STJOHN BUNKELL, HEAD OF EQUITIES AT PRESCIENT INVESTMENT MANAGEMENT

Chris Freund and Hannes van den Berg, co-heads of SA equity & multi-asset at INVESTEC ASSET MANAGEMENT

have no doubt that recent equity returns have been very frustrating for most investors. Politics, policy uncertainty and slowing growth have been front of mind for investors, not helped at all by the dawning realisation that trade frictions between US and China were in fact part of a wider battle for tech and overall economic supremacy.

“We see these risks more fully reflected in asset prices than a year ago, but expect twists and turns to cause bouts of anxiety. Markets are vulnerable to fears that a downturn is near, even as we see the actual risk of a global recession as low in 2019.

“Keeping inflation under control is a key driver or risk. The important question is whether inflation will remain benign. If not, the Federal Reserve Bank will be seen as behind the curve — bond yields would increase significantly while equities and other risk assets decline substantially.

“Wage growth will likely be the key driver. Continued slow inflation gives central banks an excuse to either take their foot off the brake or continue easy money policies. Recent Federal Reserve Bank dovishness surprised investors and revived the Goldilocks mindset of early 2016.

“US growth is holding up while rates and the US dollar are being capped for now, which is positive for risk assets and emerging markets, like South Africa. Earning positive returns is easier when companies don’t have to “fight the Fed” or other central banks.

“In line with late cycle patterns, growth stocks should generally continue to outperform. As long as China’s all-important demand for commodities holds up, cyclical commodities should remain supported.

“The bottom-up fundamentals for resource companies remain constructive and are centered on broadly balanced supply/demand, falling inventories, supply bottlenecks and moderate demand. Were it not for the negative macro headwinds prices would be a good deal higher.

“Equities are likely to remain choppy for much of the year, but given reasonable earnings expectations going into 2019, better starting valuations and a no-recession assumption, 2019 return projections should show improvement on 2018,” say Freund and Van den Berg.

StJohn Bunkell, head of equities at PRESCIENT INVESTMENT MANAGEMENT

says in emerging markets and notably in South Africa, valuations seem attractive currently and from a bottom up perspective equities look well priced with selected sectors and shares being cheap.

“From a top down perspective however, the landscape is far from certain; the quantitative easing programs implemented by central banks to support the financial system in the aftermath of the global credit crisis has become one of the largest, unprecedented financial experiments, the consequences of which are largely unknown.

“Furthermore, growth expectations are beginning to slow with macro-economic data in many regions beginning to soften; central banks and financial policy makers have become more dovish with supportive rhetoric lending some support to the equity markets.

“In the local space we continue to have a bias towards stocks offering compelling valuations coupled with strong quality of cashflow and market capitalisation. Our asset allocation models favour Europe to outperform other developed markets from a valuation point of view, however, in a crisis dollar strength will support the US. We remain cautiously optimistic about equity market performance for the next year,” says StJohn Bunkell.

Patrick Mathidi, head of equities at ALUWANI CAPITAL PARTNERS

says even though overall domestic equity market valuations are looking attractive (current p/e ratios relative to long run averages) the much-needed catalyst for real returns is likely to remain elusive over the most of 2019 as domestic GDP growth and corporate earnings (for such domestic companies) disappoint.

“There is growing indications of 2019 being another difficult year for domestic equities, as evidenced by below expectation corporate earnings and gloomy outlook, the National Budget not providing any relief to consumers.

“We see opportunities in the Rand hedge component of our domestic equities index, largely influenced by our view on the USD/ZAR exchange rate and a stable growth and earnings outlook on emerging markets, supported by compelling valuations. We are of the view that the growth differential between developed and emerging economies favours emerging, and our companies that have a presence in some of these emerging economies will do better than our locally based ones, in addition a weakening USD/ ZAR exchange will enhance total returns.

“Even though at an overall index level we are not that positive, 2019 just like 2018 is most likely to be a year where stock selection trumps: there will always be opportunities to pick stocks that can materially outperform,” says Mathidi.

