Investment Environment May 2019

01.07.19

While we had a great start to 2019 the old adage of “Sell in May and go away” has again tested equity investors by almost halving year to date growth figures (highlighted in blue) as shown in the table. The S&P500 graph (arguably the key US index) shows how confused the market has been over the last year!

This highlights the fact that markets react to global events that might only be short lived. If one were to pinpoint the negative May effect it undoubtedly comes down to the “trade war” between the US and China. More pointedly, one can blame Trump and his populist approach to government, which is certainly predicated on his “America First” tag line.

Logically, if one looks at the graph it is difficult to assume that the two largest economies in the world can continue a trade war to both of their detriments. Between China and the US the contribution to world GDP is in excess of 50% and estimated by the IMF to contribute GDP of USD35.8 trillion in 2019 and growth of USD 2.27 trillion in 2020. It is difficult to imagine how they will trade without one another’s cooperation.

There are further highlights worth mentioning from the graph which are:

The US economy remains clearly dominant which probably gives it the right to perpetuate the trade war. However, it’s forecast to grow by USD830 billion which is approximately 3.5%;

China continues to come under scrutiny as its growth is expected to “slow” to around 6.1% next year. What everyone forgets is in absolute terms Chinese growth amounts to USD1.44 trillion whereas the US growth amounts to USD830 billion (42% less than Chinese growth), followed by the Euro area of under USD700 billion.

The above two points demonstrate who is driving world economic growth and it would be foolish to obstruct trade with the Chinese economy – maybe Trump has another agenda?

While the above trade war rhetoric has currently stalled and negated equity growth, it is worth noting that equities are not unduly expensive (see PE ratings highlighted in green). Valuations reflect the maturing economic growth cycle. Proponents of a negative outlook say equity earning will stop growing as world economic growth slows late in the cycle. To date this has not happened. There is also an element of a normalisation in monetary policies after the global financial crisis and consequent quantitative easing, some of which remains today, eg Europe. Interest rates were undoubtedly normalising in the US and there was great concern in the last quarter of 2018 that the Fed would raise interest rates too much. In fact, the contrary has occurred and with curtailed inflation and a fully employed job market there is an outside chance that the Fed drops rates in the latter half of 2019. This might not be enough to stimulate a “risk on” approach but it certainly would be supportive of equity prices.

 South Africa has just come through recent elections, which with the benefit of hindsight appear to be as predicted. Ramaphosa’s cabinet appointments retaining Mboweni and Gordhan as Ministers probably allow SA Inc to breathe a sigh of relief. Ramaphosa’s critics expected him to go further (whatever that means) but there is no doubt Ramaphosa is a statesman and sees himself as a President for all South Africans, and not just the ANC! He has and will continue to play a long game, with the intent of righting the wrongs of the new democratic government’s errors since 1994 and certainly those of the last decade. We have to hope that his long game will be allowed to play out and not be fraughted by his detractors (most notably the Zuma camp) within the ANC.

 Dealing with the politics within government will prove no easy task, but this political revival needs to become an economic revival. The economy disappointed in 1Q2019, showing a GDP contraction of 3.2%. As shown in the graph this is the most dramatic drop since 2009 and was prevalent across all sectors of the economy. The ZAR has weakened sympathetically and simultaneously and government need to pull every lever to turn the economy, avoid debt downgrades and support social wellbeing.

Equity investment - like Ramaphosa - has to be a long game and therefore portfolios must remain constructive on equities, take advantage of regional and sector growth and in the case of South Africa be ZAR hedge defensive.

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