global Market Overview
- Global markets, as represented by MSCI All-Country World Index, or ACWI, were up 6.1% in USD for August led by Japan (catch-up performance after having lagged in July) and U.S. stocks.
- Emerging markets underperformed developed markets, as the rally in Chinese shares back in July lost even more steam.
- What had appeared to be a calmer market environment earlier in the month turned into an outright frenzy as retail investors bid up tech stocks following AAPL/TSLA stock split announcements.
- Fed Vice Chair Richard Clarida put the final nail into the Phillips Curve coffin by declaring that the Fed will pursue a symmetrical inflation target (i.e. willingness to let inflation run hot).
- The latest market advances are increasingly being driven by momentum sentiment resulting in narrower breadth as a handful of large companies are driving an ever-increasing percentage of market returns.
At the start of the summer, when lockdowns were gradually lifted, some hoped that the Covid-19 pandemic would recede during the hotter summer months. However, even though record temperatures were registered in August, the virus has unfortunately continued to spread. There have now been over 25 million cases globally, up from 10 million at the start of July.
Even though the number of new daily cases in the US has started to decline, some regions- including Europe-are now facing a second wave. So far, better testing and tracing capacity has allowed European policymakers to treat this second wave with targeted measures, including travel restrictions or the requirement to wear a face mask in public, instead of national lockdowns.
On the economic front, high-frequency data, such as travel and navigation app usage, point to continued global growth over the third quarter, albeit at a more moderate pace, particularly in the US, than in May and June. However, these challenges haven’t dented investors’ enthusiasm, which seems to have been lifted by a better-than-expected second-quarter earnings season and by the potential for a viable Covid-19 vaccine in the coming months.
In the US, the number of new daily Covid-19 cases reported has been decreasing since the start of August. However, the percentage of Covid-19 tests that are positive remains above the World Health Organization’s recommended limit for reopening (5%) in 27 US states. This high infection rate helps explain why high-frequency data, such as the Google community mobility index and in-store credit card spending, have moved sideways over the month.
On the political front, the negotiations relating to a new coronavirus relief bill have continued to stall in Washington. For millions of Americans, the delay in passing another stimulus package could have painful consequences. Thanks to the CARES Act, passed in March, an extra $600 per week of unemployment benefit was provided to workers who qualified for unemployment insurance but this extra financial support expired on 31 July. Since the beginning of August, those who have lost their jobs are back on normal, much less generous, unemployment benefits. Without further fiscal stimulus or a vaccine, the jobless are likely to struggle in the face of a potential prolonged period of inactivity due to the pandemic.
The presidential campaign has continued to gather steam with the nomination of Kamala Harris as Joe Biden’s running mate and the official nomination of Donald Trump as the Republican nominee. So far, the most recent polls continue to point to a victory for the Democrats.
On the economic front, most data releases continued to point to solid, though moderating, growth in August. The flash purchasing managers’ indices (PMIs) for both manufacturing and services have both beaten expectations by a wide margin, with readings of 53.6 and 54.8 respectively. However, other advanced economic indicators, including the Empire State and Philly Fed Manufacturing surveys, fell short of expectations. The housing market remained the bright spot for the US economy with housing starts, existing home sales, and homebuilder sentiment (NAHB) all beating expectations.
In terms of monetary policy, the Fed announced a shift to average inflation targeting at the Jackson Hole virtual conference, confirming that monetary policy will remain supportive for the foreseeable future.
August also marked the end of the second-quarter earnings season, which surprised on the upside relative to weak expectations. Even though earnings per share were down 33% year on year, 84% of companies beat expectations and a large number revised their guidance higher for the coming quarters. With the S&P 500 12-month forward price/earnings ratio reaching 23x , well above its 10-year range, risk-seeking behaviour seems to have no limits as investors conclude that with the Fed on the side-lines why bother placing a price target on equities? Some of this euphoria has a fundamental basis as U.S. companies have been reporting better than expected 2Q2020.
In the UK, high frequency data, such as travel and navigation app usage, show that activity has strengthened in August. Restaurant bookings have been particularly strong thanks to the success of the government’s “Eat Out to Help Out” scheme. Against this backdrop, new cases of Covid-19 have risen again in August but remain relatively low and the percentage of Covid-19 tests that are positive has remained well below the World Health Organization’s recommended limit for reopening.
The Office for National Statistics reported a 20.4% (quarter on quarter) decline in GDP for the second quarter of the year. However, the monthly data showed that GDP has already started to rebound in May and June, with monthly increases of 2.4% and 8.7% respectively, but overall output still remained almost 26% below its pre-crisis level.
Consumption was strong in July with retail sales rising 3.6% over the month, rising back above their pre-crisis level. The flash services PMI for August rose to 60.3 but the employment component of the survey was concerning, decreasing to 38.7. The unemployment rate has remained low until now despite the substantial decline in economic activity thanks to the furlough scheme, which has been used by over 9 million workers. However, with surveys showing that over 3 million workers are still furloughed, the unemployment rate could rise much higher with the scheme set to end in October and the government so far ruling out an extension.
These concerns about a fiscal cliff in October together with stalling Brexit negotiations, have weighed on investors’ appetite for UK assets. Nevertheless, the FTSE All-Share still gained 2.4% in August, although it lagged the recovery in most other regions.