Neville Chester, portfolio manager at CORONATION

says the company is more optimistic on future returns from risk assets and our funds reflect this in higher allocations to equities, property, and in South Africa, to bonds. Globally, fears over rate hikes are receding, which is positive for sentiment towards equities generally and emerging markets specifically.

“The tough local economic conditions have seen many domestic shares disappoint and this is largely reflected in share prices which have fallen significantly in the past six to 12 months. In SA, small incremental improvements in domestic conditions should be positive for these oversold domestic assets.

“Given the tough economic outlook in the short term we have preferred gaining exposure via more defensive businesses, and are still invested in a number of global businesses that are listed on the JSE.

“Our global allocation is predominantly focused on equities given the poor return expectations from global bonds, with a bias towards emerging markets where valuations are very attractive, and the weaker dollar should be more supportive,” says Chester.

Patrice Rassou, head of equities at SANLAM INVESTMENT MANAGEMENT

says global markets had a tumultuous close to the year with their third worst quarter on record. However, the company remains positive that risky assets globally and locally are poised to deliver improved real returns this year.

“With the Fed adopting a more dovish tone and the Chinese focusing on easing measures, we have a clear preference for global equities over bonds and cash and local equities also offer very attractive upside with the PE now in line with long-term averages.

“As value investors, we find the industrial stocks with global footprints particularly attractive given their defensive nature. In fact, despite defensives outperforming globally last year, the defensive shares had a torrid time on the JSE, with global giant British American Tobacco being hit by negative news emanating from its US regulators.

“However, it is not slam dunk as the JSE still trades at a premium to the broader emerging market universe. It is also fair to say that the bull market globally is long in the tooth and that the JSE is unlikely to decouple from any global sell-off which could be caused by policy error or worsening trade tensions.

“Political outcomes are increasingly having a magnified impact on capital and currency markets. Brazil ended 2018 as the best performing stock market – in a year where only four markets ended higher. This is an indication that capital has been flowing to havens of relative political predictability. In our case, more market friendly rhetoric from the ruling party may indeed lead to another bout of Ramaphoria and a strengthening of the Rand. However, such sentiment-driven flows are extremely difficult to forecast,” says Rassou.

What opportunities do you see in the bond and credit markets at this time considering the full range of investments (nominal and inflation-linked bonds, credit, local vs. international markets, etc.)? What is your current view on listed property investments?

Conrad Wood, head of fixed income at ALUWANI CAPITAL PARTNERS

says local fixed income asset classes have re-priced substantially in response to tightening global liquidity conditions and a plethora of domestic risks that cumulatively can be distilled into the real threat of losing our investment grade sovereign credit rating.

“With the 10-year yield on nominal bonds at around 9% and inflation-linked bonds at 3%, investors need to evaluate whether all risks have been priced and if these asset classes are set to out-perform in 2019? On the face of it, bond yields relative to the one year expectation for inflation of 5% look like a very appealing prospect. However, we see a year ahead where the global economy slows, posing risks for emerging markets, especially South Africa whose growth prospects are closely linked to those of the globe and whose financing needs are heavily dependent on foreign capital.

“If you add the domestic risks of debt sustainability and political uncertainty, we believe 2019 will be a volatile period for local bonds and while the current levels of yield offer significant protection, we remain somewhat cautious on the prospects for bonds. However, on a relative basis we prefer nominal bonds over inflation-linked bonds as inflation remains benign and the premium investors usually pay for real assets is eroding.

“Given the prevailing uncertainty for fixed income assets, investors seem to have moved to local credit as a defence mechanism. Ironically, it is the lack of investment over the past few years that has improved the quality of balance sheets of most borrowers and thus despite the challenging macro environment, capital has flocked into local credit at the same time that issuance has declined, compressing spreads fairly substantially.

