Don’t Let Recession Talk Rattle Your Cage

It’s been an interesting year for investors. Given the state of the global economic outlook, there has been a lot of talk of an impending recession, or even that we’re already in one. Understandably, this may leave you feeling nervous. Recessions may elicit fear in us, as we might expect a slower economy to affect both our portfolios (through lower investment values) and broader lives (through less income or a job loss). The implications of a recession tend to play games with our emotions and often drive us to make bad decisions.

What exactly is a recession? The technical definition is two quarters (six months) of negative economic growth, measured by a declining gross domestic product, or GDP. GDP is the total market value of the new goods and services produced during a specified period. More simply, a recession describes a shrinking economy rather than a growing one.

As counterintuitive as it may sound, recessions can be a great time for investors, because prices can become lower than they normally are. That gives your investment manager an opportunity to buy assets more cheaply and, in so doing, sow the seeds of future growth. The problem is that recessions create uncertainty around the future and thus it does not feel like a great time to invest, so some investors are tempted to pull money from their portfolios. This typically leads to selling at depressed prices, locking in losses.

The best thing we can do is to be prepared, should we find ourselves in a recession, by having a few rules in place to help us make better decisions and know what to do. Here are a few habits that can help protect your savings in a slowing economic environment.

  1. Take some time to make sure your financial position is secure. In a recessionary market, it’s a good rule of thumb to make sure you have a cash buffer and that your portfolio includes exposure to assets that can thrive in a depressed environment. If you are unsure about this, take some time to check in with me to make sure your total financial position is still appropriate for your goals.
  2. Remember the rules of wealth attainment. Namely, save early and often, and invest your savings in a portfolio that reflects your risk tolerance. Then let the power of compounding grow your wealth faster than inflation. In a recession, fear may drive some people to stop saving and/or choose a more cautious portfolio. But, as we’ve said, some of the best returns historically have been recorded during rebounds from recessions. Taking a break from markets can mean missing out.

Given the current environment, staying invested can be easier said than done. I encourage you to give me a ring if you have any concerns, or if your financial situation has changed and you think that warrants a rethinking of your investments. Regardless, save every little bit you can, as we’ve discussed.

  1. Don’t sell out. We all know the old adage, “Buy low, sell high”. Yet, when fear drives you to move to a more conservative portfolio, you sell stocks low (again, locking in losses) and buy bonds high (increasing the chance that they’ll return less or even lose money over the long run). The start of a recession is not the time to liquidate your investments. Depending on your time horizon, you most likely have enough time to ride out short-term stock price drops if you stay focused on the long term.

A recessionary environment could even be a time to increase your contributions to your portfolio. By saving when the market is down, you’ll likely buy low. This brings me to my next point.

  1. Stay the course by averaging in. With uncertainty in the air, holding together your finances can be tough. Therefore, it’s a good idea to set accounts on autopilot to avoid the temptation of hoarding cash under your mattress. Automated savings plans take the guesswork and hesitation out of your present self and help attain your financial goals.
  2. Think long-term and keep concentrating on your goals. It’s important at all stages of the market cycle to think about the goal of your investment portfolio. Ignore short-term performance in favour of your progress toward your goals. If you do that consistently, it’s really going to help you to continue investing through this or any recession.

Above all, let’s remain focused on the long term and avoid being spooked by the “R word”. We should all expect at least one recession over our investment horizon (likely many more) so we should try to make the most of it.

As always, please let me know if you would like to discuss this or anything else in more detail.

Raoul Gordon

Raoul Gordon

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Budget 2022 Highlights

On 23 February 2022, Finance Minister Enoch Godongwana delivered the annual budget speech, providing an update on South Africa’s finances. 

Low economic growth, vast unemployment, increasing debt levels, coupled with South Africa still being in a state of disaster two years since the start of the Covid-19 pandemic, all contributed to a complicated juggling act for the Minister of Finance. 

Given the unrest witnessed in 2021 along with weak foreign investment, the 2022 budget had to be geared not only to curb unemployment and to stimulate economic growth, but to also give assurance to foreign investors. 

In the words of Minister Godongwana “we need to strike a critical balance between saving lives and livelihoods, while supporting inclusive growth. This budget presents this balance”. 

 Some key aspects to consider that has affected spending potential and therefore, economic growth: 

  • An already high unemployment rate that was exasperated by Covid-19. 
  • A lot of companies had to implement retrenchments and/or salary cuts, leading to lower household income and therefore lower spending. 
  • Lower income levels also directly impact the amount of personal income tax and VAT that is gathered. 
  • Inflation has increased to 5.7% – placing increased pressure on low-income bracket tax earners. 
  • The emigration of highly skilled workers has increased. 
  • Higher commodity prices, which supported the economic recovery, slowed in the second half of 2021. 
  • Industrial action in the manufacturing sector, and the re-emergence of loadshedding, also slowed the pace of the recovery. 
  • Continued requests for financial support from financially distressed state-owned companies. 

According to Minister Godongwana, “only through sustained economic growth can South Africa create enough jobs to reduce poverty and inequality; enabling us to reach our goal of a better life for all.” 

 Revenue, deficits, and debt to GDP according to the 2022 budget: 

  • Tax revenue for 2021/22 is estimated to be R1.55 trillion, exceeding the original budget estimate by about R182 billion. 
  • Higher income levels have been primarily driven by the resources sector due to increases in commodity prices. 
  • The budget saw higher revenue from other sectors and other tax instruments, such as personal income tax, value-added tax followed by corporate income tax. 
  • Government debt has reached R4.3 trillion and is projected to rise to R5.4 trillion over the medium-term. 
  • The consolidated budget deficit is projected to narrow from 5.7% of GDP in 2021/22, to 4.2% of GDP by 2024/25. 
  • The debt ratio will stabilise at 75.1% of GDP by 2024/25 (which is 3% lower than projected in the MTBPS). 

