In the first three weeks of 2017, the JSE All Share Index has delivered double the entire 2016 return. This by itself is not really significant; the adage “as goes January, so goes the year” is rarely true. The first three weeks of 2016 saw an 8% loss on the JSE, wiping out more than 2015’s return. Yet returns for the rest of 2016 were positive. What matters more is that the global and local economy are on a much sounder footing as we kick off the New Year, and therefore market sentiment is also more positive.
Global upturn underway
Starting globally, a wide variety of indicators suggest a cyclical rebound in growth started towards the end of last year. Global purchasing managers’ indices have improved across the developed and emerging world. Similarly, consumer confidence is at high levels in key markets like the US and the Eurozone. Inflation is also increasing from worryingly low levels, which indicates improved pricing power for companies. The firmer oil price does not (yet) represent a price shock for consumers, but does aid producers (the plunging oil price in January last year was a key factor behind the global equity sell-off). In response to all this, the International Monetary Fund last week upgraded its growth forecast for advanced economies over the next two years. After relentless downgrades over the previous four years, the global growth outlook has stabilised at 3.4% in 2017 and 3.6% for 2018.
In other words, while the markets seemingly responded strongly to Trump’s victory, conditions on the ground were improving before the election, supporting higher equity prices and higher bond yields. With Trump now in office, the most unpredictable presidential term in the modern era has commenced, headed by the most unpopular incoming president. While Trump has promised expansionary fiscal policy (tax cuts for the rich and infrastructure spending) it looks set to occur when the economy is approaching full employment and does not need it as much as in 2011, when the Republicans were dead set against any increase in the budget deficit. With unemployment below 5% and inflation creeping up towards 2%, the Fed could counteract loose fiscal policy with tighter monetary policy (interest rate increases). Despite this, the historically mild hiking cycle will probably continue and peak at a much lower level than previously. The key outcome for South African investors to monitor is the extent to which upward pressure is placed on the already strong US dollar.
Local outlook also better
Locally, we are already off to a much better start to the new year compared to January 2016. The rand is looking firm and sailed through the global shocks of last year largely unscathed. South Africa’s investment grade credit rating is safe for the next few months, while we were still reeling from “Nenegate” a year ago. Commodity prices increased through the course of last year, most notably iron ore and coal. It doesn’t mean that it is all smooth sailing on the journey to recovery, however. November’s mining and manufacturing production data were disappointing and suggest that the fourth quarter’s gross domestic product growth rate will be muted. Growth for 2016 as a whole was probably only around 0.4%.
Despite a number of downbeat trading updates from leading JSE-listed clothing retailers, official retail sales numbers, on the other hand, were much better than expected in November. Real retail sales increased by 3.8% year-on-year. This occurred even though surveyed consumer confidence remains low. The FNB/BER Consumer Confidence Index (CCI), compiled by the Bureau for Economic Research for more than three decades, fell back to -10 points in the fourth quarter of last year, suggesting pessimism levels on par with those usually experienced during a recession. The index is based on answers to three questions: the expected financial position of households, whether the present time is appropriate to buy durable goods such as vehicles and furniture, and the expected performance of the local economy. This latter economic outlook index of the CCI plunged from -4 to -23 points in the fourth quarter. While South Africans are seemingly gloomier about the state of the economy, South Africa’s economic prospects are actually looking better compared to a year ago. The IMF forecasts a modest improvement in growth to 0.8% this year and 1.6% next year.
Rainfall improves food price outlook
Crucially, in large parts of the country, rainfall in December and January was above average. South Africa looks set to have a maize surplus this year, which suggests the food inflation shock is likely to be behind us. White maize is trading 40% lower than a year ago and wheat prices 18% lower. Therefore, while December’s inflation number was higher than expected at 6.8%, it probably represents the peak in the cycle. Food inflation remains stubbornly high at 12%, but there is light at the end of the tunnel.
February Budget
Looking ahead, tax increases in support of the Finance Minister’s aims to retain fiscal credibility and our investment grade credit rating loom as a potential headwind for the economy this year, but Treasury is likely to be careful not to derail the recovery with excessive tightening. The February Budget Speech is therefore one of the first key signposts of the country’s progress this year. South Africa is likely to be on edge again in 2017, given that the country is still on the cusp of junk status. We are not alone though, as S&P Global recently pointed out that it expects more downgrades than upgrades globally this year, after 2016 saw three downgrades for every upgrade. Of the 130 countries with a credit rating from S&P, only seven have a positive outlook, with 30 given a negative outlook.
The Reserve Bank is likely to leave interest rates unchanged this week and for most of the year, with the possibility of rate cuts depending on the behaviour of usual suspects: the rand, the oil price, and inflation expectations. This means South Africa’s yield curve is steep – long-term interest rates are higher than short-term rates – and therefore presents a relatively attractive investment. Local equities are also more attractive after moving sideways for the past three years. Therefore, while return expectations are certainly lower than over the previous decade, they are not dismal.
Investing in 2017
It is true that 2016 returns were disappointing. The average retail balanced fund* delivered only 1.4% in 2016 according to Morningstar. This was the worst year since 2008. The 12.6% appreciation of the rand against the US dollar last year meant that offshore returns were negative for most balanced funds. (It does mean though that for dollar-based investors South African assets were among the best performing in the world last year.) Over the last 10 years, a period that includes the 2008 crash, the average balanced fund returned 8.8% per year on average, enough to double an investment over this period, but some years were decidedly mediocre (5% in 2011). In other words, to benefit from the great years (18% in 2013), one has to sit through the tough ones.
A further head-scratcher for local investors is that the best performing fund returned 22% and the worst (out of 157) -11%, indicative of the sharp turnaround in sector and asset class performance from the previous year. (Resources lagged the All Share by 40% in 2015 but outperformed by 30% in 2016.) Tempting as it might be to switch into recent winners, it is not necessarily a good idea. The top performing balanced fund over the 12 months to end 2016 was ranked 105 in 2015. The top performer over 12 months in 2015 was ranked 104 in 2016. Again, it is better to set a strategy (and identify a manager or managers) and then stick to it.
If 2016 taught us anything, it is to expect the unexpected. Since no one has a crystal ball (at least one that works consistently), appropriate diversification remains the foundation of a successful investment strategy. The other lesson is not to overreact to headlines, short-term market volatility and shifts in sentiments. Trump’s unexpected win did not cause a market collapse (on the contrary); the Brexit shock hit the pound but not the rand; and despite the on-off charges against Finance Minister Gordhan (and the ratings axe hanging over our heads), local bonds were the best performing domestic asset class in 2016, and among the best globally.
*ASISA Multi-Asset High Equity category
Chart 1:
Source: Datastream
Chart 2:
Source: Datastream
