Global Market Overview
During October financial markets were fairly unrewarding for investors, with equities, in particular, coming under pressure towards the latter stages of the month. Fixed income returns were mixed, with US bond values falling, while EU bonds generally posted modest gains on the hope the European Central Bank might extend monetary stimulus.
As the northern hemisphere headed firmly into autumn, the October news flow was dominated by two topics: the resurgence of Covid-19 in Europe, and the upcoming US elections. Markets spent much of the month in wait-and-see mode, before the announcement of widespread restrictions across Europe in the final days of the month tipped the balance of risks to the downside.
Europe is unfortunately suffering a second wave of coronavirus infections with all major economies now reporting new highs in infection rates. The policy response was originally much more targeted than that seen in the spring, with governments imposing local restrictions in a bid to avoid national lockdowns.
Sadly this approach appears to have had limited success with a number of countries now re-imposing national level restrictions. Against this backdrop, high frequency measures of European activity have started to move lower as containment measures take hold. Survey data have also highlighted a bifurcation between the manufacturing sector, which has continued to recover, and service sectors, which are once again subject to restrictions. This will bear watching to see if the trend continues as lockdowns tighten.
The issue of Brexit also re-emerged last month, with the European Council meeting on 15-16 October (which was previously seen as a key deadline) passing without a deal being struck. After negotiations were briefly paused, talks are now intensifying as both sides seek to agree a trade deal before the year end.
Positive gains in US and European stocks over the first few weeks of October were erased in the last week of the month, as market volatility spiked in reaction to new lockdowns. The S&P 500 ended October down -2.7%, while Europe ex-UK stocks were the biggest laggard, down -5.4%. Asia was the regional winner, with strong Chinese data helping emerging market stocks to return 2.1% over the month. In fixed income, US 10-year Treasury yields rose by 18 basis points, while European virus concerns pushed 10-year German Bund yields 10 basis points lower. Corporate bonds were broadly flat, with returns of -0.1% for global investment grade credit.
The UK also saw a significant increase in Covid-19 infections in October. In England, a tiered system of restrictions was initially rolled out before a persistent rise in new cases led to national lockdown measures being announced on the final day of the month. Restrictions varied across the different nations but the direction of travel towards tighter controls was consistent. After much back and forth, the UK’s furlough scheme will now be extended, having previously been due to end on 31 October. With 9% of the UK workforce still on furlough in October prior to new lockdowns being implemented, it is clear that additional fiscal support was required.
The second key issue driving UK markets is Brexit. Posturing aimed at domestic audiences slowed progress in October, with the European Union (EU) beginning legal action against the UK government as a result of the UK’s internal markets bill, and the UK briefly calling off talks following the European Council summit in mid-October. Our base case remains that a deal will be struck and indeed negotiations that were called off have restarted with renewed vigour. Risks do, however, remain of a breakdown in talks, and any deal is likely to be narrow.
UK equity markets declined sharply at the end of October, ending the month down -3.8%. The pound fluctuated with Brexit headlines but ended the month at the same level against the US dollar as it started. UK 10-year Gilt yields rose by just over 10 basis points, resulting in negative returns in a month where UK equities also declined.
China was the first country to suffer from the virus and has retained stringent controls since. October finally saw the relaxing of the internal controls restricting movement between provinces that China has kept in place since the outbreak. This has not, so far, led to a resurgence in infections.
China’s success in controlling the virus has allowed its economic recovery to gather pace, with third-quarter GDP growth printing at 4.9% year on year. After a strong bounce over the summer, China now looks set to be one of the only major nations that will see positive economic growth in aggregate over 2020 relative to 2019. Chinese imports have also recovered with the latest data for September showing imports 13.2% higher year on year. A resurgent Chinese consumer may help international exporters given the potential for weaker demand in their home markets.
Against this backdrop, strong returns from Chinese stocks helped emerging market equities to a 2.1% gain over October.