Below is a quick overview of some of the key updates announced in the budget speech: 

Tax credits and rebates: 

Levies, duties, and charges: 

Other areas of tax collection that were introduced and/or increased for the first time in a while: 

Disclosure of wealth will be required to assist with the detection of fraud 

To assist with the detection of non-compliance or fraud through the existence of unexplained wealth, it is proposed that all provisional taxpayers with assets above R50 million be required to declare specified assets and liabilities at market values in their 2023 tax returns.1 

Retirement fund taxation and reform on the cards 

Changes have been proposed to allow for greater investments into infrastructure funds by Regulation 28 compliant funds. Amendments to Regulation 28 are expected to be gazetted in March 2022. 

There are proposals to allow members access to one-third of their retirement fund savings while the two-thirds balance must be preserved for retirement. The tax consequences of these changes are still being considered. The draft legislation on these amendments will be published for comment in the middle of the year. 

In conclusion 

Given the endless stream of hardships that South Africans have had to face since the outbreak of Covid-19 and its devastating aftermath, the 2022 budget was expected to be consumer-orientated, and it has delivered on expectation. Given the fragile state of the economy and the country’s growing debt burden, National Treasury faced a difficult balancing act between providing the necessary relief to consumers and businesses while also taking steps to improve the country’s fiscal metrics. 

Minister Godongwana shared this view and stated, “…in these trying times and without compromising our ability to collect revenue, we have managed, through these tax proposals, to keep money in the pockets of South Africans, and to create conditions for greater investment in the economy”. 

According to Treasury, if the personal income tax brackets were not adjusted, revenue would have increased by R13.5 billion. This relief is mainly targeted at individuals in the middle-income group. 

The government’s main task will remain to create jobs, to ensure that we continue to grow and stimulate the South African economy and to keep government spending low. 

Perhaps the most crucial element of the budget was the continued commitment to the fiscal stabilisation programme, with the restriction on increases in public sector wages being a vital component. As we have seen from previous budgets, implementation risk is high, given the politically unpopular move of restricting wage increases. This restriction is likely to continue to be contested by labour unions. Fiscal prudence going forward will be essential if South Africa is to avoid a debt trap in the medium term. 

 

Useful links and resources: 

1 Source: http://www.treasury.gov.za/documents/national%20budget/2022/review/Chapter%204.pdf

 Michael Kruger

Investment Analyst
Morningstar Investment Management
South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Reflecting on the year that was

At face value, it appears as though markets have performed well, however, broadly speaking there have been some landmines that simply could not have been avoided by all investors. 2021 was also by no means a dull year – global bonds bottomed out, the Evergrande debacle, Chinese tech stocks slumped and the contagion of it all to emerging markets. 

 If we look at the various asset classes across the calendar year, the first point that stands out is the broad positive returns across all the nine asset classes in 2021 (as can be seen in the chart below). The second is the rotation in the ranking, highlighting the importance of diversification.

 Looking at local markets in 2021 

  •  S.A. Equities are making a comeback
    After a seven-year drought of returns for domestic equities, the past 18 months have seen a strong rebound in S.A. equities with broad-based returns across the sectors. While 2020 saw resource shares (mainly platinum and diversified miners) performing well, 2021 saw a rotation into more unloved areas of the market. Looking back at 2021, the strongest performing areas were what we would term “S.A. Inc.” shares, namely banks, retailers and select industrial shares. 

    What caught many investors by surprise in 2021, was the sharp fall in the Naspers and Prosus share price. Market darling Naspers, combined with Prosus (its European listed counterpart) account for almost 20% of the All-Share Index. A combination of concerns regarding the Chinese government’s interference in their market with regards to the new regulation for select tech companies alongside the disappointment surrounding the Naspers Prosus share swap and/or company restructure has proved to be strong headwinds for these shares.

     

  • Fixed Income, wasn’t so ‘fixed’
    Fixed income managers did not have an easy year, with 2021 not being the year for income assets. What had appeared to be a stable (and dare I say “boring” asset class) was no more, as 2021 saw fixed income assets experience a lot of volatility.

     

  • S.A. Government bonds bamboozled
    S.A. Government bonds remain perplexing. We are seeing good value in this asset class, with S.A. government bonds offering a yield of around 9.5%. This is almost 5% ahead of cash and 4% ahead of inflation, which is unheard of in global markets. Yet despite this attractive yield, foreigners have not been investing in our bond market to the levels they have previously. As a result, this asset class is generating a decent yield for investors but has been subject to market volatility this year due to the lack of foreign support.
     

  • Cash is still out in the cold
    We see little room for holding cash in portfolios. Not only is the nominal yield low (around 4%), it is in fact offering a negative real yield, given that inflation is close to 5%. 

Turning to global markets, it seems nothing could stop this bull. 

While value shares and unloved sectors (such as energy and UK equities) certainly rallied and were solid contributors to portfolio performance, the tech stocks in the US reached stratospheric levels (both in terms of performance and in price). 

In our opinion, this sector is starting to carry a striking resemblance to the tech bubble of the late 90s. Firstly, the market is trading at extreme valuations and is experiencing new IPO’s (stock listings) in the magnitude last seen in the late 1990s. (If it walks like a duck and talks like a duck…) We prefer to be cautious at this point. We remain materially underweight US large-cap tech shares. 

Despite emerging markets selling off sharply on the back of the Chinese government’s interference in capital markets and the restrictions and regulations placed on their tech companies, we are seeing good pockets of opportunity in emerging markets. 

It was not only S.A. fixed income managers that had a tough time in 2021; global fixed income managers had it even worse. Global bonds were one of the worst performers in 2021. With starting yields at low levels and bond yields rising throughout the year, this led to bondholders experiencing meaningful capital losses. 

How have we positioned Morningstar portfolios? 

Our Morningstar capital markets work guided us to have meaningful exposure to domestic equities, with an overweight allocation to the S.A. Inc. shares (which benefitted portfolios). We have always had an implied 10% cap exposure to Naspers and Prosus combined, which also helped limit drawdowns as this share fell. I have to say that for the years that this share drove returns, the implied cap we held in portfolios resulted in a contained drag on performance. Nevertheless, risk mitigation is key. We are prepared to forego some upside in order to protect on the downside. 

We have remained fully invested offshore with the majority of this allocation being held in global equities. This allocation has been a solid contributor to performance as we have captured the returns from global equities markets, despite the rand zigzagging between R14.50/$1 – R16,50/$1. We have a healthy exposure to emerging markets which detracted marginally from performance; however, this remains a high conviction allocation looking forward. 

