POSITIONING TO WEATHER HEADWINDS

THE ECONOMY exited its recession in the third quarter of last year, and while attention will be on the country’s fourth-quarter 2018 gross domestic product growth figures from Statistics SA on March 5, all indications suggest they’ll be weaker than the previous quarter.

Although economic growth has been muted, inflation has gradually edged higher, as shown by the Consumer Price Index for January. Inflation is within the target band of 3 percent to 6 percent set by the SA Reserve Bank (Sarb), but above the mid-point, which has been its focus in recent times. Although demand pressures are low, Sarb sees rising inflation expectations and tighter global financial conditions as a risk.

During the fourth quarter, we at PPS Investments advocated a change of view. Towards the middle of the quarter, global equity was downgraded from “maximum overweight” to “over-weight”, tempering enthusiasm for the asset class.

Our constructive view on global equity has been a high conviction multi-year call, which to date has stood the portfolios in good stead. Although we remain positive on the outlook, risks have increased.

First, while valuation of the MSCI All Country World Index (ACWI) became slightly less demanding during the sell-off, the US market (a major part of the index), remains vulnerable given its elevated multiples and peak profit margins. Second, there are global macro risks, with the monetary tailwinds of previous years now reversing, alongside slowing global growth.

In addition, US pro-cyclical fiscal support has pushed the region unsustainably beyond full employment, and this driver of global growth is more likely to wane than step up.

Third, it appears that there will be no speedy resolution to the titfor-tat trade war, the effect of which is already appearing in disappointing results from some multinationals.

Fourth, markets will increasingly start to look beyond the recent strong global growth, and will characteristically begin to focus on the next phase of the business cycle of a slowdown.

Last, the progressive deterioration in price action across several markets also highlights likely continued “indigestion” for risk assets over the medium term.

Taking all of this into account, we felt it prudent to exercise a higher degree of caution going forward, and we began dialling back risk exposure.

Importantly, we remain constructive on equities overall in our house view, and although we still advocate being over-weight, our positioning reflects our preference for global over local equity exposure.

In the fixed-interest space, we are still “neutral” on South African bonds, after having upgraded the asset class in the third quarter.

The real yield of about 4 percent on offer from the 10-year bond is attractive, but we have resisted the temptation to upweight bonds more aggressively for the moment.

The lingering risk of a sovereign credit ratings downgrade – to be announced by Moody’s at the end of March – remains too large to ignore, and although the relevant portfolios have a healthy level of exposure, we are poised to upweight into any material weakness.

In contrast to South African bonds, PPS Investments remains negative on the outlook for global bonds.

Reza Hendrickse is a portfolio manager at PPS Investments.