Courtesy of Old Mutual:
Impact of Global market sell-off:
Global equities had the worst start to the year in several decades. South African markets have followed and the rand is extremely weak. Some advisers are telling clients to “sell everything” but we don’t share that view.
What has been happening?
Global economic growth disappointed in 2015. Although the US and Eurozone registered somewhat better growth, it was the Emerging Markets that disillusioned investors. These concerns have if anything intensified in the first few days of 2016, with concerns centred on China. China’s stock market collapsed again despite several official intervention attempts. While Shanghai’s volatile equity market rarely reflects economic reality, these interventions have once again made things worse instead of better. The behaviour of the Chinese Yuan has also unsettled investors. In early December, China switched from pegging the Yuan against the US dollar to tracking a trade-weighted exchange basket. This allowed the Yuan to depreciate against the US dollar. However, the steep fall in China’s foreign exchange reserves points to capital still flowing out, which places further downward pressure on the Yuan. A weaker currency could send deflationary ripples through the global economy and challenge the slow expansion.
Other factors behind the market sell-off include:
• The Federal Reserve hiked US interest rates in December for the first time in seven years, and investors appear uncertain about the impact on growth. Emerging markets are experiencing large capital outflows, declining financial asset prices and weak currencies.
• The strong US dollar has already surged due to the anticipation of higher rates and is hitting the profits and prospects of US companies that export or compete with imports.
• The collapse of the oil price (with Brent crude below US$30/barrel) has also spooked markets as oil producers and related industries are taking massive strain. Many investors seethe plummeting oil price as a symptom of economic weakness.However, the lower oil price is a windfall for the world’s consumers and good for economic growth although these benefits have been slow to materialise.
• Closer to home, Emerging Market and commodity producer sentiment towards South Africa was negative even before the credit downgrades and unexpected rotation of finance ministers in December. As a result, the rand fell against the US dollar and other major currencies in December and January. This is likely to result in higher inflation and interest rates as well as weaker growth.
How are our portfolios positioned?
While the volatility is extremely unpleasant and clients are understandably nervous, we see the events of the past few weeks more as a correction and not a repeat of the 2008 credit crunch and equity market crash. In other words, markets are adjusting to the uncertainty around economic fundamentals, but the global fundamentals themselves have not imploded as would be the case in a sudden global recession. The sell-off presents opportunities for our fund managers to buy solid businesses at lower prices but we have not made major changes to our asset allocation.
We have been and remain underweight local equities in light of above average valuations and a poor local economic environment. 2015 was a difficult year in the local equity market as share performances diverged massively with resources being hammered and many companies linked to the local economy being punished. Only one of our local equity managers, namely Coronation, underperformed, largely due to a higher resources exposure. We are comfortable with the underweight SA equity and the ability of our managers to deliver sound returns over the long term.
After surging in December, local bond rates are well above longer-term domestic inflation expectations. The bond sell-off in December obviously hurt our portfolios given our overweight position in fixed interest, but the asset class is now even more attractively priced than before. Interest rate-sensitive domestic property shares also sold-off in line with bonds.We retain a slight underweight in local listed property.
International equities are still favoured over local equities. Within this asset class, Emerging Market equities have struggled. Our Emerging Markets manager, Coronation, has significantly lagged its benchmark and this exposure subtracted from our overall performance. However, we believe this is not the time to sell out as valuations strongly favour Emerging Markets over Developed Markets. We are in the process of introducing additional global equity managers to improve manager and style diversification within this asset class.
Global property is still performing well in rand terms. We hold no global bonds but remain at the maximum offshore allocation in terms of our Regulation 28 portfolios and have therefore benefited from the slide in the rand over the past few years.
What should investors do?
Looking ahead, investors should expect continued volatility amidst all these uncertainties. In these volatile times, portfolio diversification is of utmost importance. Following recent weakness, equities generally appear reasonably priced, but the prospects for earnings seem unclear as economic growth remains anaemic. Although shorter-term prospects are uncertain, investors should remain focussed on their long-term goals.An appropriately diversified portfolio is considered the best approach for achieving those goals.
Old Mutual Multi-Managers’ funds are fully diversified across regions, asset classes and fund managers and remain well placed to deliver on the longer-term real return targets. The funds are actively managed so investors do not have to switch in response to changing market conditions.
Dave Mohr & Izak Odendaal
Old Mutual Multi-Managers