Our meaningful exposure to S.A. government bonds has not provided the returns we had envisaged, however, when compared to cash, it has been the right decision. We remain confident in this holding as we expect interest rates to rise in 2022 (albeit in small increments) and this should be beneficial for long-dated government bonds. 

Looking forward – onwards and upwards into 2022 

Overwhelmingly, the so-called “TINA Theory” narrative from 2021 is still alive and well as we enter 2022. For a while now, the TINA – “There Is No Alternative” – Theory, has been used as the reason or basis for why the current bull market simply won’t quit. 

The fact that we have very low cash yields and very low global bond yields has pushed investors towards riskier assets such as stocks, which seemingly continue to go up (and up, and up). Let’s not forget that equity markets looked fairly expensive going into 2021—and many key markets are again looking expensive going into 2022. 

In the wise words of Warren Buffett – “Be fearful when others are greedy and greedy when others are fearful”. There is much exuberance, easy money and excitement in certain areas of the market. This level of optimism and crowding makes us “fearful”. 

There will be good news stories for companies and sectors that will be extrapolated into the future with investors prepared to pay extreme prices just to own these golden companies. Remember that “Price is what you pay, but value is what you get” – another valuable lesson shared by Mr Buffett. Now is the time to be vigilant and to ensure that you are getting value for what you buy. 

At Morningstar, we are certainly seeing attractive opportunities in select areas of the market. While we have a healthy exposure to select equities (both domestic and global) we also retain our holding in S.A. government bonds in favour of cash and global bonds. As a result, our portfolios are constructed to invest in areas where we see good long-term upside but also to ensure that risk is considered and there is a balanced exposure to both growth and income assets. 

You may not know if you should choose heads or tails, but at least you have the coin. 

You may hear some commentators saying that “markets are expensive and now is not the time to be invested” whereas others say that “things will just keep going up”. To this we would say there is never a “right time” to invest, the key is just to be invested and to remain invested. 

To quote Morgan Hounsel “Compounding works best when you can give a plan years or decades to grow. This is true for not only savings but careers and relationships. Endurance is key. 

And when you consider our tendency to change who we are over time, balance at every point in your life becomes a strategy to avoid future regret and encourage endurance. “ 

As you reflect on the year that was, you can be pleased knowing that you remained invested and that you now have more wealth than you did this time last year. The seasons will inevitably keep changing, and so too the seasons for asset classes. This is exactly why your portfolios are being actively managed to ensure that as markets change, your investment changes to take advantage of the next cycle. All you need to do is stay invested and let the magic of compounding do its work. 

Victoria Reuvers

Managing Director
Morningstar Investment Management
South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

The Consequences of a Market Correction

I have a confession to make.

I just can’t get myself worked up this Evergrande story.

Some markets people are comparing this Chinese property developer to Lehman Brothers or Bear Stearns.1

But if we’re being honest here 99.9% of investors had never heard of this company before they showed up in the headlines last week. And how many investors actually understand how the Chinese government is likely to handle all of the debt on this company’s books?

You can read all of the stories and listen to all of the podcast explainers but is it really going to help you become a better investor? Is this company really going to impact your ability to reach your financial goals?

Maybe I’m just over the fact that we’ve been swatting away potential canaries in coalmines for years now when the majority of them simply haven’t mattered.

Or maybe it’s just that I’ve resigned myself to the fact that market corrections can and will happen and the reason is mostly irrelevant.

If you’ve been reading this blog for an extended period of time you’ve read all of my market correction stats.

  • The average peak-to-trough drawdown for the S&P 500 in a given calendar year since 1928 is around -16%.
  • There have been 53 double-digit drawdowns overall in this time frame.
  • The average loss for those corrections is -23%, lasting more than 200 days from peak to trough.
  • Over the past 93 years the U.S. stock market has fallen 20% or worse on 21 different occasions.2 That’s once every 4-and-a-half years.
  • It’s fallen 30% or worse 13 times or one out of every 7 years.

Of course, there’s a big difference between averages and reality.

The stock market fell 50% from 2000-2002. It repeated that feat just 6 short years later.

From 1940-1968, there wasn’t a single bear market in excess of 30%. Then over the next 6 years it happened twice.

There are also some years in which there are no corrections. In 34 out of the past 93 years, there was no peak-to-trough drawdown that reached double-digit levels in a calendar year period (it hasn’t come close this year just yet).

On 7 different occasions, there wasn’t even a 5% correction in a given year (most recently in 2017).

From 2007-2011, the average peak-to-trough drawdown in the S&P 500 each year was -24%. Then from 2012-2017, it was just -8%.

There are ebbs and flows to these things.

It’s also true that each time there is a correction there is a different reason.

Sometimes it’s macro-related. Sometimes it has to do with market fundamentals. Sometimes it’s geopolitical in nature. Sometimes investors are simply looking for an excuse to sell after experiencing large gains. Sometimes the downturns feel completely random.

Most of the risks investors worry about don’t occur. And even if they do occur, they don’t match up with the time frame you’re worried about them occurring.

Markets are hard.

Now, just because this Evergrande story will likely never morph into another Lehman or Bear Stearns moment doesn’t mean it won’t impact certain investors or investments. It still might lead to some damage.

The question is: Does it matter?

If you measure your time horizon in years and decades, you’re going to be dealing with many more corrections along the way. At times, a large portion of your portfolio will seemingly vanish (for a time at least).

I suppose you could try to predict every geopolitical, macro and fundamental story in the years ahead to figure out how it will impact the market. But the odds show even if you could predict the headlines, you’ll never be able to predict how investors will react to those headlines.

And even if you could predict the direction of the markets over the short-term, you’ll never be able to predict the magnitude or length of those moves.

And even if you happen to nail the timing on the next correction, you’ll likely never be able to do it again.

My point here is market corrections are going to happen whether you know the reason or not. It’s not an if, but a when.

And since no one can figure out the when with consistency, the only thing you can do is recalibrate your portfolio or expectations ahead of time.

Either you learn to live with volatility or make your portfolio durable enough to better withstand the bursts of volatility.

This is true if we’re living through the next Lehman moment or a minor dip we all forget about in 3 months.

