Looking back on 2020’s impact on local and international markets and what we can expect in 2021
As we approach the end of this crazy year, let us look at its impact on investment markets.
As 2019 ended, December and January brought a bit of cheer to weary equity investors, as the FTSE JSE All Share delivered a positive return of 5.6% from the start of December until 14 February. The rally was short-lived, however, as the JSE tumbled 34% by the 23rd March 2020 in response to the government reactions to the COVID-19 pandemic. Year to date the JSE has already all but recovered this fall, while many offshore indices are in fact positive YTD. The S&P 500 is up 15.5% in USD, while the MSCI World Equity Index is up 10%. The speed of the recovery has been remarkable and illustrates how difficult it is to get market timing right.
MSCI World Equity Index
S & P 500
However, there is a caveat to these index returns. Most of these gains have been concentrated in the share prices of the large tech shares (FANGS – Facebook, Alphabet, Netflix, Google, etc.), while the broader market has lagged significantly. This has resulted in good performance of passive index tracking and Growth/ Momentum strategies, while it has been a struggle for most actively managed equity funds. It will be interesting to see if this trend starts to reverse as the world economy begins to normalise post COVID (once vaccination programmes start rolling out, etc) and post the US elections.
South African Bond yields
At the last MPC meeting (19th November 2020), the repo rate remained unchanged at 3.5%. While the low interest rate environment is welcome to try and help the economy to recover, the precarious government debt situation is still cause for concern. While the MTBPS did indicate a commitment to cutting the public wage bill significantly, it remains to be seen if they will be able to implement these policies. Unions are pushing back as expected, and the hard decisions regarding SOE’s remain a challenge for government.
South Africa’s credit rating has been cut further into junk status by the rating agencies, and the yield curve has steepened, with investors demanding a premium (for the now higher risk) for longer dated bonds.
The inflation rate in South Africa increased to 3.3% YoY in October, the highest increase since March this year. The increase was mainly driven by food and non-alcoholic beverage inflation. The inflation outlook remains benign, and there is still scope for further rate cuts going forward.
South African Property Market
It has been a bleak year for SA listed property, with the index down 44% YTD. While there has been some recovery over the last month, there is a long road back to previous highs.
Residential rental properties have not been spared, with the latest CPI rental increase falling to 1.8% as at June 2020. This is below the inflation rate, and as such indicates a real deflation in rentals.
Another important metric to keep an eye on is the number of tenants in good standing. This has fallen dramatically, reflecting the pressure households are under given the tough economic conditions we face as well as the woeful unemployment numbers. These factors will affect the pricing of residential property, although the low interest rate is supportive.
The outbreak of the pandemic in the beginning of the year, and subsequent emergency lock-down strategies imposed by governments world over, has had a massive effect on the world economy as reflected in the equity indices shown above. Initial predictions for mortality were dire, and thankfully the IFR (infection fatality rate) has dropped significantly since these initial estimates. Recent vaccine announcements have been positively received by markets.
Understanding the long-term impact of the virus will be key. As mentioned, while it has good for tech companies, its been a disaster for airlines, travel and hospitality industries and the like.
In order to try and predict what will happen in South Africa, it’s useful to look at countries in the Northern Hemisphere, as this will show us what’s likely to transpire as we move out of summer and into the winter respiratory disease season. All the old coronaviruses are seasonal, so its likely the novel coronavirus will be too.
Comparing Sweden and the UK, gives great perspective, as they have had quite different approaches to the pandemic. Both countries illustrate that there is a rise in reported cases (widespread PCR testing), however there is not currently a corresponding rise in the death rate (although there is a small seasonal rise). This could be due to a fault with the PCR testing itself, and these tests certainly have their critics. Alternatively, is it a case of the susceptible i.e. elderly, those with at least one severe comorbidity, and the terminally ill sadly having passed already?
Time will tell, but as more actual data becomes available, it does seem that the impact of the virus will be less severe than that of the economic downturn because of the initial pandemic response. Having a vaccine available for the susceptible will improve things dramatically, as illustrated by the world equity market reaction to the initial announcement of a viable vaccine at the beginning of November.
After the polls failed spectacularly to call the US election in 2016 and the Brexit vote result, they finally managed to call US election 2020 right. Well, sort of! The result was far closer than they predicted, with Donald Trump receiving more votes than he did in 2016.
The Biden victory has been well received by markets. This was perhaps unexpected by some, who anticipate that a Democrat President would increase taxes and social spending, and slow US economic growth.
The fact that the Democrats may have won the presidency but did not manage to secure a majority in the Senate, and barely held on to their majority in the House of Representatives, means President Biden may struggle to get these changes through.
All these factors seem to be favouring the risk-on trade. This can be seen in the strengthening of Emerging Market currencies, with the Rand trading at R15.18 to the USD at the time of writing. Foreign buyers are buying South African bonds again, as the yields are attractive given the current low yield environment dominating developed markets.
Certainly, the South Africa economy faces significant headwinds, with the burgeoning debt burden and unemployment being front and centre. However, it is encouraging to see that there is movement on the anti-corruption front, with the NPA finally starting to act against implicated individuals. Eskom seems to be improving under De Ruyter, and he has announced that they will have enough power generation capacity to end load shedding by August 2021.
The oil price is a key metric to keep an eye on, as it is a good indicator of economic activity. At the time of writing Brent Crude is approaching USD $48 per barrel which is a significant improvement since the drop in oil price in March this year.
Looking ahead to 2021
The last 5 years have really been a US story on equity markets, with significant outperformance of other developed & emerging markets. Looking at valuations, the US does seem relatively expensive compared to the rest. If the ‘risk-on’ trade continues, we should see continuing weakening of the US dollar, and the therefore can expect the Rand and other EM currencies to continue strengthening.
The above could also result in good equity performance for Emerging Markets, including our local bourse (which has lagged the rest of the world significantly in recent history). Certainly, at this stage China will be the only country that ends 2020 with positive economic growth (approximately +1.8%).
The bull market that ran from the Great Recession of 2008/09 until the beginning of this year was the longest bull market run in history, although markets did seem to run out of steam at least 3 years ago. In the past the first few years after a correction in equity markets have generally resulted in above average returns.
The risk we need to keep an eye on is inflation. The amount of stimulus that has been provided for pandemic relief, as well as the quantitative easing post 2008 that has been employed by the US and Europe, is a concern. All this money being added to the system would normally have the effect of increasing the inflation rate. However, with the amount of debt governments have been adding to their balance sheets, they have great incentive to keep inflation under control.
The pandemic has caused great economic harm to the world. Even Sweden which did not employ hard lockdowns or closed borders has seen a negative effect on their economy. How governments deal with the pandemic going forward is going to be key. Fortunately, the science is beginning to show that economically harmful lockdowns do not have a positive effect in curtailing infections (and may in fact result in higher deaths over the long term). Even the WHO (World Health Organisation) has changed its recommendation on this, and now encourages countries not to use lockdowns as a strategy. If the IFR (Infection fatality rate) continues to reduce, and vaccines become available for the vulnerable, we should see economies begin to recover quickly as the world gets back to work.
The old saying ‘it’s time in the market, not timing the market’ has been proven correct repeatedly. This time will be no different. If you would like to discuss your strategic asset allocation, we would be happy to review it for you.
From all of us at Cornerstone, we wish you and your family a happy, safe and peaceful festive season and a prosperous 2021.