Investment Environment February 2019

07.03.19

Equity investors were really tested in the final quarter of 2018, and in particular the week leading up to Christmas. Indices like the S&P500 gave up all their gains virtually back to the beginning of 2017 and other markets, developed or emerging, followed suit. It is possible that the situation was exaggerated by computer trades but nonetheless it did occur! As we enter 2019 there has been a substantial recovery, that is most pronounced in the US (S&P500 + 11% YTD), because equity valuations became unreasonably cheap in this unusual December period.

However, it is more than investor valuation criteria and computer trades that is driving the markets and as explained by Kevin Lings (Stanlib Economist) the world is a very uncertain place as shown in the index. This can be attributed to a variety of things, not least of all the lack of political leadership and the consequent “Trump effect” which threatens world economics with the prospect of trade tariffs being imposed by the two largest economies, being the US and China – the so called trade war. It is critical for equities that the “trade war” reaches an amicable conclusion soon.

Furthermore, the Fed lived up to its promise of raising interest rates and followed through until December 2018 but since then has issued more market friendly statements in the new year indicating that interest rate increases might stall. This decreases the threat of a risk free return alternative to equities.

The third major economic region, being Europe, continues to suffer recession in its core economies and has zero interest rates to provide monetary stimulus.

So economically we need the US to continue to maintain its economic growth and China to achieve GDP growth of ± 6%. This probably requires monetary stimulus to support Chinese consumer spending which is the long term plan for the economy to grow.

Outlook for Equities 2019

As can be seen from the graph, the so called FANG’s (Facebook, Apple, Netflix and Google) which are representative of the large cap technology stocks, took a similar knock to equities in general. This was to an extent dramatised by Apple’s profit warning in December. It has to be asked if this is not an opportunity. The tech stocks did outrun the market in general and became highly rated, but as we enter the fourth industrial revolution – which is fundamentally driven by technology – are these not the stocks of the future? (not limited to FANG but technology as a whole).

Having established an extremely low base in December 2018, it is probably reasonable to expect some equity growth, with the favoured region being the US as the Fed has demonstrated some sensitivity to markets. If this can be supported by a reasonable trade agreement with China, equities will probably show double digit percentage price growth. However, it is not a time to be sanguine as there is considerable risk in the system. The Economist Intelligence Unit recently released an article highlighting global risks for 2019 which is neatly summarised in the table and diagram. This supports the spike shown in the Global Policies Uncertainty Index.

If the world is facing policy uncertainty this could not be more true for South Africa as illustrated by Shapiro. Obviously this is compounded by the 8th May elections. The JSE has shown some recovery in sync with world markets .

Bloomberg has highlighted that Foreigners net equity sales in the YTD are at an all time high since 1999. This is despite the relative value compared to Emerging Markets being at its lowest / most valuable in recent years. It appears that Foreigners are bailing out of SA equities!

In spite of load shedding surprises the ZAR has been stable and, barring other surprises, will probably remain so with a slightly softer USD because of the interest rate cap announced by the Fed. However, it still makes sense to be rand hedge biased in structuring an SA portfolio.

Markets don’t like uncertainty but are off to a great start in 2019 so the old saying comes to mind that “markets are climbing a wall of worry”!

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