Emerging markets like South Africa lagged their developed market peers in August, despite a weaker US$ and upbeat investor sentiment as global economic activity is gradually starting to show signs of life. Certain asset classes like the Rand and domestic bonds performed better than the broader equity market, gaining 0.5% (against the US$) and 0.9% respectively. The JSE All Share index was marginally weaker at the close (losing 0.3%), after being firmly in the black for most of the month. For a change we saw some of the domestic, small cap businesses rally on the back of the easing in lockdown regulation that allow for longer trading hours, and the opening of provincial boarders that allow for leisure travel. The best performers on the index include the likes of Massmart, Italtile, and Sun International who gained 39%, 33% and 30% respectively. Leading year-to-date contributors for the ALSI such as Naspers and Anglo Gold also happened to be the biggest detractors in August, falling 2% and 11% respectively.
Signs of a cyclical turnaround were evident in the strong gains seen in the industrial metals sector. In the last month, iron ore and copper rallied 11% and 4.3% respectively, thanks to strong demand from China. The likes of BHP Billiton and Glencore benefited from this, achieving returns of 2.8% and 3.4% respectively. The rally in the gold producers came to an abrupt halt as the yellow metal fell back below the $2 000 mark. Year to date the, gold is still up more than 30% in US$ and could remain at elevated prices if real yields remain under pressure.
The SA listed property sector dropped by almost 9% as investors reacted to downbeat earnings reported by the likes of Nepi Rockcastle, Redefine and Resillient. Falling distributable earnings and rising LTV’s have started to reflect the damage done by the nationwide lockdown, and the structurally weak aspect of the local property market that we’ve seen for some time now. Redefine, Fortress B and EPP all fell by more than 20% during the month, while Investec Australia, Equites and Fortress A bucked the trend and ended in positive territory.
SA’s annual inflation print for July came in just above 3%. This is an increase from June’s annual inflation rate of 2.2% and May’s 2.1% print which puts it back in the SARB’s target band of 3-6%. The July increase was largely attributable to higher petrol prices as well as an increase in the annual electricity tariff and low base effects. Considering stable oil prices, a strengthening rand and subdued economic activity, we expect that inflation will remain at the bottom end of the SARB’s target range in the short to medium term. However, the fixed income market now anticipates that the domestic interest rate cutting cycle is over, or least for the foreseeable future.
The major policy shift by the Fed to target the average inflation rate of 2% has the potential see US inflation running much higher and could underpin SA’s real yield advantage. Already it would appear that the carry trade is firmly in focus, but it could gather pace and lead to further rand strength and a compression in domestic yields, provided that the risk-on sentiment in global markets remains in place. In the last 3 months, the rand has gained 3.9% and 2.4% against the US$ and the Yen respectively.
National Treasury released its statement of revenue and expenditure for July which highlighted a further deterioration in the budget deficit. At the end of July, the YTD budget deficit stood at 5.1% of GDP, or R260bn. While this is alarming, it is marginally better than the projected figures presented by the Finance minister in the supplementary budget earlier in the year. The muted revenue figures that came in below expectations suggests the rebound in the economy has not been as great as many had hoped. Bond yields have not reacted too much to worsening fiscal position Treasury finds itself in, but that is probably because it has already been priced.
Local politics dominated news flow as the ANC NEC delegation met to confront ongoing revelations of corruption and fraud by its party members. Ultimately Cyril Ramaphosa was able to stamp his authority which has recently been put into question, announcing that anyone who is facing formal criminal charges must step down from their government and party positions. This shift has the potential to rid the organisation of the weeds that has cost the party its reputation and placed the economy at the hands of thieves. Already there are rumours doing the rounds that we may just see a cabinet re-shuffle, but it may take longer for implicated leaders to be shown the door in a more discrete fashion. In other political news, the NPA have also announced that they are on the verge of making high profile arrest in relation to state capture allegations, specifically relating to the Vrede Farm dairy case. We have heard utterances like this before and the party should only be judged on action that follows. Should there be some follow through, this could just be the turn in the tide that we’ve all be been waiting for.
The next few months will be an interesting time for local investors as households are taken off life support when the TER payments are withdrawn, and the true effects of the 6-month (and counting) lockdown are revealed in data releases, both at a corporate and economic level. All eyes will be on the Minister Mboweni as he delivers the medium-term budget statement in October in which we hope to hear about some structural reforms that could put SA on a more stable growth path. And lastly, the outcome of the US election has the potential to introduce heightened volatility as November approaches, but this could also provide opportunities for those that have missed out on the most rapid market recovery in history.
The swift and sizeable Covid-19 policy response from central banks and governments has managed to cushion the economic shock and lift markets, as policymakers aimed to build a bridge to the other side of the virus. However, the second wave in Europe reminds us that the battle is far from over and until a vaccine is widely available, economies will likely remain constrained by measures aimed at slowing the spread of the virus. It is therefore important that governments continue to support consumer incomes and businesses until a vaccine is available or until the virus is brought under control by other means. The extent to which they do so will be key to the outlook from here. The Fed policy will stay easier for longer, which is positive for stocks, but negative for both the dollar and the long end of the curve. The policy shifts will encourage more risk-taking, leading to further multiple expansion and eventually, asset bubbles. A sustained dollar weakness could also lead to rising asset values in the rest of the world as other central banks may intervene to slow down their local currency appreciation, leading to overflows of local currency liquidity. The policy changes could see a mini economic boom in 2021.
Given the degree of uncertainty around the outlook for the virus and a vaccine we continue to believe it makes sense to aim for balanced and well-diversified portfolios. In this environment, we favour an up-in-quality approach across both stocks and bonds, along with a focus on valuations relative to fundamentals. Alternatives, such REITS and commodities, may also help diversify portfolios given the reduced diversification benefit that government bonds are likely to provide at current yields.