“This makes us somewhat cautious on the prospects for local credit as well and we are very selective in deploying investment in this space. Lastly, the outlook for listed property remains hazy in our view. Despite very attractive yields (relative to bonds), the asset class is likely to be plagued by the challenging macro environment and rising bond and equity risk premia.

“We don’t necessarily see 2019 as an opportunity for fixed income investors, but rather a time for capital preservation with the odd tactical opportunity along the way,” says Wood.

Malcolm Charles, portfolio manager at INVESTEC ASSET MANAGEMENT

says locally, macroeconomic fundamentals and the Fed-induced change in global sentiment is supportive of fixed income assets.

“We remain constructive on nominal bonds over the medium and long term. At a fundamental level, we believe local bonds are still attractively valued at current yields, relative to the emerging market peer group, and offer outright value against inflation and cash.

“While inflation-linked bonds offered better protection compared to nominals for most of the previous year, we believe the benign inflation environment and continued weak trend in real yields will continue to weigh on the asset class. The limited currency pass-through in past months is also likely to be a drag on the inflation carry, thus making nominals more attractive in our view.

“We maintain our underweight allocation to the local listed property sector. We remain wary of earnings in the long term for this sector and believe the asset class is the least attractive in our opportunity set.

“We maintain our overweight allocation to investment grade credit. Spreads among quality issuers continue to tighten and the lack of supply continues to buoy the local credit market. Security selection remains key in this space and our bottom-up views remain consistent with a preference for assets with defensive credit qualities. Our preferred sectors remain banks, insurance and real estate. All the while, we also look for companies displaying strong asset quality, valuation, contractual cashflow and conservative management.

“From a portfolio construction perspective, we maintain our offshore exposure in order to balance local interest rate-sensitive risks and, more specifically, to offset rand weakness. We maintain the bulk of our foreign currency allocation to the US dollar, which we expect to remain broadly stable over the year,” says Charles.

Henk Kotze & Grace Debeila, portfolio managers and analysts at PRESCIENT INVESTMENT MANAGEMENT

say currently they see the local fixed income market as attractive considering the real yields being earned.

Kotze says the company is earning a real yield of between 3% and 4% in its cash and income funds This is achieved without taking any undue risk from a credit and duration perspective.

“We believe the credit market is too tightly priced and portfolios should be positioned conservatively with high quality names and shorter-term maturities.

According to Debeila, despite the recent fall in South African bond yields, Prescient still sees it as being attractively priced given that we are earning real yields of between 4% and 5% on the long end of the curve.

“Broader EM sentiment has been supportive for SA bond yields and we have seen strong flows from foreigners into the market in early 2019. Notwithstanding that, risk of a deterioration of EM sentiment remains elevated and there are significant idiosyncratic factors locally that add to duration risk in the short term.”

Debeila says in line with US yields, real yields in South Africa rose strongly throughout 2018, and fell marginally recently as the market has begun to digest the idea of lower global growth. However, nominal bond yields have fallen even more so breakeven inflation rates have compressed in the first month of 2019.

She says the reason for this may be that market participants’ inflation expectations have fallen and they are more inclined to hold fixed rate bonds. Also, near-term inflation numbers will have some negative monthly prints, which will make the opportunity cost of holding inflation linked bonds high in the short term.

“At current levels, we think ILBs are at fair value. We have been adding real duration to ILB-dedicated portfolios throughout the year, such that we are now neutral in real duration terms relative to the index,” says Debeila.

Kotze says offshore credit opportunities include buying South African bank dollar bonds. These spreads have moved wider and present value for a South African investor who is comfortable with local bank risk. If you hedge out the currency risk, there is a pick up above the locally issued bank bonds.

“We are constructive on listed property as an income asset currently. The opportunity arose following the sharp downward price movements seen last year. When we allocate to listed property, we do so for the yield generated and look for entities that are trading at a discount to their net asset value,” says Kotze.

“We have invested in good local property shares in this regard. We always remain cognisant of our risk benchmark and size the allocation to this asset class accordingly,” adds Kotze.