Global Market Overview
Stocks continued their march higher in July, adding a fourth consecutive monthly gain. Despite renewed COVID-19 concerns, rising tensions with China , and signs of stalling economic recovery , the S&P 500 returned to positive territory for the year, helped by remarkable gains from a handful of mega cap internet stocks and generally better than expected corporate earnings. Strong advances in Chinese equities helped Emerging Markets outperform the US, while foreign developed market equities trailed despite the weaker USD. The 10-year US Government yield is a closely watched indicator of broader market confidence and that hit 0.52% on the 31 July. Yields this low point to slower growth and lower inflation expectations. Over the month, the MSCI Emerging Markets equity index rose by 9.0% and MSCI Developed Markets by 4.8%. Credit also rallied, while government bonds held on to their gains
for the year and gold rose by 11%. The S&P 500 rallied 5.6% over the month in USD.
With 90% of second quarter earnings reported, results were much better than feared. So much better in fact, that second quarter earnings per share beat analyst estimates by 17%, representing the biggest beat since 2000, according to Bank of America. The earnings beat was primarily driven by healthcare and large cap tech names like Facebook, Apple, Amazon, and Alphabet. And according to them, the
better-than-expected earnings results could continue in the third quarter as recent dollar weakness should flip to a tailwind for company profits. Additionally, 59% of companies who’ve reported so far this quarter beat both profit and sales estimates, representing an all-time high. That 59% figure tracks well above the two-decade average of 39%, according to the bank. July provided further evidence that economic activity has improved since lockdowns were lifted, but high-frequency data pointed to a pause in the recovery, particularly in the US. The pace of increase in new infections also rose in most regions from the start of July, but appeared to slow towards the end of the month in the US, while rising, from much lower levels, in Europe and Japan. Hopes for a vaccine were boosted by positive early-stage trial results.
Major central banks took something of a back seat over the past month, having already flooded the market with liquidity and taken rates close to their lower bounds. However, governments have been under pressure to provide further fiscal support. Congress debated the extent to which unemployment benefits should be extended and whether further stimulus cheques should be provided, with a deal proving difficult to get over the line.
Daily new cases of Covid-19 in the UK had been falling, but again concerns around a small increase in cases have surfaced at the same time as the government has lifted activity restrictions. A summer economic plan put forward by the Chancellor aims to introduce measures to get the economy back on its feet by reducing stamp duty, cutting VAT for the food and hospitality sectors and offering companies GBP 1000 for each furloughed staff member that they retain until the end of January. At the same time as giving with one hand, the Chancellor plans to take with the other as he rolls back the furlough scheme, which had helped protect the jobs of millions of UK workers. Some of those jobs could now be at risk if activity doesn’t recover before the scheme is wound down. UK assets have been somewhat out of favour compared with other regions over the past month. The FTSE All-Share fell by 3.6% in July.
Emerging Markets and Asia
The increase in new cases in Brazil and India continued throughout July. Recent outbreaks in Hong Kong have also seen the reintroduction of restrictions, which will limit the number of people in group gatherings to just two, while mask-wearing is mandatory.
In China, GDP for the second quarter grew by 3.2% year on year. Travel app data shows that mobility in China and South Korea has recovered well without a significant rise in cases. Both countries appear to show, at least so far, that a recovery is possible without a vaccine if the virus can be brought under control with other measures. Chinese equities were up 8.7% over the month.
Europe looked to have managed the virus better than many other regions in the second quarter, though there are some concerns about rising cases more recently. Activity has been rising across the region, particularly in Germany, given new infections had remained low for some time. However, a recent outbreak in Spain, coming just before the peak of the summer tourist season, has cast some doubt over the potential for a swift economic recovery. The risk of an increase in Covid cases as economies reopen is leading to a potentially more stop-start and geographically differentiated recovery, though an effective vaccine would clearly be a strong catalyst for a more sustained economic rebound.
Second-quarter GDP fell by 12.1% compared with the previous quarter – the largest quarterly decline in the eurozone’s history. European consumer confidence also stalled after healthy gains in previous months, but the composite PMI improved significantly, to 54.8 versus April’s reading of just 13.6.
The European Union (EU) agreed a EUR 750 billion recovery fund in response to Covid-19. Importantly, the recovery fund will be backed by common bond issuance by the European Commission. This is a significant step toward potential fiscal integration across the EU and has increased appetite for European assets. Italian and Spanish bonds returned over 1%.
South African equities were carried by the broad-based gains in global markets but lagged their emerging market peers by a considerable amount. In US$ dollar terms the FTSE/JSE All Share Index gained 4.6%, while the MSCI Emerging Market Index was up 8.9%. The basic materials index was once again the best performer, delivering 9% over the month. Year to date, the FTSE/JSE All Share Index has almost recovered all of its March losses, but the breadth of the recovery has been extremely narrow. Year-to-date Naspers and Prosus which collectively make up just over 20% have contributed 6.5%, while Gold Fields, BHP Biliton, AngloGold, and Sibanya collectively added about 5%. Industrials, Financials and Retailers are still reeling from the effects of COVID epidemic and the effect of various lockdown measures still in place.
