Uncertainty is everywhere: Coronavirus complexities, volatile investment markets, the long-term effect of monetary stimulus, global political tensions (US/ China, Brexit, US election, etc), SA’s politics and economic future, another Tech bubble brewing, news manipulation (fake news).
Key market views:
- A Coronavirus vaccine is likely to be distributed in 2021 to the more “vulnerable” globally and locally, which will alleviate fears and promote economic activity.
- The SA economy in 2020 is at risk of slumping lower than Treasury’s forecast of – 8.2%.
- The Rand is likely to remain volatile but should continue to weaken over the long-term.
- The local investment market appears attractive but is dependent on positive government policy changes to lift consumer and business confidence.
- Global markets are expensive and are vulnerable to political and inflation fears.
The effects of the Coronavirus are being managed better
There remains a lot of ‘unknowns’ surrounding the Coronavirus and how effective an imminent vaccine will be. But the world has learned to manage the risks of the virus a lot more effectively, leading to a sharp decline in the global mortality rate from a high of 9% in April to 2% in September.
Although there has been a resurgence in infection rates in Europe with the opening of economies, mortality rates continue to decline as the vulnerable are being better protected and treatment protocols have improved. In SA, infections and deaths have dropped sharply from peaking in July, which is being ascribed to a younger population and the theory of a “herd immunity” taking effect with estimates of around 30% to 50% of the population being infected to date with anti-body build up.
SA politics and the economy are a major concern
Constant government infighting and Ramaphosa’s inability to make critical changes is hampering the economy. According to the Reserve Bank, SA GDP is forecast to decline 8.2% this year, growing 3.9% and 2.6% in 2021 and 2022, respectively, leaving the SA economy still well below its 2019 level in 2023.
The key problem is government’s debt spiral as revenue is unlikely to exceed expenditure in the foreseeable future. This will put unremitting pressure on the Rand as the government is forced to take on more expensive debt.
In July we wrote that the economy was in trouble and that the Rand should weaken into the future, due to the country’s ballooning debt. We continue to recommend that your investment portfolio has a hedge against a weakening Rand.
The volatile Rand
The Rand is one of the most volatile asset classes, which contributes to it being extremely risky in the short term and can lead to enormous frustration. One needs to take a long-term view on the Rand (5 years +) when deciding on its percentage weighting in your investment portfolio.
Over time the Rand will depreciate against the US Dollar by the country inflation deferential, which on average is 4.7% (7.1% – 2.4%). This can be translated to the Rand’s purchasing power parity (PPP) to the Dollar, which is currently 13.5. See the graph below as the Rand moves with its PPP value. The difference is the “country’s sovereign risk” premium / discount.
As the outlook for the SA economy weakens the premium will increase, which currently is 26%. Given SA’s spiralling debt trap and weak government, this premium should be +30%, in our opinion. The graph below shows this Rand/Dollar premium /discount to the fundamental PPP value:
Volatile investment markets are here for some time
The JSE All Share Index retraced most of its losses since its 36% collapse in March but over the last month has declined 8%. The bounce was driven by offshore shares (Naspers, BHP, etc), but local shares (SA Inc.) have had little recovery.
Although local shares appear cheap, only an improvement in consumer and business confidence will drive their prices higher. Until then, the JSE will continue to be driven by offshore market forces, which currently rely on interest rates remaining near zero for the foreseeable future. This is a serious risk, with inflation being the enemy of the market.
With global economies still far from knowing the true fallout of COVID-19, uncertainty will drive volatility for at least the next year.
The long-term effects of monetary stimulus
Global central banks have pumped an enormous $15T (17% of global GDP) into economies from March in the form of debt relief and bond purchases. Although these actions and the size are difficult to understand, it can simply be described as giving investment markets a “sugar high” that will wear off leaving long-term hope that economic recovery will not be suppressed by debt repayment. This potential long-term negative impact will unnerve investment markets for many years to come.
Global political tensions keep rumbling
This is an era of weak political leadership supported by a widening wealth gap and a dearth of sound long-term policymaking, which in turn, fuels more uncertainty. Currently, the outcome of the US election in November will have a material effect on global politics and investment markets. The election could go either way, primarily due to a likely abnormal high voter turnout (60% versus 40%), which could boost numbers materially either way. A Biden win will be negative for markets and Trump positive.
Another tech bubble is brewing: The Big 5 tech stocks are a cause for concern
At the beginning of 2020, we wrote that US equities were expensive and to be cautious when investing offshore.
The trend towards tech stocks has accelerated with the arrival of Covid-19 with the Big 5 tech companies now comprising 22% of the S&P500 index as their valuations continue to skyrocket.
Looking at the returns of the S&P500 in 2020, one could be led to believe that the US stock market has thrived given the rapid recovery from the stock market correction in March. Overall, the S&P500 index is up 4% in USD year-to-date. However, upon closer inspection, we observe that while the US stock market is up 4% overall, the Big 5 tech stocks are up 33% and the other 495 companies are actually down -5%. This illustrates the dominance of these 5 stocks in the index and they appear overvalued and risky.
News manipulation (Fake news)
It is estimated that 60% of people get their daily news through some form of social media (Facebook, Google, etc.). These mediums identify the type of news you read and send you news you want to read, leading to cementing a particular bias. This is polarising attitudes and views in societies, which is a major concern and hopefully will be responsibly addressed by government regulators. This is a risk to markets and could negatively affect social media shares.
In these uncertain times, now more than ever, one needs to ensure your investment strategy matches your personal risk profile. Uncertainty is emotionally draining and leads to irrational behaviour. It’s the worst ingredient for investing and it needs to be recognised and protected against in your investment strategy.
With investment markets likely to remain volatile going into next year, patience and confidence in your financial plan is necessary.
Although money market rates are moving down towards 4%, capital preservation in the short-term is still key. We recommend a conservative investment strategy that incorporates an appropriate low-risk offshore allocation.
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