Article 19 | Economic and Market Overview: Quarter 2, 2020

For the period ended June 2020

The following market review looks at the performance over the past quarter of local and global asset classes and currencies and puts this into perspective relative to longer-term performance. The purpose of this review is to provide a context in which the performance of the investment solutions in which you are invested can be assessed.

International

The second quarter of 2020 was a period when economic activity collapsed, central banks and governments delivered record levels of financial support, and risk assets recovered remarkably from their March lows.

Towards the end of the quarter there were signs that economies were picking up as restrictions were eased, although there were growing worries that global and US infections were continuing to rise.

On the political front, tensions between China and most other countries increased with accusations that the Chinese had created the virus and concealed its deadly nature. Australia led calls for an independent investigation, with China retaliating with punitive tariffs on some Australian exports. The US also upped the ante with various trade and sanction threats, fuelling talk of a new cold war. Tensions in Hong Kong over new sedition laws fanned the flames, with the US threatening to remove Hong Kong’s special trading status.

Towards the end of the month, the death of George Floyd saw impassioned protests break out across US cities and beyond, reigniting the “Black Lives Matter” campaign. With the race for the presidency now in its final few months, Trump’s poor handling of both the pandemic and the racial unrest saw his popularity slump, allowing democrat nominee Biden to take a meaningful lead in the polls. While a Biden presidency would probably help ease global political tensions, financial markets would be less welcoming of a democrat president.

European markets were buoyed by the unveiling of a plan for a new jointly funded EU recovery fund that could provide fiscal support to some of the weaker economies. If agreed, this would be a significant step towards greater fiscal cooperation across the euro area. Prior to this announcement, Italian government bond yields had been rising as investors worried that the costs of dealing with the pandemic could spark a second “euro crisis”.

The first quarter corporate earnings season concluded in May, and there was little to cheer as the majority of companies reported falling earnings and a weak outlook for the coming quarters. Even so, some investors took heart that the results were generally better than expected.

After a dismal February and March, equity markets bounced back strongly, with the MSCI AC World Index rising +19.2% in US dollar terms. The recovery was led by the US (+21.6%), Emerging Markets (+18.1%) and Asia ex Japan (+16.7%), with the UK (+7.8%) lagging some way behind, partly on its sector mix, but also on worries about its economy and Brexit. Sector performance was mixed and quite disparate. The strongest returns came in information technology (+30.1%) and consumer discretionary (+28.7%), while utilities (+6.8%) were relatively weak. In terms of style, the market continued to reward growth (+25.2%) over value (+13.0%), while smaller companies (+25.0%) outpaced larger companies (+19.2%).

Fixed income also saw positive returns as sovereign bond yields generally drifted lower. Central Bank support encouraged investors to return to higher yielding assets, with the riskier segments of the asset class seeing the strongest returns. Over the quarter, the JP Morgan Global Government Bond Index delivered a return of +0.7%, while narrowing spreads saw the ICE Merrill Lynch Global Corporate Investment Grade and High Yield Bond Indices gain +8.0% and +11.1% respectively (all hedged to US dollars).

Most commodities gained as the Bloomberg Commodities Index rose +5.1% over the period. The largest advance was in crude oil (+23.6%), which recovered some of the astonishing first quarter losses seen. Industrial metals (+12.3%) also saw support on hopes of a pick-up in economic activity, although more cautious investors looked to gold (+12.1%) as a safe haven.

Considering all the volatility across financial markets, currencies were remarkably stable. Commodity related currencies, such as the Australian and Canadian dollars, were among the strongest, rising by +11.2% and +3.5% respectively against the dollar. The euro also gained +1.8% versus the dollar, while the yen (-0.4%) and the pound (-0.2%) both lost ground. Emerging market currencies were mixed, with the Chinese yuan gaining +0.7%, the South African rand +2.7%, and the Mexican peso +2.9%, while the Brazilian real lost -5.0% and the Turkish lira -3.6%.

Note: All quarterly data is quoted in US dollar terms unless otherwise stated.

Domestic

South Africa continues to progress the reopening of the economy, even as coronavirus statistics increase and hospitals rapidly fill up. At the start of May, South Africa moved to level four restrictions after the initial 21-day lockdown was extended to 35 days. This was followed by a noisy and somewhat clumsy transition from level four to level three at the start of June. Level three marks the full or partial return of business activity for much of the economy with an estimated 8 million employees returning to work. This is a positive for the economy even as infection rates continue to escalate, especially in the so-called regional hotspots. Preparedness remains the focus, but the inevitable peak in active cases is yet to come and may again illustrate the complexity of the balancing act between lives and livelihoods.

President Ramaphosa unveiled a R500bn fiscal stimulus package in April aimed at providing immediate relief for the most vulnerable through social grants, while supporting businesses via tax deferments and a R200bn loan scheme in conjunction with local banks. Although the aggregate numbers are large, much of the funding will come from reprioritisation of the 2020 Budget and social security funds like the Unemployment Insurance Fund. South Africa will also seek an estimated R95bn in funding from international financial institutions such as

the IMF, World Bank and New Development Bank (BRICS Bank). The funding will be used for the COVID-19 health crisis and as such should not carry the conditionality that often accompanies loans from these entities.

The South African Reserve Bank (SARB) cut interest rates by a further 100bps in early April, in an out-of-cycle but unanimous decision. In line with market expectations, the SARB then again cut interest rates in May by 50bps, with a vote of 3:2, with two members favouring a 25bps cut. The SARB has so far cut the repo rate by 250 basis points this year, taking the repo rate to a 50-year low of 3.75%.

The Supplementary Budget in June detailed a revenue shortfall in excess of R300bn, R3bn in support for the Land Bank and ballooning debt service costs, which would result in an expected budget deficit of -14.6%. Large scale reprioritisation of expenditure and the introduction of zero-based budgeting signalled belt tightening, but it was fiscal consolidation that took centre stage. Finance Minister Mboweni spent some time unpacking the fiscal

reckoning that was looming in the absence of an active approach to the country’s debt problem. Treasury is never short of a plan, but a poor track record of execution on reforms and difficult fiscal choices, left credit ratings agencies Fitch and Moody’s sceptical of South Africa’s consolidation plans.

The full impact of the lockdown will only be seen in activity numbers for the second quarter, but the first quarter GDP contraction of -2.0% already includes signs of decreased mobility, activity and a change in spending. The third consecutive quarterly contraction, however, confirms a weak economic backdrop prior to the health crisis, weighed down by the heavy burden of load shedding.

Sharing the dramatic but uneven turnaround of global markets, the FTSE/JSE All Share Index gained +23.2% over the quarter with the most noteworthy moves from Sasol (+258%), which rerated alongside the oil price and gold miners (+68%). The SA Listed Property Index also took part in the global recovery. However, most property companies are looking to preserve cash in the face of an uncertain return of trading and consumer activity,

withdrawing or moderating distribution guidance for the time being. Although this is prudent, the lack of income generation may continue to weigh on sector valuations and investor appetite. The All Bond Index had a good start to the quarter, benefitting from the 150bps rate cuts, but fell by 1.1% in June on the back of a very weak budget review.

The tables below provide a review of key local and international investment indicators for the past quarter, as well as over longer periods.

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