2017 – A year of vindication for risk assets
There is a powerful proverbial saying which goes as follows, “The stone the builders rejected has become the cornerstone”. Rattled by the difficult 2016 experienced by a large number of investors, both locally and globally, the retail investment market experienced a large rotation from risk assets (equity and property) into cash.
The political uncertainty and economic weakness experienced on a global and local front over the period 2015 - 2016 was enough to induce many investors to ‘reject’ their initial investment strategies (many with large exposures to equities) for the safety of cash as they entered 2017.
However, in context, one could be sympathetic to these investors, especially those depending on their investments for their monthly income, as inflation in the United States (US) and Euro Area was below their targeted 2% inflation figure (figure 1); there were many instances of low and negative interest rates, together with waning global Gross Domestic Product (GDP) growth (figure 2) and weaker returns from equity markets.
Commodity prices also experienced a downward trend from mid-2015 through to mid-2016, and with South Africa (SA) being a major commodity export-driven country, many SA resource companies felt the short-end of this fall in prices, until demand for resources from China stepped up again in the second half of 2016. All said and done, for many investors 2016 ended like a drama motion-picture playing out to the tune of a dirge.
Politics continued to play a major role in 2017, both locally and globally, and both in developed and emerging markets. On the global front in 2017, we saw the rise of the “Rocket man” with North Korea’s leader, Kim Jong-un, launching test missiles in defiance of the global community and heightening geo-political tensions, particularly with the US. Locally, SA experienced some turbulence early on in the year with a cabinet reshuffle by President Jacob Zuma and then the subsequent downgrading of SA’s sovereign bonds to junk status.
However, the year ended with a positive twist as market-friendly African National Congress (ANC) presidential candidate, Cyril Ramaphosa was elected as head of the party.
Inflation comparison: US and Euro Area
Figure 1: US and Euro Area Inflation Source: Trading Economics
Long-term trend of world GDP growth rate
Figure 2: World GDP growth Source: Trading Economics
However, given hindsight, these benign conditions were merely setting the stage for one of the strongest recoveries in global economic indicators and investment markets since the Global Financial Crisis (GFC). Subsequent to the election of President Donald Trump as the leader of the US, economic and investor sentiment has turned positive, driven by the expectation of policies which would be pro-business, specifically lower corporate taxes and concessions for many local US industries. We now know that the US Senate narrowly approved a tax overhaul late in 2017, moving Republicans and President Donald Trump a big step closer to their goal of slashing taxes for businesses and the rich.
Short-term trend of world GDP growth rate since GFC
Figure 3: World GDP growth Source: Trading Economics
Working off the low-base in both investor sentiment and equity returns in 2016, the arrival of 2017 ushered in a strong recovery in local and global equity returns.
This was driven mainly by positive economic sentiment backed by synchronised global growth, strong corporate earnings, emerging markets assets offering attractive investment opportunities and large technology companies reaching record highs in both the US and China.
This positive economic and investor sentiment has subsequently translated into a strong period of ‘risk-on trade’ which has figuratively taken the bull by the horns and pushed the second longest bull market to record highs. We now see equity indices across the world reaching record highs and pushing valuations of risk assets into unchartered territory.
Therefore, investors who remained invested in risk assets toward the end of 2016 would have benefitted from this strong recovery.
Figure 4: SA and US Equity at record highs Source: IRESS
Overview of market returns
Table 1. Asset Class Returns – ZAR Source. Morningstar and Glacier Research
As seen in the table above, local equity outperformed all major asset classes in 2017, which is in stark contrast to the previous year’s returns, thereby rewarding investors who remained invested.
Table 2. Sector Returns – ZAR Source. Morningstar and Glacier Research
As seen in the table above, the main driver of local equity returns was the Top40, while mid and small caps struggled in contrast to their 2016 performance.
For SA investors, rand appreciation against the US dollar played a major role in investment performance during 2017. This occurred despite the rand weakening on the back of President Jacob Zuma firing former finance minister Pravin Gordhan on 31 March 2017, recovering strongly and appreciating by 9.59% against the US dollar for the 2017 calendar year. This detracted from the performances of offshore assets, but also had a meaningful impact on rand-hedge stocks as well as listed property counters. As a result, clients who made full use of their 25% offshore exposure in Regulation 28 portfolios would have been negatively affected by the rand strengthening on the back of Cyril Ramaphosa’s win in the ANC electoral conference which took place in December.
What’s in store for South Africans in 2018?
A sizeable budget deficit and disappointing revenue collection over the past tax year, coupled with added commitments from government such as free higher education have placed an emphasis on tax hikes in 2018. As described in the Medium Term Budget Policy Statement, which took place in October 2017, National Treasury projects a revenue shortfall of R50.8 billion in 2017/18 – making it the largest under-collection since the 2008/2009 GFC. Treasury could implement the following to make up the shortfall: increase the capital gains tax rate, increase the value-added tax rate, introduce a form of wealth tax, or increase the donations tax rate. Furthermore, the major rating agencies will be keeping a close eye on the 2018 budget speech in terms of South Africa’s credit rating, with Moody’s rating agency the only one to still downgrade SA’s local debt to junk status.
The South African Reserve Bank in its November policy meeting kept its interest rate unchanged at 6.75%. The next interest rate decision will be announced on 18 January 2018. The rand is seen as an important factor in terms of the interest rate decision, where the currency strengthened both before the ANC’s national conference in December and after Cyril Ramaphosa was elected as head of the party.
In December 2017, President Jacob Zuma announced a revised definition of poor and working-class households and increased the qualifying household income threshold for the National Student Financial Aid Scheme to R350 000. It is unclear how government will finance Zuma’s plan, but details are expected in February when Finance Minister Malusi Gigaba delivers his budget speech.
The National Energy Regulator of South Africa (NERSA) agreed to a 5.23% increase in electricity tariffs, while Eskom applied for a 19.9% increase. NERSA flagged serious problems facing Eskom such as a decline in sales and poor management of costs. The power utility company is expected to ask the government for a bail-out amid cash flow issues.
In conclusion, 2017 was a year of vindication for risk assets. Investors who remained invested were rewarded despite local politics and the Steinhoff debacle. As always, it is important to remain calm and to stick to your long-term investment plan in order to avoid much of the noise and pitfalls out there. This, coupled with building a diversified portfolio with your financial adviser should go a long way in allowing you to successfully navigate 2018 and the years beyond.
Mail and Guardian
South Africa’s Medium Term Budget Policy Statement October 2017
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