By Dave Mohr (Chief Investment Strategist) & Izak Odendaal (Investment Strategist), Old Mutual Multi-Managers.
Global equity returns are on track for a strong year. The MSCI All Countries World Index (Acwi), a broad index of developed and emerging market stocks, returned 1.98% in November to end the month at a record high level. With one month to go, the 2017 return is at 22.6% in US dollars. The index has returned 250% (or 15% annualised) from the lowest point of the global financial crisis in March 2009.
Although investing in global equities over this period has been profitable, it hasn’t been a straight line. There was a bear market (according to the traditional definition of a 20% loss) between April and October 2011, while the 18% loss from May 2015 to January 2016 came close. Worries about the eight-year length of the rally are therefore somewhat misguided. At 16.2, the forward price earnings ratio of the Acwi is slightly above the long-term average of 15.7.
US listed shares account for about half of global equity market capitalisation. The S&P 500 returned 3% on the way to a new record high level. The US equity benchmark has returned 20% this year. The US is the most expensive with the forward PE of 19.8 above the long-term average due to the best uninterrupted run of the major markets.
Emerging markets were flat in US dollars in November, but the MSCI Emerging Markets Index has still returned an astonishing 32.9% in 2017 to date, handsomely outperforming developed markets (though the period of underperformance between 2011 and 2015 still has to be made up). Emerging markets are still attractively priced relative to developed markets, with a forward PE of 14.
Bubble, bubble, toil and trouble?
While concerns over a bubble in global equities are largely misplaced, Bitcoin is firmly in bubble territory. It jumped 70% in November to close above $10 000 for the first time. In the last week of November alone, it surged 28% (which included a 20% decline along the way). These kinds of rapid price increases (interspersed with sharp declines) are typical of a speculative mania. In fact, the last time such price surges were witnessed was probably during the tulip and South Sea bubbles of the 17th and 18th centuries. While the underlying blockchain technology is useful and might well become part of our day-to-day lives, its fundamental value cannot have increased that much in the space of 11 months. Daily Bitcoin transactions have risen 30% this year, but the price has increased tenfold. Investors should not ask themselves whether the news is good (or bad) but whether the good news is priced in. Unfortunately, bubbles tend to burst only when many latecomers are sucked in by the lure of quick riches.
Equity markets have been supported by favourable conditions on the ground. Global economic growth is accelerating, inflation is low (but positive) and the interest rate outlook is benign. The US economy grew 2.3% year-on-year in the third quarter, the fastest pace in two years (but still below the pre-2008 average of 3%). Surging equity markets, a recovery in house prices and plentiful jobs have seen consumer confidence rise to the highest level in a decade. Consumers also benefit from low inflation. The personal consumption inflation rate – the Fed’s preferred gauge of price pressures – slowed slightly to 1.6% year on year in October. Nominal wage growth remains sluggish though, and while this is one factor weighing on household spending, the absence of accelerating wages despite low and falling unemployment (4.1% in October) suggests interest rate increases will be very gradual. The Federal Reserve is expected to hike its key policy interest rate by 25 basis points in December, but it is the pace of increases next year and beyond that is crucial.
Eurozone growth also accelerated to 2.5% in the third quarter, the fastest rate in six years. Confidence surveys show that businesses (across a range of sectors) and consumers are extremely optimistic about the economy, and suggests solid growth can persist.
In China, credit conditions are tightening as the authorities attempt to rein in rampant lending growth and shadow banking activity. Corporate and government bond yields are rising and house price growth is slowing. However, November’s purchasing managers’ indices for manufacturing and services remained in solidly positive territory and support the view that China’s growth rate will fall gradually over time, instead of rapidly.
Another positive month on the JSE
Local equities also had another positive month, even outperforming global markets in dollar terms. The FTSE/JSE All Share Index (Alsi) broke through 60 000 index points for the first time during November, but slipped below that level on the last trading day. Nevertheless, the Alsi returned 1.5% in November, including dividends and 21.4% for the year. The FTSE/JSE Shareholder Weighted Index (Swix) returned 3% in November, lifting the year to date return to 21%. The rally on the JSE has been driven by large cap shares. The mid-cap index only gained 2.5% year to date while the small-cap index was marginally negative. In contrast, the Top 40 index returned 24%. The Swix’s forward PE of 16.8 is high relative to its long-term average, but the index has changed considerably over the past decade and is now dominated by shares that are priced in global markets. The valuations of the domestically focused shares generally reflect the economic outlook which was recently described by Reserve Bank governor Lesetja Kganyago as “subdued but positive”.
Subdued but positive economic outlook
Recent evidence of the “subdued” part of that characterisation includes business confidence and credit data. Total bank loans to the private sector advanced by only 5.2% in October. The growth in borrowing by companies in particular has slowed down sharply from 11% year on year in January to 7% in October. Household borrowing growth has remained in the 3% to 4% range for the past three years (adjusting for the removal of African Bank loans from the data), below the pace of income growth. Therefore, consumers have been deleveraging.
Business confidence remains depressed. The RMB/BER Business Confidence Index remained in negative territory in the fourth quarter, but improved marginally from the previous quarter. The BER noted that political uncertainty is perceived to be a bigger constraint for businesses now than at any time in the past. The constant (probably exaggerated) worry over the potential impact of downgrades will not have helped.
But there is also evidence supporting an improving outlook: South Africa posted a surprising R4.5 billion trade surplus in October. It is typically a deficit month as imports surge ahead of the festive season and year-end. For the first ten months of the year, the surplus is a healthy R51 billion which compares very favourably with the R10 billion deficit for the same period in 2016. This improvement in South Africa’s external balance – largely due to robust iron ore and coal exports – is one of the factors supporting the economy’s gradual recovery. The Absa Purchasing Managers’ Index increased for the fourth month in a row in November. However, at 48.6 index points it remains below the key 50 level that separates positive from negative growth.
Encouragingly, the forward-looking component is positive, as new sales orders exceed stock levels, suggesting production will have to be ramped up. New vehicle sales increased by 7.2% in November compared to the same month last year, the sixth month in a row of positive year on year growth.
Local bonds weaker with other emerging markets
Bond returns were negative for a second consecutive month in November. The All Bond Index (Albi) lost almost 1% which capped the year to date return at 4.3%. South Africa’s 10-year government bond yield increased from 9.1% to 9.3% during the month, but traded as high as 9.5% ahead of the ratings announcements. In other words, yields declined after S&P Global downgraded the sovereign rating and Moody’s placed it on a negative watch. Other emerging markets also saw bonds selling off during the month. Brazil’s 10-year yield increased from 9.9% to 10.4%, while the equivalent Turkish yield rose from 11.5% to 12%. India, which was upgraded by Moody’s for the first time in 14 years during the month, saw its yield rise from 6.8% to 7%. Broadly speaking, emerging market yields have followed US yields higher since early September.
To December and beyond
The rand gained 3.5% against the dollar in November despite the downgrade. The rand ended the month at R13.66 per dollar, only a few cents below where it started the year. This was despite all the bad domestic news since January, including Cabinet reshuffles, the downgrades to junk status and a technical recession. Ultimately, global factors overshadow local conditions when it comes to the overall direction of South African markets. Local events can cause short-term volatility, but the trend is determined internationally, and global conditions are currently still favourable. It is important to remember this as political uncertainty will increase around the ANC’s elective conference later this month.