Despite a weaker global economic backdrop and increased geopolitical uncertainty throughout the year, asset class returns in 2019 managed to surpass all expectations. Although 2018 presented quite a low base, the pivot from central banks in 2019 from tighter to more accommodative policy created the easier financial conditions that helped spur markets ahead and provided a floor in the face of increased volatility. The US outperformance over the year was the main driver for the MSCI All Country World Index (ACWI) gaining 28.4% in 2019. The S&P 500 continued to reach new highs throughout the year and rallied into year-end, gaining 3.0% in December, bringing the full year return to 31.5%. Technology-heavy index NASDAQ 100 ended the year up +39.5%, a far cry from the 2018 result of 0%.
With weaker growth in China and a strong US dollar throughout the year, emerging markets underperformed their developed counterparts. Even so, emerging markets gained 18.9% over the prior 12 months, helped by a strong finish to the year as markets revelled in trade talk progress and accommodative tones from central banks. The improved sentiment and modestly better data saw cyclical assets rebound with the MSCI Emerging Markets Index gaining 7.5% in December, helped in part by a reversal of US dollar strength, which benefitted emerging market currencies. The rand experienced a volatile 2019, depreciating due to domestic fundamentals and load shedding. Over the year, however, the rand appreciated by 2.8% relative to the US dollar, and 7.8% over the last quarter of the year.
Resources drove local equity market returns
South Africa also benefitted from these trends, with domestic equities lifting alongside international markets. The FTSE/JSE All Share Index gained 3.3% in December to conclude the year up 12.1%, while the SWIX 40 Index delivered 8.6% in total return terms for the full year. Although 2019 index returns for equities compared favourably with cash (7.3%) and inflation, returns weren’t broad based and largely driven by strong momentum from resources. Resources were the stand-out performers for the year, with the platinum sector gaining 203% and gold counters ending the year up 108%. As a result, large- and mid-cap indices gained 11.7% and 15.6% respectively, while small-cap counters bore the brunt of a weak domestic economy, losing -3.9% over the year.
South African preference shares delivered the best asset class return of 18.6% over the last 12 months, thanks to improved pricing and attractive yields. These instruments continue to offer decent real yields and serve as a great diversifier in portfolios. From the current starting point, however, we expect future returns to be closer to historic long-term returns and in some instances have opted to take profits.
Despite a volatile and noisy fourth quarter, local bond markets managed to end the year on a strong note. Domestic risk assets benefitted from improved sentiment towards emerging markets as well as a robust rand, with the BEASSA All Bond Index (ALBI) gaining 1.9% in December, helping fourth quarter performance to achieve 1.7%. The Medium Term Budget Policy Statement (MTBPS) emphasised how interwoven Eskom’s travails are with the fortunes of the economy and the fiscus. In line with expectations, revenues came in weaker than expected with expenditure greater than targeted due to financial support for Eskom. While the MTBPS can be commended for more realistic economic growth and revenue assumptions, the path for all fiscal metrics and lack of debt consolidation shocked the market. Shortly after, credit ratings agencies Moody’s and S&P downgraded the outlook for the sovereign to negative. These well-broadcasted risks were largely already priced in by the bond markets, but still caused weakness over the quarter. Looking back over 2019, South African bonds delivered 10.3% over the year and 1.7% in the last quarter despite heightened volatility and concerns over the state of the economy, government finances and credit rating downgrades.
South Africa’s yield curve remains one of the steepest in the world, a reflection of accommodative central banks globally, as well as the poor state of government finances. Longer-dated bonds have remained under pressure as the market continues to price in weak economic growth prospects and a precarious fiscal position which is under additional pressure from several state-owned enterprises (SOEs), with the biggest burden being Eskom.
Given the benign inflationary backdrop in South Africa and broadly accommodative stance of global central banks, we believe South African bonds continue to offer attractive real returns. This is balanced against a difficult fiscal position for the country, which also remains vulnerable to external supply shocks, such as a higher oil price and volatile currency. As such we continue to retain a balanced stance as we closely watch the developments unfold.
South African property saw a loss of 2.1% in December, bringing the performance over the year to a paltry 1.9%. This marked the end of another difficult year for the sector after the dismal outcome of -25.2% in 2018. While the 2018 downturn was driven largely by stock-specific issues, 2019 saw deteriorating fundamentals, which started to reflect in corporate financial results as the year progressed. A sluggish economic backdrop weighed on trading densities, rental escalations and consequently distribution growth. In addition, increases in operating costs (municipal costs and services) have been eroding profits.
