How markets have performed in the first quarter
Since the equity markets bottomed a year ago after one of the sharpest sell-offs in history, life and the economy have yet to return to normal. However, financial markets continue to look beyond the current reality, toward a rosier future.
This quarter equity markets once again showed impressive strength, with SA growth assets performing particularly well. Last year global growth was non-existent, but where we currently stand, there are concerns that growth might be too strong, causing market participants to reflect on what this could mean for the future. Even South Africa is rebounding at a reasonable pace (albeit from a depressed base) while, beneath the surface, the National Budget was positive this quarter. The relative performance of developed versus emerging markets, value versus growth stocks and cyclicals versus defensives, were all among topics which were passionately debated by market participants this quarter. Other topics of interest also included the growing prevalence of speculative forces in the markets and how to protect against inflation inevitably materialising.
There was a continuation of the bullish undertone which has been a feature of markets over the last few quarters. South African equity, as measured by the FTSE/JSE Capped SWIX, was the best performing asset class (+12.6%), driven primarily by resource and industrial shares, while financials posted low single digit performance overall. Among financials, SA listed property counters were some of the best performers, with the sector rebounding (+8.1%) off its low base. Strong appetite for local risk assets led to these asset classes significantly outperforming bonds, with the All-Bond Index declining for the quarter (-1.7%). SA asset classes have delivered handsomely over the past 12 months (i.e., roughly since the depths of the COVID-19 sell-off), with SA equity up 54.2%, SA property up 34.2%, and SA nominal bonds up 17.0%.
Global equity (+5.1%) also delivered a respectable gain this quarter, but underperformed the South African equity. This was contrary to the broader outperformance of developed markets (+5.5%) over emerging markets (+2.8%) globally, all in rand terms. Global listed real estate (+6.0%) also participated in the rally, with growth assets in generally outperforming defensives, such as global bonds (-5.2%). The rand was largely steady, contributing less than a percent to offshore returns when translated into Rands. Over 12 months, global equity (+27.8%) and global property (+11.4%) have far outpaced global bonds (-15.8%). At an index level, global equity returns in Rands have not matched JSE returns over the past year, impacted significantly by the almost 20% strengthening of the rand. Despite this, given the rich opportunity set within global equity, we are pleased that our global equity managers managed to eke out outstanding absolute and relative performance, outperforming both the global and local equity markets this past year.
How are the portfolios positioned?
Global equity valuations are high, distorted by the US equity market which is now as expensive as it was at the peak of the Dotcom mania. This does not bode well for future returns, which are inversely correlated to starting valuations. What complicates matters however, is that if we look at valuations from the perspective of the equity risk premium (the difference between the earnings yield from equities and the long-term bond yield), then global equities are still quite cheap in relation to bonds, because bond yields are very depressed. Regardless of which way one prefers to look at valuations though, the fact is that valuations alone are a poor timing tool. For now, it matters more that the global economy is in an upswing, and that monetary policy is highly accommodative, because stocks usually tend to outperform under these conditions.
As a result, we remain overweight global equities, having increased exposure last quarter to within the maximum band dictated by the various portfolios’ unique tactical asset allocation ranges. As always, we leave it to the managers we’ve selected to decide where to invest regionally, and to what extent they should be exposed to either growth or value opportunities. We have stayed neutral on South African equities, after having upweighted them last quarter. Although we are no less circumspect regarding the long-term prospects, the cyclical backdrop is positive given that our market is closely linked to the commodity cycle and that SA, as well as other emerging markets, have a larger valuation underpin than developed markets at present. There is therefore scope to tactically upweight SA equity should the opportunity arise.
Outside of equity, the only other attractive opportunity we see is in South African bonds, which offer the prospect of strong returns going forward. These higher-than-normal returns reflect the higher embedded sovereign risk, which is born from our tenuous long-term debt sustainability position. We feel one is being adequately compensated for these risks, while the potential for a positive surprise exists, given the incremental improvements we are seeing, which might be underappreciated by the market. We therefore maintain our full weight in SA government bonds, which are significantly more attractive than SA cash. SA Listed property, given the sector’s downfall, is cheap and there are some opportunities within, but overall, it remains exposed to some of the weakest parts of the SA economy, which potentially still face the enduring effects of the post-pandemic world.
Looking ahead, we expect the investment environment to remain challenging. The economic rebound means that less global fiscal and monetary stimulus is potentially needed going forward but weaning off from the support will probably create some tension in the markets in the process. Although less stimulus being needed is a good thing in theory, in reality, asset prices have to some extent been supported by these ultra-accommodative conditions. The gradual transition to a less “managed” economy, and the risk of a policy error potentially leading to over-restrictive financial conditions, are therefore key issues to monitor over time. In the meantime, and as always, investors should maintain a diversified approach and position for a range of potential outcomes, bearing in mind that in order to reap the benefits of long-term investing, one needs to remain materially invested over time, rather than be underinvested for fear of near-term volatility.
By Reza Hendrickse, PPS Investments Portfolio Manager
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