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By Brian Butchart*
The sharpest rebound in history during April continued into May after unprecedented volatility in March, reminding investors not to sell in panic, and instead focus on long-term strategy, especially in well-constructed portfolios. Seasoned investors have seen this many times before and understand why remaining calm, is their best response. The risk of losing capital is not necessarily market volatility, but how we as investors re-act towards market volatility.
S&P 500 vs MSCI ACWI vs JSE ALSI
7 February 2020 to 08 May 2020 USD
Markets are yet to fully recover from their peak earlier this year but bounced back strongly from the more than 30% decline in US Dollars in March. In rand terms the recovery looks dramatically better due to recent rand weakness.
Billionaire investor, Warren Buffet referred to the recent bout of volatility as “an interruption of growth” at Berkshire Hathaway’s AGM on the 2nd May 2020.
Recent events are temporary and government co-ordinated stimulus injection and interest cuts (the largest being in the US) have provided some stability to global markets.
With more than 50% of the global economy back in operation, and more economies expected to open slowly on a phased in approach, growth will inevitably return.
There is no doubt however, as global economies start re-firing, the impact of global lockdown, job losses and fall-out of small to medium businesses will impact consumer spending and company earnings.
So, how do we approach the market, where should we invest and what should we avoid?
- Hold Core quality, growth businesses geared to ride out market cycles.
- Identify Industries, sectors and businesses which will struggle to recover and limit exposure to them.
- Hold enough cash to enable taking advantage of irrationally priced opportunities.
- Keep a cool head. Always!
Global developed market (DM) bond yields and interest rates offer zero to negative returns and cash in the bank will erode capital values nominally and your wealth in real terms. There are scant returns to be earned in global markets from assets without risk. But investing in equities means volatility and a long-term mindset – this is the price we pay for larger returns over time. However, the need for an optimally positioned portfolio has never been more important in a post COVID world. The way business is conducted will change forever and only those that adapt will survive.
The SA economy and local equities have been on life support for several years prior to the virus. The additional debt created by the recent stimulus package together with the impact of lock down on the SA economy, businesses and consumers will have a detrimental impact on GDP. The Reserve Bank and other commentators expect a contraction of between 6% and 10% depending on how quickly the SA economy reopens, with unemployment numbers expected to increase to between 30% and 40% or more. Companies such as Edcon, Comair and SAA are in business rescue with potentially more to follow. Caxton & CTP Publishers are withdrawing magazines such as Bona, Country Life, Garden & Home, Rooi Rose and others, which have been in circulation for decades. This environment won’t bode well for consumer spending or the SA economy and locally listed companies may continue to struggle in the pursuing environment as cash strapped consumers tighten their belts. Foreign and local investors continue to seek attractive yields from the local bond market but expect little interest in SA equities even at current prices which may remain lower for longer. Funds continue to flow offshore as investors seek wider investment opportunities and better returns than the local market offered investors for more than 7 years, clearly evident in the graph below compared to the MSCI world Index and S&P 500.
S&P 500 vs MSCI ACWI vs JSE ALSI
8 May 2013 to 08 May 2020 ZAR
|Fund||1 Year (%)||3 Year Annualised (%)||5 Year Annualised (%)||7 Year Annualised (%)||10 Year Annualised (%)|
|FTSE/JSE All Share Index TR||-6.84||1.25||2.09||6.72||9.64|
|MSCI World Index TR||27.98||16.22||14.12||18.19||17.72|
With the exception of a handful of quality listed businesses, mostly rand hedge stocks with international interests, we expect continued lack-lustre returns from SA equities for the short-term, despite attractive valuations and instead prefer local income funds, combined with selective global equities for alpha generation.
There is a lot of money to be made in current conditions, but certain sectors and companies such as airlines, leisure, hospitality, automotive, oil and consumer cyclicals in general will take significantly longer to recover.
Defensive and sensitive sectors such as technology and healthcare, the new gold rush in many respects were least affected by the recent volatility and expected to recover the fastest. In fact, some of the largest quality growth stocks are in technology, Bio-tech and healthcare sectors and only available internationally.
Our outlook for global property is risky as we expect the value of listed property funds to drop considerably as property owners feel the impact of (a) more people working from home and (b) more people shopping online for at least the immediate future with possibly a longer-term trend emerging post lockdown. Businesses will strategize and reassess the need for excessive office space especially when individuals that have and will continue to work from home, do so in a post lockdown world. Retailers globally, some of which have been under pressure won’t make it post lockdown and those that do will experience a deepening change in consumer behaviour, already evident prior to lockdown across major economies, as global consumers shop more online. This will continue to decimate the demand for international retail space and have a massive disruptive impact on listed property groups.
Locally Interest rates in SA dropped 200 basis points (2%) so far this year and could drop further to provide support to a fragile SA economy, especially if lockdown continues longer than initially anticipated albeit on multiple levels and severity. The repo rate is now 4.25% and the average Money market offers between 5% and 6%. The risk of cash on an after-tax basis is the erosion of capital in real terms.
The recent dislocation in the bond market presented opportunities to income fund managers as yields spiked more than 10% despite weakening prices. Buying into these weaker prices offer attractive yields for conservative investors especially considering lower interest rates and return on cash.
I must stress however, that not all income funds are equal and there are some aggressive funds in the income fund category. We prefer low risk income funds which invest in low duration, quality investment grade bond instruments, are actively managed and provide liquidity which we expect will deliver inflation beating returns of 9% or more.
A sound financial strategy should include multiple financial planning disciplines and not focus on investing and returns in isolation.
For a comprehensive financial planning strategy including asset allocation, risk planning, estate planning, tax planning, offshore investment and more Read here.
- Brian Butchart is the Managing Director of Brenthurst Wealth, a CERTIFIED FINANCIAL PLANNER® professional and head of financial planning for Brenthurst’s Cape Town offices. He manages compliance and operations nationally for all Brenthurst offices. He started his career in financial services in 1998 and previously worked at Citadel and Magnus Heystek International.