From the desk of our CIO

March 2020

The Great Reset

The global economy is experiencing an unprecedented degree of demand destruction with most economies experiencing varying degrees of industrial shutdown. Against this backdrop, the Saudi Arabia and Russian decided that it was best to abandon output cuts at OPEC+ and go full tilt on oil production. In a “normal” world, the collapse in the oil price would have resulted in a massive windfall for many emerging markets (oil being a major import for those needed); however most currencies have weakened against the dollar, negating to some extent the windfall of lower prices.

Our Global Macro fund has performed exceptionally over the past year in rand terms. Whilst the MSCI index has lost around 10% over the 12-month ending March 2020, the local currency has had a torrid spell on the back of credit downgrades coupled with dollar strength, as a flight to safe haven became the norm amidst the pandemic.  During the 1st quarter, we increased cash exposure as valuations continued to outpace earnings expectations. This proved to be well timed but will require close monitoring as cash yields will no doubt move lower, creating opportunities in other asset classes including equities.

In domestic markets, both bonds and equities came under pressure during the recent quarter with correlation between asset classes breaking down as a result of a 1 in 100-year event in the global economy. Whilst we had been expecting a credit downgrade at some point, we argued that a lot of the bad news had been priced into the bond yield curve prior to the Moody’s downgrade. What we did not expect was a global economic shutdown which has caused the currency to reach all-time lows. Against this backdrop, as Rowan points out, the term premia for SA bonds are at all-time highs.

Equity markets bore the brunt of the global market rout, with the SWIX delivering -24.5% over 1 year to March with a quarterly return of -26.6%. The recent sell-off in domestic markets has dragged the annualised 5-year return of the SWIX to -1.94% p.a, which is in stark contrast to longer term real returns for domestic equities of 5-6% p.a. The carnage has been indiscriminate with most sectors selling off to values not seen even in the Global Financial Crisis and much lower in some instances. Whilst opportunities exist, care needs to be exercised to position equity funds carefully for a recovery at some point.

From a balanced portfolio perspective, we have had preference for domestic bonds and cash over domestic equities and global equities. Whilst normal market conditions would have favoured bonds if equity markets had corrected in the ordinary course of events, what happens in a global pandemic was not contemplated. Correlations between asset classes soared with losses being experienced across the risk spectrum. Whilst global markets were lower, the rand buffered domestic returns. As Ntsekhe points out, there remain opportunities to take tactical positions in equities in the next while; however we continue to hold large positions in domestic bonds and cash.

The current environment will require some stoic resolve to navigate but we remain optimistic about the future.  Post the national lockdown we will emerge into a world that we all may experience differently. We have learnt to embrace technology for communication so will we all revert to air travel for short meetings as willingly as we did before? Will supply chains retain their current format or will more jobs be brought back to SA?  We do not have the answers to these questions, but time will ultimately reveal our new realities and opportunities to build a stronger society and economy. Let us not waste a crisis to create a stronger South Africa and RESET our growth trajectory!

Keep safe and remain positive!