After a strong rebound in the listed property sector in June, it came under pressure (down 3%) as recent company updates have suggested that earnings may not recover anytime soon. The structural headwinds facing office and retail space continues to hamper the sector and while select opportunities may arise, we do not anticipate a broad recovery anytime soon.
The SARB cut the repo rate by a further 25bps in July with only 3 of the 5 MPC members voting in favour of the cut. According to the repo rate implied by the SARB’s quarterly projection model (QPM), it is unlikely that we will see further cuts this year unless growth and inflation surprises to the downside in the coming months.
Inflation rose to 2.2% in June (from 2.1% in May) with the majority of the categories recording sub 4.5% inflation. Growth figures that were released for April and May continue to paint a dire outlook for the local economy with mining, manufacturing, energy, and retail sales all contracting between 25% and 75% on an annualized rate. One should keep that this period coincides with far more stringent COVID lockdown measures than the current level 3 (expanded). It is clear however, that without any material policy reforms, the local economy will at best return to pre COVID-19 levels.
While the local bond market performed well on aggregate in July (+0.6%), the yield curve steepened considerably, and capital losses were incurred on the longer end of the curve. Cash is by no means attractive following the string of rate cuts that we have seen in recent months, and even short duration nominal bonds have lost their competitiveness over cash. Longer dated bonds look significantly more attractive, but one needs to be mindful of the funding pressure that could weigh on returns in the coming years. Inflation linked bonds have been under the hammer thanks to the demand shock this year but will likely gain attention when inflation normalizes with the resumption of growth.
Credit has been a popular asset classes in recent years, providing real returns where traditional asset classes have been unable to do so. For the retail investors it has been a saving grace, but one should be cautious of the illiquid nature of these instruments which often fail to reflect the credit risk embedded because of their illiquidity. Year to date only some segments of the credit space have re-priced (most notably senior bank paper), but our managers remain cautious of the potential for further re-pricing across the credit market.
The good news this month that probably has not received the attention it deserves is that SA successfully secured a $1bn 30-year loan from the New Development Bank and a $4.3bn 5-year loan from the IMF. Only a month earlier, it appeared that Tito Mboweni did not have the backing of the ANC who believe that assistance from the IMF would mean trading in SA’s sovereignty. Recent evidence however suggests government folded with clearly no other options. Terms of the agreement with the IMF include a complete revamp of the PPE procurement system that needs to be transparent and address the weakness that allow state capture to occur so freely. It will also need to ensure that all COVID-19 related procurement contracts are public disseminated with their ultimate beneficiaries detailed, and spending will be audited. Lastly, the IMF will focus on their return of capital and the government will have no choice but to address its debt problem and fast track economic reform.
On the 15th of August, the National State of Disaster is due to expire and there is a glimmer of hope that further restrictions may be eased. To date, South Africa still has some of the most stringent restrictions in place which includes the ban on the sale of tobacco products and alcohol. However, it appears that government has realized that COVID-19 is something we will have to learn to live with which is a view echoed by the World Health Organization (WHO). The daily active case curve for SA has stabilized and is expected to peak in the coming weeks. Already we’ve seen the daily active cases and deaths in the Western Cape (which is a month or so ahead of the rest of the country) appears to have rolled over considerably.
With earnings coming off an extremely low base, there is the potential for strong moves should the sentiment shift in the coming months. Already emerging markets have caught a bid which is a step in the right direction for South Africa. The relative attractiveness of risk assets over cash now favours the former which has the potential to generate double digit returns when the market begins pricing in a recovery.
The policy response to Covid-19 from central banks and governments has been swift and sizeable and helped lift markets, as policymakers have aimed to try carry the economy to the other side of the virus. However, a full economic recovery can only take place if rising activity doesn’t also lead to rising infections. Governments should therefore continue supporting 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. It appears progress is being made towards a potential vaccine, but it is too early to sound all clear just yet.
Given the high uncertainty around the outlook for the virus and a vaccine we continue to favour an up-in-quality approach across both stocks and bonds, along with a focus on valuations relative to fundamentals. Alternatives such as gold and silver help diversify portfolios given the reduced diversification that government bonds are likely to provide at current yields. With the uncertain outlook so dictated by the virus, but also given the potential for a vaccine, we continue to believe it makes sense to aim for balanced and well-diversified portfolios.
Fund and Portfolios Overview
The Iza global balanced fund ended the month in the Top 10% for the ASISA Global Multi Asset Flex Category and is still the best performing fund when converted to rands year to date in this category. The Stable and High Growth portfolio once againoutperformed their respective benchmarks with strong performances from both Scottish Mortgage and Fundsmith. Each besting the All country world index for the month. The biggest detractor for the GBP portfolios during the month was the weakness in the USD which weakened some 6.5%. The weakness in USD and all-time lows for real rates was a big driver of strength for the Iza Global Balanced gold position, which was up over 11% in USD for the month. The Iza Stable portfolio underwent some changes in July by selling out of its position in RIT position and took up a position in Royal London Short Duration Credit. At the same time the allocation to Iza Global Balanced was increased by 10% and Rubrics Global Credit trimmed by 5%.