By the end of the month, all the major economies in the region were recording record daily cases per million citizens. Policymakers sought to balance economics with virus control and initially adopted a series of local lockdowns. Yet, as the month progressed, several major governments including Spain, France, Germany and Italy were forced to adopt national level restrictions.
The Spanish government’s decision to extend its furlough scheme now means that all of the major economies in the euro area will benefit from ongoing labour market support. Yet this has not been enough to prevent a deterioration in the consumer outlook: the increase in infections and restrictions has impacted sentiment with consumer confidence falling.
Equally of concern is the increase in the eurozone unemployment rate, which rose to 8.3%. European equities delivered negative returns of -5.4% over the month underperforming most major regions. Germany was the biggest laggard, giving back some of the outperformance witnessed over the summer. This same cautiousness translated to fixed income assets, with 10-year German sovereign debt yields moving 10 basis points lower to end the month at -0.63%, while European credit eked out modest positive returns.
Local equities failed to escape the broad-based global sell-off in October which proved to be the most significant drawdown since March this year. The spike in COVID-19 infections in many developed countries, dwindling momentum in economic growth with no apparent fiscal stimulus on the horizon, and US election risks all contributed to an increase in market volatility in major asset classes. The FTSE/JSE Top 40 lost 5% in the month while SA listed property fell by a further 8.5%.
The characteristics of this sell-off (compared that of March) were quite different for emerging markets such as South Africa, who proved to be far more resilient this time around. Not only did the currency strengthen by 3% against the US$, but domestic bonds held their own despite a mediocre MTBPS from Tito Mboweni and another wave of foreign selling.
From a COVID perspective, emerging markets have been somewhat more insulated from the 2nd wave of infections seen in Europe and the US. In fact, there is little evidence to suggest that South Africa or any other dominant emerging markets like China will be forced into another round lockdown like the UK, Austria, France or Germany. Frankly, the South African economy cannot afford any further lockdown measures and fortunately with summer approaching it seems less of a risk, especially with our borders still loosely closed.
Prosus and Naspers received a welcome uplift after it announced plans to spend up to $5 billion in a buyback program, citing no adequate acquisition targets at reasonable prices. The local internet giant says it will repurchase up to $1.27 billion of its own shares and $3.63 billion of Naspers’s stock in an attempt to create more value for shareholders and narrow the discount its shares trade at relative to the value of its underlying holding of Tencent. Naspers and Prosus ended the month 6.8% and 5.7% respectively.
Food retailer Pick n Pay also bucked the trend in October after it posted better than expected results, although concerns have been raised on the news it will be buy Bottles, the online grocery service that repurposed its app when alcohol sales were band. While Bottles enabled the Pick n Pay to penetrate the online food sales market during lockdown, recent updates suggest that it too has been negatively affected by the lockdown restrictions. Pick n Pay ended the month 9% higher.
Other stand-out performers in the month include Pepkor (+7%), Foschini (+5%), Distell (+11%), Tiger Brands (+6 %), Clicks (+6%) and Dischem (+5%).
Stocks more closely linked to global economic activity, like the resource basket performed very poorly in October, with the JSE Resource Index down close to 12%. The stronger rand was certainly a headwind for these stocks but they’ve done exceptionally well of late and some profit taking was probably warranted.
Local inflation linked bonds were the best performing local asset class (+1.2%), benefiting from the highest monthly inflation carry in many years. For nominal bonds, the short end of the curve benefited from a heightened chance of rate cuts in the short term, while longer end lagged due to the persistent fiscal concerns. Overall, the FTSE/JSE All Bond Index ended the month 0.9% higher. Inflation slowed to 3% and will likely remain at the bottom end of the target band so long as economic growth remains subdued.
Finance Minister Tito Mboweni delivered the medium-term budget in what must be the most challenging economic climate in South Africa’s democratic history. In short, the budget paints a worse debt-to-GDP trajectory compared what had been presented in the June Supplementary Budget. The base case has been raised to a debt-to-GDP peak of 95.3% in 2025/6 compared with an “active scenario” of 87.4% in 2023/4. While broadly anticipated by the market, this further fiscal slippage means that by 2024 approximately 24 cents of every 1 rand collected in revenue will be spent of interest costs.
