Investment Environment August 2020

14.09.20

The equity market recovery from the COVID-19 crisis has been nothing short of remarkable. This recovery has been highly concentrated and tech led which becomes obvious if one considers the table below where the NASDAQ (the US tech market) is up YTD 30% yet broader US indices are either marginally positive or negative. It is interesting to note that China, represented by the Shanghai Composite Index, has also shown a reasonable YTD performance albeit that’s where all the problems started!

The graph shows the amazing performance of the leading tech companies and how their market capitalisations have increased dramatically as the 4th industrial revolution has manifested itself. In fact, Apple reached a USD2 trillion market capitalization on 19 August. It also shows the oil crisis within the COVID crisis that has taken the Saudi Arabian oil company capitalization down to USD1.8 trillion from the magic USD2 trillion.

While this is all very positive, it remains concerning as we are in a unpredictable state as COVID continues to damage economies yet the value (market capitalization) of world equities exceeds what the economies in which they operate can generate, measured in USD. In summary, equity values have run ahead of economies and are pricing in a perfect post COVID-19 recovery. The flip side is also true in that most economies have been dragged into recession caused by the pandemic and therefore global GDP is under pressure. However, we think it is still a time for caution although we believe the “new normal” will present opportunities not least of all in tech.

So equity markets have recovered and in some cases (in the US mainly) are testing or even breaching new highs. Markets are always forward looking but currently the amount of optimism built into the recovery should call for some caution. See the graph below where the International Monetary Fund (“IMF”) predicts World GDP growth slumping to a negative -4.9%. In fact, of the major economies only China is positive at 1% but will have suffered a significant contraction.

The Organisation for Economic Cooperation and Development (“OECD”), which has 37 member countries collaborating on key global issues, has come up with two scenarios shown below. The first scenario is less negative than the IMF above and assumes that most countries are through the COVID peak, however the second scenario named “Double Hit” takes into account the potential of a second COVID wave which is obviously more negative.

The point of these graphs is to illustrate that both the IMF and OECD are forecasting negative growth for at least a further year out. Either markets are looking very far ahead or there is no doubt they are at odds with the economic fundamentals, encapsulated in the saying “Wall Street and Main Street are dislocated”.

Regrettably, the South African economy is a real casualty of COVID-19. This might be best shown in what Bloomberg calls the Misery Index. The graph shows a survey measuring economies on the basis of unemployment and inflation and the further a country moves to the top right hand corner the more miserable it is. When Bloomberg conducted this survey on 27 July South Africa unfortunately held on to its spot of being the 3rd most miserable economy in the 60 countries surveyed.

While South Africa might not be the 3rd most miserable nation in the world, because its people generally have a positive outlook, unfortunately what the economy faces is some real challenging times and the risk of a debt trap as government expenditure has had to balloon with COVID bail outs and economic recession bites, reducing tax revenues. South Africa is not alone and the graph below shows how Emerging Economies are lagging the recovery of Advanced Economies and China (which is also an Emerging Economy) is virtually back to pre-COVID levels.

In conclusion, it remains sensible to keep a balance of equities in portfolios according to the client’s risk profile but it is sensible to be cautious. In any event one should expect volatile times ahead and be prepared (have a big enough war chest) to ride it out. ZAR hedge investments remain core to our South African investment profile, not only because of an expected weakening currency but also it facilitates investing in businesses that operate in a stronger economic environment.

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