1There have been dozens and dozens of “Is this the next Lehman?” stories since 2008.

2It is worth noting the S&P 500 has fallen 19% and change on 5 different occasions since 1928. Oh so close to a bear market but not quite.

Source: https://awealthofcommonsense.com/2021/09/the-consequences-of-a-market-correction/

Ben Carlson

Director of Institutional Asset Management at Ritholtz Wealth Management

Have we been here before?

Could our current status quo be déjà vu? Have we been here before? The answer is no. Since the formation of our democracy, we have not seen violence, looting and riots of this nature. While it’s impossible to comprehend and rationalise what we are going through as families, communities and as a country, one thing that we know to be true, that we will survive this and we will rebuild this nation.

When the dust settles and we sit at home and reflect, we find ourselves wondering about the future and we worry. We worry about when/how life will ever return to ‘normal’. We worry about the health of our family, friends, and colleagues. We worry about the economy and work. We worry about money and our savings. While we are not able to provide guidance on all these worries, we can provide more context around money, savings, and investments.

Markets keep moving up and down, and so too do investor’s emotions. This is understandable – it is, after all, our hard-earned money we’re talking about. It’s only natural that many investors have now grown tired of stomaching this unpredictable rollercoaster ride and would much rather prefer to place their feet on solid ground. In the world of investments, the rollercoaster ride is equities and cash is often seen as the solid ground.

How will the latest unrest in the country affect my investments?

The big question across the country is around the issue of the medium-term economic impact and where to from here? We have seen the Rand weaken against major currencies as the market pulls away from South Africa in times like this. It is too early to assess if the current events will have a long-lasting negative impact on the South African economy, but we believe immediate evidence points to a short-term impact (assuming officials are successful at containing the situation).

The reality is that, in times of stress and uncertainty, markets and currencies can move sharply. Even so, these types of events create uncertainty and often leave investors with the urge to do something.

The below graph shows the 15 worst days on the JSE (the red bars) since the end of June 1995 and how the local market reacted after the drawdown. The blue bars show the 12-month returns investors experienced after the worst day and the green bars show the five-year annualised returns after the drawdown.

As an example, during the 2008 global financial crisis on 06/10/2008, there was a loss of -7.12% for the day but the subsequent one-year return amounted to 22.41% and the annualised five-year return was 19.24%.

Despite the current negativity and volatility, investors who are in Equities are advised to retain their exposure to this asset class since this is likely an unplanned short-term phenomenon that should not detract from the long-term value of equities.

If the impact is short-term, price declines may produce buying opportunities. Warren Buffett, chairman and CEO of Berkshire Hathaway, said “you don’t buy or sell a business based on today’s headlines. If the market gives you a chance to buy something you like and you can buy it even cheaper, then it’s your good luck.”

Current portfolio positioning

Current events and the possible volatility that might be experienced in the coming weeks once again highlights the importance of effective portfolio management, asset class diversification and pricing in risk to protect capital.

Client portfolios managed by Morningstar Investment Management are well diversified between strategies and asset classes and we are confident in our current positioning. Your portfolios are well diversified against SA specific risks.

Morningstar is keeping a close eye on all the above and actively managing your money. Our investment team has built portfolios that we believe are designed to not only protect investor capital in tough periods but more importantly to provide long term growth of investor capital.

This means that short-term market moves and doom and gloom media headlines, rarely (if ever) rattle our cages and we focus our energy on areas where we can add value.

What should investors do? Remain calm. Remember: time in the market is superior to timing the market.

At this stage, the best thing investors can do is to remain patient. Investing in the equity market is a long-term pursuit and is best used to reach long-term goals such as retirement. As the saying goes – a river cuts through a rock, not because of its power, but its persistence.

While noise and speculation can act as an emotional rollercoaster, your goals are unlikely to have materially changed and, therefore, your plan shouldn’t either. This is where we need to be balanced. A big part of wealth creation is avoiding the biggest mistakes and disinvesting into cash now is one of the most well-known actions to avoid.

While the consideration to grab the closest cash lifejacket, jump ship and move all your assets to cash is an understandable response to recession fears, it is unlikely to be in investors best interests.

In closing

As investors, we too often redirect our attention away from the destination to the journey when faced with a lot of outside noise. Much like in other walks of life, we can lose focus, making us susceptible to capitulation or giving up at the moments when fortitude and resolve pay off most.

Patiently allocating to assets that will help you achieve your financial goals should remain key. So, if you catch yourself getting down about the state of our economy, lockdown or speculation around government policies or trying to predict what is next, always remember what is in your control and what is not.

The habit of investing is one of the best habits you have within your control. Doing nothing and staying the course is still a decision. It is often during these difficult times that we have the greatest opportunity to add value for our clients, acting rationally when others struggle to do so.

Providence Wealth would like to send thoughts of strength and support to those who need it now.

Victoria Reuvers

Managing Director

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Running the Rand race? Best you put away your timer if you are…

It’s interesting how the value of the rand can influence our perception of the value of our country. A strong rand, when compared to the dollar, often makes us feel better about the state of affairs in South Africa. When the value of the rand climbs, so does our optimism about the growth and recovery of the country, while a weak currency fires up all the negative sentiment we read about in the press.

With that said, it’s not all doom and gloom and South Africans can find some reprieve in knowing that the value of our currency is only partially affected by South African specific factors. In the following article, we discuss the different factors that can influence the value of our local currency.

In recent years, the South African rand has been on the back foot against major currencies, with investors being extra cautious due to the many headwinds and political infighting that frequently dominates news headlines. Investors simply can’t ignore that the country has subdued growth, a weak fiscal outlook, rising industrial and social tensions, and external vulnerabilities associated with the current account deficit, all of which support a weaker currency.1

A research report2 was written by the International Monetary Fund (IMF) wherein it looked at the main drivers that impact the Rand/Dollar exchange rate since the onset of the global financial crisis and the results are very interesting.

Rand volatility could be attributed to global macro-economic factors

The IMF’s research showed that the main driver behind the movement of the rand relates to global factors and macro-economic events in the U.S. In other words, the level/value of the rand is often influenced and determined by dollar movement (strength and/or weakness). Roughly 30% of all rand volatility could be attributed to global macro-economic factors which influenced the US dollar and hence the rand.

