The dominant feature for South African investors in 2016 was the unexpected strength in the Rand when measured against the US Dollar. Over the course of the year the Rand/Dollar exchange rate strengthened by nearly 12%. It was clear in hindsight that the extreme weakness in the exchange rate after the Zuma-led Finance Minister debacle in December 2015 was overdone and the strength in 2016 just represented a recovery from that very severe negative market reaction. While the FTSE/JSE All Share Index delivered a small 2.6% return for 2016, the bond market was up by 15.5% and the listed proerty sector rose by 10.2%. However, returns from offshore exposure in local portfolios were hurt by the strong Rand.
Last year was thus characterised by a recovery in politically-sensitive asset classes (currencies, bonds and property) and it seems as though 2017 will be more of the same. While the impact of politics on portfolios last year was as a result of South African political noise, the expectation for this year is that the political drivers will be from offshore.
There are a number of major themes that have been identified as critical to the outcome of investment decisions this year. The first is new US President Trump. Markets rallied on the election of Mr Trump, who promised to focus on US job creation, tax cuts and investment in infrastructure during his campaign to be president. But investors are now waiting to see whether his promises will become official policy. The London Financial Times newspaper reports that Bill Gross, the renowned bond investor and portfolio manager of the Janus Global Unconstrained Bond Fund, says that he believes
The “success or failure of Trumpism” will be one of the biggest investment issues in 2017.
In his first working day in office, President Trump signalled that he would put protectionism at the heart of economic policy, by withdrawing from a historic Pacific trade pact and threatening to punish companies for moving production overseas. Mr Trump said that pulling out of the Trans-Pacific Partnership (TPP) – which was a signature initiative of predecessor Barack Obama – was a “great thing for the American worker”. His signing of the TPP executive order came shortly after he warned a White House gathering of US business executives that he would place a “very major” border tax on companies that moves production overseas and exported products back into the country. “A company that wants to fire all of its people in the United States and build some factory someplace else and then thinks that product is gonna just flow across the border … that’s not gonna happen,” he said. While Mr Trump made clear during the campaign that he would withdraw from the TPP, the move was a potent signal that he will use his first days in the Oval Office to plough ahead with the populist, antitrade agenda that catapulted him into the White House.
While President Trump’s first week in office has been characterised by a flurry of executive orders, the most controversial is the temporary ban on immigration from seven predominantly Muslim countries. The White House measure bars refugees from entry for 120 days and indefinitely prohibits entry for Syrian refugees. It also barred citizens from Syria, Iraq, Iran, Sudan, Libya, Somalia and Yemen from entering the US for 90 days. This move has provoked protests from civil liberties campaigners, tech industry leaders and foreign governments.
Global news is now dominated by the reaction to this particular Trump executive order and balanced views are hard to find. An editorial in the London Financial Times however does provide a sober perspective. The editorial recognises that many people around the world are in a state of shock about Donald Trump’s first week in office. In this first week, the new President has abandoned or called into question trade treaties and caused chaos at America’s borders by blocking immigrants in the name of security. America’s business leaders, particularly those from companies that have benefitted so greatly from globalisation in the markets for goods, services, capital and people, are urgently debating how to respond. So are the counterparts in Europe and Asia. The editorial contends that business executives are now counting the cost of concentrating more on tax arbitrage and lofty rhetoric about the global economy rather than convincing the public of their worth to society.
Brexit and the future of the European Union (EU) is another concern for Mr Gross who wonders whether the “EU can hold it together”. Elections are due to take place in France, Germany and the Netherlands in 2017, while Brexit negotiations between the United Kingdom and the EU are expected to kick off in March. Phil Poole, head of research in the chief investment office at Deutsche Asset Management says: “There is a lot of political uncertainty in Europe”. The risk is that anti-establishment votes in the UK’s Brexit referendum, the US election and Italy’s referendum last year could continue during 2017’s elections.
The expectation of rising inflation is another concern that global investors have raised.
