Understanding the Alsi in uncertain times

One might expect that the downgrading of a country’s sovereign debt would result in the devaluation of its currency, cause its stock market to tumble and provoke an interest rate hike. But often this isn’t the case; SA is a case in point.

It’s actually rather common for markets to strengthen after a downgrade. A market downgrade doesn’t come out of the blue: it’s usually a lengthy process with many signposts along the way. Accordingly, the market will price the downgrade into equity and bond indices, and the currency in tan- dem. Then, if the downgrade happens, certainty returns to the market and it begins moving upwards.

This is what happened in SA’s case. The rand strengthened 4.7% against the dollar, while the All Share Index (Alsi) (total return) and All Bond Index flicked up 1.4% and 3.5% respectively (April 7 to May 31, 2017).

By contrast, ex-finance minister Nhlanhla Nene’s dismissal was completely unexpected, prompting a dramatic drop in the rand and in both indices.

Why then, if the Alsi’s moved higher since the downgrade, are some SA funds not performing?

One has to understand the complex set of factors that a portfolio manager/investor makes when constructing a portfolio. In each case, the guiding principle is their fundamental view about where markets are headed.

Currently, international investors are driving emerging markets higher as they search for good returns. China is the largest emerging market, and investors believe it’s basically stable and holds little risk. All emerging markets benefit from this perception, SA included.

We look quite a bit better than the likes of Russia, Turkey and Brazil, even with the volatile political situation. As such, our currency and equity and bond markets are strong.

Alsi returns show that this strength is derived almost wholly from rand-hedge stocks – those also listed on an exchange in one of the developed markets.

Look at the returns of the five largest stocks in the All Share Index as of May 31, 2017: Naspers, Richemont, BHP Billiton, Anglo American and British American Tobacco (BAT). They contributed 6.95% of the Alsi’s 7.1% return as a whole. Naspers, Richemont and BAT, which make up 26% of the Alsi, returned 7.7% – meaning the rest of the market actually showed -0.6% negative growth.