Naspers and Gold mining were a drag on our equity house view
The equity house view return for the year fell short of its benchmark, the SWIX 40. This is attributable to two main factors − the low weighting of Naspers relative to the benchmark and no exposure to gold mining shares. Naspers comprises approximately 28% of the SWIX 40, while our equity house view is less than half that. While we are constructive on the investment case for Naspers, we restrict the exposure for risk-management and diversification reasons. As a result, when Naspers generates returns in excess of the market, the house view lags. In the face of rising global uncertainty over 2019, gold rose 18% over the year. Gold mining shares surged in response, with the sector delivering a 108% total return in 2019. We have never been owners of gold miners as they do not measure up to the quality hurdles we require companies to meet. Gold miners exhibit volatile earnings patterns, consume cash and struggle to meet their cost of capital.
On the other end of the spectrum, we continue to view AB Inbev as a high quality, globally diversified, defensive business, led by able and aligned management. Much of the negative sentiment over the last few reporting periods for the business were based on the geared balance sheet. Management have, however, already pulled a few available levers to address the elevated financial risk by:
Going forward, we expect a continuation of the strong organic cash generation to further deleverage the balance sheet as the premiumisation and portfolio expansion strategies are executed.
Historically low prices have prompted corporate activity throughout the year as shareholders seek ways to unlock value in a market besieged by poor sentiment. After an investment period of more than 20 years, RMB Holdings (RMH) announced plans to distribute its stake in FirstRand to shareholders, which will also see similar unbundling action taking place at Remgro given its exposure to RMH. More information will only be released in the first quarter of 2020, but both RMH (7.0%) and Remgro (21.6%) moved higher on this news over the fourth quarter. Holdings in both counters helped our portfolios over the quarter.
In 2018, disappointing financial results and difficulties in their offshore businesses led to lower earnings expectations and negative price movements for Mediclinic. With a focus on operational efficiency and balance sheet repair, Mediclinic staged a recovery in 2019, delivering very pleasing results (31.5%), supporting portfolio performance.
In acknowledgement of a fluid environment, we retain a focus on balanced portfolios. We favour neutral allocations across the asset classes. Our exposure to international earnings via locally listed equities represents 60% of the asset class exposure and we retain a modest allocation to higher quality, small- and mid-cap shares, where valuations have retraced to bear market levels, last seen in 2008/2009. After the strong run preference shares had in 2019, we expect more moderate returns in the future. As such we recommend a neutral position in preference shares. Bonds offer yields significantly above expected medium-term inflation and are therefore attractive from this perspective. For tax-sensitive clients, the positioning recommendation is neutral and overweight for non-tax sensitive portfolios. Our property positioning is neutral, but stock selection is vital given the downside risks to valuations and we have a strong preference for higher quality counters with strong balance sheets.
We have observed evidence of improvement in global activity but believe this points to the stabilisation of global growth. Slow economic growth, both domestically and internationally, and volatile markets look likely to continue into 2020. This is arguably already priced in, but disruption risk, whether from geopolitics or economic crises, remains high. We continue to seek balance and diversification in the portfolio, both at an asset allocation and equity level, to benefit from a range of scenarios and will proactively consider hypotheses that differ from our views. We will also look to take advantage of the long-term opportunities that volatility may bring, remaining focused on achieving returns ahead of inflation objectives. As always, we remain committed to our over-arching investment philosophy: ‘Long-term investing, well-considered’ and we would like to thank our clients for sharing the same long-term disposition.
This communication is issued by Nedgroup Private Wealth (Pty) Limited and its subsidiaries (“Nedbank Private Wealth”) for information purposes only, and recipients should not rely on such information as advice without obtaining financial, tax or other professional advice. The information referred herein has been obtained from various sources and may include facts and events or prevailing market conditions as at the time or date of the information going to print. Nedbank Private Wealth does not warrant the completeness or accuracy of any information contained herein, nor does it not make any representation that the information provided is appropriate for use by all investors in all jurisdictions. All opinions expressed and recommendations made are subject to change without notice. Nedbank Private Wealth and its employees may hold securities or financial instruments mentioned herein. The information contained in this document does not constitute an offer or solicitation of financial services or products and Nedbank Private Wealth accepts no liability for any loss or damage of whatsoever nature including, but not limited to, loss of profits or any type of financial or other pecuniary or direct or special indirect or consequential loss howsoever arising whether in negligence or for breach of contract or other duty as a result of use or reliance on the information contained in this communication.
Nedbank Private Wealth, an authorised financial services provider through Nedgroup Private Wealth Pty Ltd Reg No 1997/009637/07 (FSP828), registered credit provider through Nedbank Ltd Reg No 1951/000009/06 (NCRCP16), and member of JSE Ltd through Nedgroup Private Wealth Stockbrokers Pty Ltd Reg No 1996/015589/07 (NCRCP59).
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