As a small, open, emerging market that makes up less than 1% of the world economy, we are more likely to be affected by what is happening globally rather than in our own country. This is further exacerbated by the fact that the rand is one of the most liquid and tradeable currencies when compared to other emerging market currencies globally. Often when there is global risk aversion (better known as a “risk-off trade”) and investors flock to safe-haven assets, the rand acts as a proxy for all assets perceived to be risky by global investors. This can often lead to the rand depreciating.

1 Source: International Monetary Fund (IMF) “Surprise, Surprise: What Drives the Rand / U.S. Dollar Exchange Rate Volatility?” Data as at October 17, 2016.
2 Source: International Monetary Fund (IMF) “Surprise, Surprise: What Drives the Rand / U.S. Dollar Exchange Rate Volatility?” Data as at October 17, 2016.

Commodity price volatility is a key factor

A second finding was that commodity price volatility was a key factor that influenced rand/dollar volatility. Roughly 30% of the volatility of our currency was a result of commodity price volatility. Over the past year, we have seen a sharp rise in commodity prices of which South Africa has been a beneficiary.

South Africa is a net exporter of resources, and local exporters benefit from the rand weakness in that it makes the goods and services that we produce cheaper for foreigners and more attractive when compared to the goods and services available in other markets.

South Africa also imported a lot less in 2020, which has impacted our current account balance positively which, in turn, has been a factor causing the recent Rand strength.

Impact of domestic factors on the rand

The IMF’s research also looked at the impact of domestic factors on the currency. They found that neither domestic macro-economic surprises nor those originating from other emerging markets are statistically related to rand volatility. However, they did find that local political uncertainty is positively associated with rand volatility.

Purchasing Power Parity’s part

Of the many metrics used to determine the valuation of the rand against other major currencies, is the Purchasing Power Parity Index (PPP). PPP is an economic theory that compares the different currencies from countries across the globe through a “basket of goods” approach.

In 1986, The Economist created the Big Mac Index 3 to create a lighthearted way of showing PPP and whether currencies were cheap or expensive. The Big Mac Index uses a price of a Big Mac burger in the US (as a base) and then compares the price of a Big Mac burger in every other country (in its native currency) and then looks at the price differential.

According to the latest Big Mac Index data, the rand is very cheap compared to the US dollar. A Big Mac costs R33.50 rand in South Africa and US$5.66 in the United States. The implied exchange rate is 5.92. The difference between this and the actual exchange rate, 15.52, which suggests the South African rand is 61.9% undervalued.4

With that being said – it should also be pointed out that we do not believe the Rand to be 62% undervalued – this is merely a fun way of looking at relative currency strength or weakness versus the US dollar.

3 https://www.economist.com/big-mac-index
4 https://www.economist.com/big-mac-index

So, how should we go about working out a fair value for the rand?

Currencies can deviate significantly from fair value over time, however, over the long term, movements between currencies should reflect inflation differentials between two countries. Due to the relatively higher inflation environment in South Africa (especially compared to most developed markets), we would expect the rand to depreciate against most developed currencies in the long term.

Currencies can frequently deviate from purchasing power parity over time. Extreme examples include the height of the commodities boom in 2005 and 2006 when the rand reached R6 to the US dollar. Following the removal of previous Finance Minister Nhlanhla Nene (in late 2015 and early 2016) the rand reached around R17 to the US dollar.

What should be apparent, however, is the movement in the exchange rate following these events. In almost all cases, the exchange rate moved back to a value that would be regarded as fair when judged according to PPP. That is not to say that currencies do not stay cheap or expensive for long periods of time. Idiosyncratic events may cause currencies to deviate from fair value for extended periods, however, currencies tend to move back to levels reflective of inflation differentials in the long term.

As can be seen in the below graph, the rand is currently undervalued on a Purchasing Power Parity basis.

Work done by the capital markets team at Morningstar supports the view that the Rand remains undervalued compared to the US dollar. It is also worth remembering that the rand never really trades at fair value. Historically, the rand moved in big swings from being expensive to being cheap and each time shooting through fair value.

Where does that leave us?

While the rand (at roughly R14/$) is undervalued/cheap, we don’t believe the economic data supports a materially stronger rand. Over time the inflation and growth differentials between South Africa and our developed counterparts support a depreciating currency. While the commodity cycle and US economic factors favour a firmer rand for now, we do expect that in a 10-year horizon the rand is likely to depreciate from these levels.

We are often asked the question, “Is this the time to be taking money offshore given where the Rand is?” and the best way to answer that is to quote Howard Marks who said, “This is not the time but it is a time”. The decision to invest offshore should be based on the investment opportunity. While the value of the currency does play a factor, we would encourage investors not to try to time the currency.

The above factors once again emphasise the need for investors to remain patient, stay the course and avoid making investment decisions in a panic due to gloomy news headlines. This would include articles forecasting which direction the rand is heading. Previous experience has taught us that these forecasts are seldom accurate. It is during these challenging investment times that we should remove emotions from our investment decision-making process and focus on the fundamentals.

In Conclusion

Over decades of evidence and through the investment literature there is one golden thread –time in the market remains superior to timing the market.

Ask yourself this: “Given where I am now, what actions move me closer to my long-term goals?” “Would an investment change align with the original investment plan for reaching well-defined goals?” These are different questions than, “What do I wish I had done last month?”.

We believe that investing is a long-term pursuit, patiently allocating to assets that will help you achieve your investment goals.

Victoria Reuvers

Managing Director

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Bubble Territory or not? Everything has changed – should my investments change too?

It is hard to imagine that only a year ago, markets hit rock bottom and investors were worried about how the rest of 2020 would pan out. Across the globe, investors were faced with questions such as – will valuations decline even further? How and when will markets recover? Is it perhaps time to deploy cash into the market? Should we disinvest and wait for better days? Should we sit on our hands and do nothing?

Today we are facing a different dilemma. Markets are at an all-time high. In a short space of time, everything has changed. The rollout of Covid-19 vaccines and associated hopes for imminent economic recovery, along with unprecedented fiscal and monetary support from governments and central banks around the world, has driven equity markets beyond or close to record highs of late. With stock market valuations at historically high levels speculation about a market bubble has been rekindled.