Minister Mboweni provided more detail on the much-anticipated expenditure cuts, predominantly through reductions in the public sector wage bill which is now due to rise by 6% below nominal GDP in the coming 4 years, following 15 years of 1.5% increases above nominal GDP. These funds are expected to be re-directed towards infrastructure spend which forms part of Cyril Ramaphosa’s growth initiative. This is clearly a sensitive political issue that is fraught with execution risk and poses the greatest threat to achieving a desirable fiscal path.
The disappointing aspect of the MTBPS was Treasuries promise to provide SAA with an additional R10bn for its business rescue. Although the funding of this support is fiscal neutral, the funds are obviously diverted from more necessary, and likely more productive parts of the economy. It is now estimated that over the last 20 years, SAA has received at least R60bn in funding from government. On the plus side, there were no further allocation to any other SOE’s.
Recent economic data from August released in October suggests a strong rebound in local economic activity. Mining and retail sales recorded growth of 85% and 165% QoQ annualised respectively. Many of our managers now anticipate GDP for Q3 to significantly outperform current consensus forecasts of 40% (and the SARB which expects 45%). September PMI surveys and the SARB’s leading indicators further suggest a significant outperformance. However, despite a strong outperformance, GDP for FY 2020 will still likely be the worst annual recorded contraction in the post WW2 era. With the local economy on the edge, successful execution of governments recovery plan in the coming years will be critical for the long-term prosperity of SA.
The fourth quarter of 2020 contains an unusually high number of unpredictable events for markets to negotiate. Market volatility in October was elevated as investors waited for a clearer steer from both the US election and the results of coronavirus vaccine trials before increased infections and subsequent lockdowns forced the market to re-evaluate the near-term risks. Binary potential outcomes call for balance in portfolios, and currently this applies across asset classes, factors and regions. That being said we do still favour risk assets and in particular equities for next 12 months with volatility to remain elevated.
Early November saw some answers to major macro question markets in October with Biden taking the presidency and some promising vaccine results out of Pfizer. This has driven markets sharply higher with tech initially the main beneficiary post-election and value catching more of bid with the vaccine announcement. The vaccine is not a guarantee that the worst is behind us but does feel like the beginning of the end for the virus and its now down to getting it distributed. The belief is that this good news will continue to propel markets higher along with very accommodative monetary policy.
The elephant in the room is certainly fiscal spend out of the US and without a blue wave and democrats controlling the senate the risk is that this is smaller than the market would like. Despite this there is enough positive momentum heading into next year and global economies should gain some growth traction if we can get a handle on the virus.
Fund and Portfolios Overview
The Portfolios gave back a little of their gains achieved this year, but this is to be expected given some of the macro factors at play as we head into the close of 2020. The important thing is that this did not change our view or positioning within the portfolios, choosing to look through the noise of the upcoming election and keeping the risk on given several positive fundamental factors. This has worked well early in November as Biden took the presidency and markets responded favourably, delivering their best 3 day run since March.
This has been further supported by some positive announcements around a vaccine for COVID 19. We did not take a gamble on who would win the presidency but rather focussed attention on the fact that monetary policy will remain accommodative, a package is likely no matter who wins and that a vaccine was expected to be found early next year or even this year. Finally, a record more than 85% of S&P 500 companies that reported Q3 earnings beat expectations.
The Iza Global Equity Fund officially launched early October into the worst sell off since Feb. While ending the month negative along with equity markets the portfolio has made back the losses and then some in November to date. We continue to underweight bonds and duration in the rest of the portfolios which has paid off as bonds offered no safe haven during the sell off in October and yields have now backed up in November with the 10 YR approaching 1% as the curve steepens given the expectation for improved growth. Gold has given back some of its gains with the recent risk on but we believe that this still remains an attractive hedge for turmoil and if the dollar continues to weaken as expected along with a pick up inflation we can see this asset class ascend once again.