• Dave Mohr (Chief Investment Strategist) & Izak

A better year - says Old Mutual Wealth


Believe it or not, but it is December already. Barring a surprise Christmas rally or a visit from the Market Grinch, we have a reasonably good idea what the calendar year returns for 2019 should be.


On one level this doesn’t matter, since most investors’ financial horizons don’t neatly overlap with calendar years (unless, for instance, you retire on 31 December.) Still, humans like compartmentalising, and we also like looking back. December is the season for reflecting, after all.


Bonds


Let’s start with bonds. The All Bond Index returned 8% for the first 11 months of the year, ahead of cash, despite all the negativity. After all, this year has seen financial media saturated with articles on debt traps, downgrades and unfounded fears of International Monetary Fund (IMF) bailouts. (Why a country that borrows in its own currency would need to turn to the IMF was never clearly explained.) To be clear, there is a lot of bad news for the bond market.


Government’s fiscal deficits are increasing, not declining, and too-big-to-fail Eskom is still lurking in the shadows, cap in hand for more state support. More borrowing means more bond supply, which should in theory suppress prices and raise yields. The key thing is that the demand for bonds remains healthy, due to the attractive yield. Also, the yield is high precisely because of all the bad news, which is already priced in. By the time you read about something in the newspapers, it has long been discounted by financial markets. The yield on the 10-year South African government bond declined slightly from 9.6% to 9.4% during 2019. The high starting yield means return from income will probably be good even if there is some capital loss. If there is a capital gain, the returns can be substantial.

There is also the element of luck. Global bond yields slumped during the course of the year as investors priced in slower growth and lower interest rates. This limited upward pressure on South African yields. The other factor limiting the upward pressure on yields is muted inflation. Consumer prices have been rising at an average annual pace of 4.5% over the past three years. The latest reading was only 3.7%.


Property


Listed property had a torrid time, buffeted by three broad trends. Firstly, the local economy is struggling, suppressing demand for property even as supply growth (new malls, office buildings and logistics facilities) has been reasonably robust. The result is rising vacancies and downward pressure on rents. Rental income is ultimately what property companies pay out to investors. Secondly, local companies engage in a number of financial tricks to boost short-term distributions. These were not repeatable indefinitely and are now unwinding, but caused many investors to overestimate future distribution growth. Thirdly, JSE-listed property has high exposure to UK retail, which has taken the twin blows of Brexit uncertainty and competition from e-commerce. The FTSE/JSE All Property Index returned 1% in 2019 to date, an improvement from last year’s 25% slump. The sector trades on a yield of almost 10% which is attractive, but there is still some risk that distributions will decline next year instead of growing as the adjustment to a new reality continues.


Equities


Depending on your choice of benchmark, local equities lost 10% in 2018, the first negative calendar year in ten. This year has been better, with the FTSE/JSE All Share Index returning 8.5%, most of this in the first quarter. This gain is ahead of cash and represents a real return of almost 5%, closer to the historic long-term average real return of 7%. However, the real return over the past five years is still basically zero, and the index level is still below its January 2018 record high of 61 684.

The bounce in the local equity market came despite the lack of discernible improvement in the domestic economy. While there has been steady if unspectacular progress on economic policy reform and improved state governance, economic activity is not accelerating and business confidence is still depressed. The Bureau for Economic Research’s Business Confidence Index hit a 20-year low level of 21 points in the second quarter, with only a mild improvement in the