 

The Price-to-Earnings (P/E) ratio as a measure of valuation

Investors often look at a valuation in its most traditional form, also known as the P/E multiple. A P/E multiple (price to earnings ratio) gives investors an indication of what the market is willing to pay for every R1 of earnings generated. Setting aside the impact of short-term changes to profit, a high P/E ratio typically indicates the expectation and/or perception that a company could/would have good growth prospects, or less risk to profits, than the average company. Thus, a company with a proven long-term track record of growing profits would normally trade at a high P/E ratio and a company with low growth, or a patchy profit history, would trade at a lower P/E ratio.

While P/E is an incredibly good starting point to assess the valuation of a company or a market, many investors fail to look deeper.

 

Delving deeper into markets

The P/E ratio of the S&P 500 is trading at near-record highs. One could argue that it is, perhaps, a very blunt way to look at the world. It is important to unpack what drove the performance of the S&P 500 to these levels.

When analyzing the data depicted in the below two graphs, it is clear that most of the performance of the S&P 500 came from large FAANG stocks. [FAANG is an acronym referring to the stocks of the five most popular and best-performing American technology companies: Facebook, Amazon, Apple, Netflix and Alphabet (formerly known as Google)].

Exhibit 1 depicts the cyclically adjusted P/E ratio for the US market.

There is no doubt that most of the large tech giants are good companies, with robust business models and incredible management teams. However, one must keep in mind the two tailwinds that existed – the first being record low interest rates for a prolonged period of time and the second being that most of these FAANG stocks were direct beneficiaries of lockdowns worldwide. Therefore, caution should be applied when assessing if they will continue to generate such exceptional performance indefinitely.

Looking at the opposite side of the coin – what about the other sectors that have not enjoyed such lucrative returns over the last number of years? Could the grass be greener on the other side but investors are not seeing it?

 

Is local still lekker?

On the local front, investors have enjoyed good returns from the JSE All Share index over the last few months. The question remains – will this continue or are we due for a correction? The truth is that nobody knows how long a rally can and/or will continue.

What we do know is that emerging markets have been severely out of favour for the last decade or so. Within the emerging markets group, South Africa has been out of favour for such an extended period that both local and foreign investors seem to have lost hope.

The recent rally could be the market playing catch up coupled with a positive global backdrop for South African equities. The domestic economy may well continue to face structural headwinds going forward but could also recover from depressed levels gradually as activity normalises and accommodative interest rates stimulate incremental demand.

While we contemplate whether this partial recovery will be enough to generate satisfactory returns from domestic shares (from current price levels), there is the possibility for a more pronounced and sustained recovery in activity and sentiment as the global economy reflates and South Africa receives a natural slice of emerging market flows.

At Morningstar, we believe some areas in the domestic market still offer a very good opportunity and has lagged in the recent recovery. Financials are a good example of such an area.

 

What is the alternative?

A few years ago, South African investors could generate a real return (a return over and above inflation) of about 3%, by simply remaining in cash. It was an easy choice for those that did not want to expose themselves to equity market risk. Today, this picture is quite different. Cash rates are at historic lows with returns from money market funds sitting at about 4% and there is not much yield either if you look at developed markets.

Long dated South African Government bonds on the other hand still offer very attractive yields and continue to make up an overweight percentage within the Morningstar Portfolios. As far as equity risk is concerned, we continue to assess all individual opportunities through a valuation lens as well as the fundamental risk associated with each asset class. We continue to find value in areas of the market like UK Equities, European Equities, S.A. Financials, Energy etc.

 

Getting back to the question, are markets in a bubble at the moment?

At Morningstar, we believe a blunt expression like this one is probably foolish. The truth is there is always a bubble somewhere, whether it is Tesla, Bitcoin or the FAANGs. The best you can do is to continue to assess opportunities as they arise and patiently allocate money to the areas that will best serve your investment goals.

Although the obvious opportunity set has declined in equity markets over the last couple of months, there is still ample opportunity for investors who are willing to look a little deeper.

Debra Slabber, CFA®

Portfolio Specialist

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Tackling the frequently asked question – How are financial markets faring well when economies are shrinking?

The seeming disconnect between the performance of financial markets versus that of economies across the globe has left many investors scratching their heads. We often get asked how is it possible for financial markets to increase in value, but the economy is shrinking?

It goes without saying that we live in extraordinary times. The South African economy had never faced such an abrupt cease in trade and/or economic activity as with the commencement of the nationwide lockdown on 27 March 2020. The same can be said for other economies around the globe. As economies started to reopen, many investors have been left scratching their heads – the recoil in financial markets painted a very different picture from the economic outlook.

It is not surprising that markets experienced some of the sharpest falls in asset prices during the first quarter of 2020. The JSE All Share Index lost more than 30% from the start of 2020 until 23 March 2020. What was surprising to see was the speed of the recovery hereafter – since 23 March 2020 (the bottom of the sell-off), the market is up more than 70% (as at February 2021) making COVID-19 seem like a mere short-term disruption.

The economy, however, tells a very different story, with one of the largest contractions in GDP ever recorded, coupled with sky-high unemployment numbers.

How are financial markets flourishing when economies are falling apart? Let’s have a look at financial markets in more detail, more specifically the equity market.

 

Equity market

The equity market is forward-looking and prices of stocks/shares/bonds (any listed liquid instrument’s) are determined by the supply and demand of investors. Investors that are buying these instruments are expecting positive outcomes looking forward. Sellers, on the other hand, expect the price of the stocks/shares/bonds to decrease in value.

So how do you know if you should be buying or selling? Ultimately, you need to consider the value of the company. The intrinsic value of a company can be estimated by taking its future expected earnings and discounting the future cash flow with an appropriate discount rate to ascertain what the value of those future earnings are worth now (or at the time one buys the listed equity).

The factor that has changed most notably in the above equation is the significant drop in interest rates – not only in South Africa but globally as well. With interest rates decreasing with 3% since the start of 2020, the discount rate being used to calculate the worth of future earnings is now significantly lower. This will result in future earnings being worth more today than before the interest rate cuts.

