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2019 Third Quarter Market Outlook

The equity investment roller-coaster ride continues. Frankly, this is part and parcel of investing. If you’re seeking a better return than a money market rate (6% to 7.5%) and you want to beat inflation (5% to 6%) after tax, you need to take on risk. This risk comes with a few bumps along the way and at times, even a roller-coaster ride, something that we have been experiencing over the last five years.

The roller-coaster investment market – why?

The JSE All Share Index’s five-year, annualised average return is just 5.6% p.a., despite last month’s 7% spike. Over this five-year period, we’ve had wild fluctuations – as much as 14% in a few months. The fluctuations have also been the case for global markets, which have a direct effect on our market.

Fluctuations are caused by uncertainty. Many fund managers believe this brings opportunity as uncertainty causes human emotions to act irrationally driving investment prices wildly up and down.

Global uncertainties are the main driver of these fluctuations:

Global economic growth – The main issue is that the US economic growth upcycle (surpassing its long-term average of 3.2%) is coming to an end. This is not abnormal and would be part of a normal economic cycle. The issue is that strong evidence of a US slowdown is not visible. Secondly, questions about the reliability of Chinese economic data continues, which prompts interrogation of the sustainability issue of Chinese growth (6% p.a. and 18% of the global economy). It just seems too good to be true that China’s growth can continue at this rate. And finally, the recovery in Europe is not taking off as political instability continues to disrupt growth.

Interest rates – US interest rates are expected to decline this year, in anticipation of slower economic growth. This would be in sync with Europe, UK and Australia. However, the extent of declining US rates is the question. What’s at issue here is that interest rates have a material effect on investment valuations (bonds, property, equities). Generally, lower rates are good for equities, but this could take some time to filter through to higher prices.

Geopolitical tensions – The US and Iran nuclear squabble persists. The US, China and other country trade talks continue. Numerous political challenges on dictatorships and the questioning of democratic and capitalist philosophies prevail as the income gap between rich and poor continues to widen. This is a serious long-term problem for the world.

The rise of social media and online entertainment businesses – Like all new industries, the extent of social media and infotainment growth is unpredictable. The social media-related company shares (communally known as FAANG – Facebook, Amazon, Apple, Netflix and Google) have soared 500% collectively over the last 6 years to now comprise 15% of the US stock market. Their valuations are stretched at double the average share and therefore pose a risk to the whole market.

Political & Local Economic Uncertainties

The political landscape – After a “near-perfect” election outcome, the country waits for the new President to make important political, government and economic policy changes. Although many important changes have taken place, there are many more that are critical and are needed as soon as possible. The reality is that these changes are likely to take longer to implement than many of us would like. Reasons include the many different political agendas that Ramaphosa needs to navigate. So far, he has done an excellent job in a turbulent ANC. We believe progress will continue but it will be held back by ANC internal fighting, which will add to the uncertainty of the country’s economic recovery.

Economic resilience – Another poor economic quarter to March 2019 saw flat growth year-on-year, which was disappointing and questions the structural strength of the economy.

With strong financial institutions and the “nationalisation of the Reserve Bank” being unlikely and a “non-event”, financially, the country can weather most storms. However, it’s going to take time to rebuild the SA economy as we find more surprises whilst cleaning out the closets. Despite this, we do believe we have turned the corner.

The SA Reserve Bank now forecasts 2019 GDP growth at 1% (reduced from 1.3%) and 1.8% and 2% for 2020 and 2021 respectively.

But it all comes down to valuations. How much of the uncertainty is already priced in?

Despite all the uncertainties, which is normal and vary at different levels over time, the true measure driving investments in the long-term is the fundamental valuation. South African domestic shares are near their lowest valuations of all time. This comprises around 50% of the JSE All Share Index and makes a compelling case to make good investments. Global equity (mostly the US comprising 60% of the world market) valuations are at high levels and being stretched by the FAANG sector. This is a risk, and caution is needed here.

Investonline Outlook

We maintain our view that the local long-term investment outlook is positive. Although the JSE All Share Index is only up 4% over the last 12 months, it is up 12% year-to-date. Global markets offer pockets of attractive value, especially Emerging Markets.  However, the roller-coaster ride is likely to continue for the rest of the year.

The Rand has also been volatile peaking at 15.02 to the US Dollar last month and now retracing to 14.10. We maintain our view that the Rand /Dollar will fluctuate mostly between 13.50 and 14.50 this year. The fundamental value of the Rand/Dollar based on purchasing power parity is around 12.50.

With SA inflation remaining stable and interest rates relatively high, the opportunity for interest rate cuts are promising, which should give the economy a much-needed boost. Although structural challenges appear daunting, the government is recognising them and implementing changes to revive them, albeit at a slow pace.

We see more value in local versus offshore investment and still recommend a conservative approach for the rest of the year. Our Prosperity Fund continues to produce good steady returns with an average annualised return of 9.0% since inception (September 2014) and 13.1% over the last year.

A measured approach is still important as a volatile environment is likely to persist for the rest of the year. So, ensuring you have the investment strategy to suit your goals is critical during these times. Speak to one of our client portfolio managers to ensure your investment goals are properly balanced.

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