The US and the UK are regularly cited as economies likely to experience inflation this year, but the outlook for other countries is less certain. Michael Hasenstab, a bond investor with Franklin Templeton, says: “We anticipate increasing inflation in the US as wage pressures rise and the economy continues to expand, while the euro area and Japan diverge markedly from the US path”. Rising inflation (and interest rates) will have a negative impact on bond prices as yields rise. Bond yields, which follow interest rates, have decreased for more than 30 years. But now some investors are anticipating change, predicting an end to years of low and even negative yields. The US Federal Reserve already raised rates in December last year and the combination of Mr Trump’s growth policies and potential inflation could lead to the Fed raising interest rates more quickly than expected. The US economy appears to be relatively dynamic now and this offers opportunity for the Fed to focus on driving monetary policy to more “normal” levels. The was underscored recently when Fed Chair Janet Yellen warned of a “nasty surprise down the road” if the Fed waited too long to raise rates.
The outlook for Emerging Markets is another factor that weighs on investors for 2017.
After disappointing returns in 2014 and 2015, Emerging Markets rallied for much of last year. But following the election of Donald Trump, Emerging Markets struggled again. The big question now is what is in store for 2017. Sean Taylor, head of Emerging Markets of Deutsche Asset Management, says Emerging Market stocks face big challenges, including strength in the US Dollar. The prospect of up to three rate rises in the US this year, as suggested in Fed guidance, could also hurt Emerging Markets. Despite this, Mr Taylor says Emerging Markets are in better shape than in 2013. “For the year as a whole we are looking for reasonable upside in Emerging Markets, both from the extra yield that Emerging Market sovereign dollar bonds give and especially from Emerging Market equities”. The biggest risk for this region is however, a sharp rally in the US Dollar or significant US-driven changes to trade agreements.
Here at home, the political developments have centered on the successor to President Jacob Zuma. While a number of names have been thrown into the ring, those of Cyril Ramaphosa and Nkosazana Dlamini Zuma have surfaced as current leading contenders. President Zuma has been very quiet of late and the rumours of a potential cabinet reshuffle are swirling again since a reshuffle is a way to place her in the local political spotlight. Ex-Eskom CEO Brian Molefe’s name is also being heard in the same talk about the possible changes to the cabinet. In addition, Finance Minister Pravin Gordhan has accused the politically connected Gupta family and their associates of plotting against him and the Treasury. A new onslaught, which follows a tumultuous 2016 for Gordhan, began early in January with Oakbay Investments accusing him of using the judiciary to settle political scores. The Business Day newspaper reports that the Oakbay CEO alleges that Mr Gordhan had given an instruction to captains of industry to “clip the wings” of the Gupta family, which had resulted in 24 businesses disassociating themselves from the Oakbay Group. This has lead to renewed calls from Oakbay for President Jacob Zuma to fire Mr Gordhan. In the meantime, it appears that Deputy President Ramaphosa made his Presidential aspirations quite clear towards the end of January when, at a speech in George, he said that: “Our movement is currently under severe strain”. “Disunity, mistrust and organisational weakness is undermining our ability to address the challenges that confront our people”. “Ramaphosa seems to be making his play,” Zwelethu Jolobe, a politics lecturer at the University of Cape Town, said by phone in an interview with Moneyweb. “There is a general consensus that the Zuma legacy is not a good one. Ramaphosa is presenting himself as an alternative.”
President Zuma delivered the State of the Nation address on 9 February. His words and possible actions have already been closely analysed and watched. The annual Budget Speech will be delivered (hopefully) by Mr Gordhan on 22 February 2017. Following these two events, we may have a bit more clarity on the future direction of South African politics. However, we will have to wait until December this year for more certainty when the ANC holds it’s elective conference and the new party leader is chosen.
As always, the only certainty in markets is that they will be volatile, and 2017 will be no exception. As investors we will be grateful for good news and good markets and will persevere when the news and markets turn sour, with the focus on ignoring as much as possible the headlines of today and shifting the mind’s eye to the longer term. The global equity earnings recession that started late in 2014 appears to have ended and forward earnings growth expectations are now starting to look healthy and appealing to investors.
While developed market government bond yields are rising and bringing a new element of capital risk to global investor portfolios, local bond yields are attractive and offer some relief when compared with inflation expectations. The wild card in 2017 remains the currency, in the form of the Rand/Dollar exchange rate, which strengthened significantly last year.
The APS Investment Committee is cautiously optimistic that 2017 will provide an opportunity for good returns in investor portfolios as the local equity market starts to contribute meaningfully after nearly three years of volatile, but overall sideways, movement.
Source – APS Monthly Economic Commentary