When the economy is slowing, the South African Reserve Bank (SARB) cuts interest rates to stimulate financial activity. This benefits businesses in that they enjoy the ability to finance operations, acquisitions, and expansions at a cheaper rate, thereby increasing their future earnings potential, which, in turn, also leads to higher share prices1. The reduced financing cost also increases future earnings figures.

Companies also have control over aspects that contribute to the current value of the company. Companies can use times of uncertainty as justification to cut their cost base and in doing so increase their bottom line/earnings. In other words, the leaner operational costs will result in higher expected future earnings.

In short, market crashes reset valuations of listed companies and provide investors with the chance to invest into opportunities that might not have been available, or an even an option previously due to prices being too high. This ‘opportunity’ buying cycle subsequently drives up market prices.

The last factor that can’t be ignored, and one that is especially important in the South African landscape, is that listed companies that sell products offshore are not reliant on how the South African economy performs. These shares are more broadly known as Rand Hedges (with the weaker Rand also working in their favour).

If one looks at every company listed on the South African stock exchange (the Johannesburg Stock Exchange or JSE), the majority of companies are not reliant on the South African economy to generate earnings. These are companies with business interests that are either predominantly outside of South Africa or entirely outside of South Africa.

In fact, 69% of the revenue generated by the top 40 companies listed on the JSE was generated from outside of South Africa for the 2019 calendar year2. In essence, when you are investing in the South African equity market (as represented by the Top 40), only 31% of company revenues are reliant on the South African economy3.

This is possible due to the fact that some of the largest companies on our stock exchange are dual-listed companies. In other words, these companies are listed on more than one country’s stock exchange. For example – the BHP Group is listed on the London Stock Exchange as well as the Johannesburg Stock Exchange. While the BHP Group used to have operations in South Africa, currently the company does not generate any earnings in South Africa.

There are many similar examples on our stock market and most of these companies carry larger weightings in the index. We call these rand hedge shares. In short, if the rand weakens, it is a benefit to own these shares as they generate earnings in offshore currencies. So, as an investor, you are hedging your currency exposure even though you are investing in a South African listed equity.

 

Local government and economy

In contrast with forward-looking equity markets, Government GDP numbers are backwards-looking. GDP is the value of goods and services produced/rendered in a country during a certain period. It provides a snapshot of a country’s economy, and it is used to estimate the size of an economy and its growth rate.

Due to stringent lockdown rules in South Africa, several sectors came to a complete standstill and, therefore, did not contribute to growing our GDP rate. As an example, in South Africa, GDP numbers are highly dependent on mining, agriculture, manufacturing and construction (to name but a few) – most of which had to halt operations for quite some time. In addition, many of the companies that contribute to our GDP numbers are not listed entities but rather privately held and/or small business.

Unemployment is another number that has a different effect on economies when compared to listed companies. When a company retrenches employees it immediately lowers the expenses of the business and can potentially grow earnings (if income is unchanged) but the opposite is true for an economy. When someone is retrenched and they can’t find an alternative job, they move from being paid by a company to being paid by the economy and thus increasing the expenses of the government.

In closing

Investors too often redirect their attention away from the destination to the journey when faced with a lot of outside noise. Much like in other walks of life, we can lose focus, making us susceptible to capitulation or giving up at the moments when fortitude and resolve pay off most.

Patiently allocating to assets that will help you achieve your financial goals should remain key. So, if you catch yourself getting down about the state of our economy, or speculation around government policies or trying to predict what is next, always remember why you are investing in the first place.

There’s no doubt that the current market conditions are unsettling. It is at these moments that we would discourage investors from making changes that could harm their ability to reach their financial goals. It is often during these difficult times that we have the greatest opportunity to add value for our clients, acting rationally when others struggle to do so.

1 Source: https://www.investopedia.com/investing/how-interest-rates-affect-stock-market/
2 Source: Ninety One Asset Management as at 31 May 2020
3 Source: Ninety One Asset Management as at 31 May 2020

Victoria Reuvers

Managing Director

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Where to from here?

Our asset class convictions at a glance.

At a Glance

  •  Markets continued to rally into year-end despite the dire economic backdrop.
  • The fourth quarter of 2020 saw two major headaches subside, with the announcement of the rollout of a Covid-19 vaccine and U.S. election uncertainty drawing to a close.
  • Markets were buoyed by lower than expected company default rates globally, aided by record-low borrowing costs and government support.
  • A rising tide has lifted many boats, with some underlying developments being particularly noteworthy. For example, cyclical investments and value managers have made a comeback after an extended period of weakness.

2020 in summary

If we cast our minds back to March 2020, we were in the midst of one of the worst market drawdowns in history. It is hard to imagine that just nine months later we would report the JSE All Share Index ending the calendar year up by 7%. This positive return was not without volatility and extreme divergence between sectors and stocks.

If we look at general equity funds in South Africa, there was a 43.9% spread between the best and the worst-performing funds. The top performer, Fairtree Equity, reported a 19.8% return, while Nedgroup Investments Growth was the worst performer, declining by -24.1% for the year.

South African bonds, which has been a significant holding and area of high conviction for Morningstar, was the best performing domestic asset class for the year – despite downgrades to our sovereign credit rating and large outflows from foreigner investors.

Listed property had a very tough year, losing -34% in 2020, despite the rebound in the fourth quarter.

The 3% interest rate cut that came into effect in 2020 will impact money market and cash returns for investors going forward. Most investors have become comfortable with a 6% return from money market holdings, however, that number is set to almost halve in the coming year.

Globally, most markets, except for the FTSE 100 (the UK Market), ended the year in positive territory in US dollar terms. The most notable performance came from the tech-heavy Nasdaq 100, which increased by almost 50% for the year. The tech sector was a direct beneficiary of lockdown restrictions imposed globally due to the Covid-19 outbreak.

Global stocks, corporate bonds, real estate, gold, commodities, and even bitcoin have all moved higher and delivered positive performance.

The wave of “good news” comes with many fascinating and constructive sub-plots. One of the most interesting happened in the fourth quarter of 2020, where small-cap value stocks bucked a multi-year trend to join the winner’s list. This was partly marked by President-elect Biden’s victory (the so-called blue wave) but is also a vision for life after lockdowns – with the reopening of the economy considered a positive for economically sensitive and cyclical stocks.

Company defaults and bankruptcies also remain low globally, defying the doomsayers, supported by record stimulus and the cheapest borrowing rates ever seen.

 

Where to from here?

At the heart of Morningstar’s investment process is our valuation-driven asset allocation. This process continually seeks the most undervalued assets, and in turn, avoids what we consider to be expensive. We continue to search the investible universe for such opportunities and calibrate the possibilities on a risk-reward basis. We then build portfolios to express our best views to ensure that clients who remain invested will reap the benefits over the long term.

The current opportunity set is exciting. Even though markets rallied recently, one must remember that the performance within markets is incredibly divergent. For example, only a third of shares on the ALSI ended in positive territory for 2020.

 

Below is a high-level view of our asset class convictions and areas of the market where we are seeing opportunity:

 

Asset Class Conviction Monitor

Within our domestic portfolios, we have reduced our cash allocations in favour of South African equities and South African bonds. While listed property is looking attractive on a valuation basis, we are cognizant of risk and therefore we currently have limited exposure to this asset class.

For our Regulation 28 compliant portfolios, we remain fully invested offshore. While we may be entering a period of possible rand strength, we believe that long term investors will benefit from not only the diversification that global exposure brings to portfolios, but more importantly, the investment opportunities we have accessed via our global exposure.

Conscious of the fact that the South African investment universe has shrunk meaningfully over the past decade and there is a limited subset of investable industries, we look at our global holdings and local holdings together to ensure that we have high conviction in all of the assets that we own, according to our capital markets valuation framework.

Within our global portfolios, we believe that US large-cap equities are currently overvalued; however, we see good investment opportunities in areas outside of the US, namely UK Equities, Emerging Market Equities (especially Korea and Mexico) and Japan. Within US equities, we do see value in certain sectors such as energy and financials.

Looking to the future, investors must consider the risks they can’t see or at least those they haven’t given weight to. Above all else, investors need to weigh the valuations they are paying, as we have seen extreme divergences that present both an opportunity and a risk. While we have exposure to areas of the market where we are seeing attractive opportunities, our portfolios remain defensively positioned and are constructed to ensure that risk is considered and there is a balanced exposure to both growth and income assets.

We remain confident that our positions are in the best interests of our clients – acknowledging tomorrow’s challenges and working towards a prosperous 2021 with good financial decision making.

Debra Slabber, CFA®

Portfolio Specialist

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Lessons from 2020 to remember in 2021

Who would have thought we would kick off 2021 in almost the same manner as 2020? Even though we were all hopeful that 2021 would start on better footing, numerous countries are still in lockdown, South Africa is fighting against its second surge of Covid-19 infections and economies worldwide continue to struggle. For humanity, we gladly waved goodbye to 2020, but for markets, we have seen a period of surprising benefit and near-record highs.

Global and local equities, bonds, gold, commodities, and even bitcoin have all moved forward and delivered positive performance despite struggling economies, widespread job losses and the biggest contraction in almost 90 years.

 

The final quarter of 2020 was strong by historical standards. Investor sentiment had been lifted by the news of the rollout of a vaccine worldwide alongside the perception of greater political stability.

 

In an article I wrote at the end of 2020, I used the analogy of a rollercoaster ride to describe the year – not only from a market perspective but especially from an emotional perspective. 2020 marked one of the most severe sell-offs in market history with three of the worst trading days recorded (historically) in March alone. With that being said, we also experienced the shortest bear market recorded (spanning over just 33 days) with most markets now sitting at all-time highs.

 

The one thing that 2020 highlighted again was our behavioural biases, exposing our good and bad traits when it comes to investing.

 

Let’s look at some of the lessons learnt in 2020 that will be worth remembering in 2021 and beyond.

 

1. Markets cannot be timed

Let’s say, hypothetically, you had anticipated that there was going to be a global pandemic, which you know would scare investors across the globe, resulting in sharp declines in the global stock markets, and you decided to withdraw your investment(s). Even with this knowledge, it would have been extremely difficult to predict the timing and strength of the rebound in the market. In this case, the severe downturn has (in many instances) corrected itself within a mere six months. Ultimately, you may very well still be sitting on the sidelines waiting for a better entry point to get back in.

It is critically important to remain invested, through good and bad times. Often the worst days in the market are followed by the best days. Unfortunately, you need to be invested through both the good and the bad to reap the benefits of gaining long-term market returns, which translate into wealth creation over time.

The graph below illustrates how missing a couple of good days in the market can severely impact your portfolio return over time.

2. Good follows bad, and vice versa

Although we have no way of knowing when a market crisis will start, we can be sure that it will end. Historically, a sharp market decline is generally followed by a strong rally. The timing of when that advance occurs is the only unknown variable at play.

South African equities experienced four of the largest one-day losses over a couple of weeks in March. In the below graph –

– The blue bars, show the 10 worst days on the JSE since the end of June 1995 and how the local market reacted after the drawdown.

– The red bars show the 12-month returns investors experienced after the worst day.

– The grey bars show the five-year annualised returns after the drawdown.

 

As an example, during the 2008 global financial crisis on 06/10/2008, there was a loss of -7.12% for the day but the subsequent one-year return amounted to 22.41%, with an annualised (average return per year) five-year return of 19.24% per year.

Yet another reason to remain invested throughout a crisis.

 

3. Optimism remains the only realism.

Humans have overcome incredible challenges throughout the centuries, and we are on our way to overcoming the latest challenge. Little did we realise just how much we would discover, explore, learn, and experience in a year that has brought with it so many different challenges and, in some cases, opportunities.

Let us not forget the lessons we learnt in 2020 as we face the new year that will bring with it, its own challenges and uncertainties.

 

Looking to the future

It is incredibly important that investors must consider the risks they can’t see or at least those they haven’t given weight to. Above all else, investors need to carefully consider the valuations they are paying, as we have seen extreme divergences that presents both an opportunity and a risk.

As Warren Buffett once said, “Only when the tide goes out do you discover who has been swimming naked”. We remain confident that our positions are in the best interests of our clients—acknowledging tomorrow’s challenges and working towards a prosperous 2021 with good financial decision making.

Debra Slabber, CFA®

Portfolio Specialist

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.