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Provided by the South African National Department of Health
A COVID-19 WORLD
Alwyn van der Merwe
Director of Investments
Apr 28, 2020
Read more below or listen to a webinar recording here:
South Africa’s economic growth – or gross domestic product (GDP) – has declined toward 0% since peaking at around 5% in 2007. In his Budget Speech in February this year, Finance Minister Tito Mboweni predicted our economy would grow by 0.9% in 2020. The economic shock of COVID-19 has changed this figure drastically – we’re of the view that the South African economy is now likely to see a growth rate of around -7.5% this year.
The only way our government will be able to create a base from which our economy can grow going into 2021 and 2022 is to introduce substantial measures to stimulate the economy. President Cyril Ramaphosa has now introduced a massive stimulus package of R500 billion – worth around 10% of GDP – as a buffer against the economic blow of COVID-19.
This will of course result in South Africa’s fiscal trauma – our debt-to-GDP ratio – increasing significantly, which will bring about its own set of problems, but at least it will keep our economy going over the short term. It’s crucial, however, that the stimulus package is substantial enough to arrest the spiral of a supply shock, retrenchments and lower demand, followed by another round of lower supply and so on.
Our fragile currency has bled profusely since COVID-19 hit our shores, the wound deepened by Moody’s downgrade of South Africa’s credit rating – the rand fell to its weakest level ever at R19 to the US dollar earlier in April.
It’s important to note that it’s not uncommon for the rand to blow out – it happened in 2001, and again in 2015 when Nenegate sent shockwaves through financial markets. In an ideal world, however, the rand should track purchasing power parity (PPP) – the method we use to determine the value of a currency. Even when it does deviate wildly around the theoretical value line for extended periods, especially in a cyclical economy such as South Africa where political uncertainty has such a marked impact over the shorter term, it has always migrated back to this line once the dust has settled.
The rand is currently trading at around four standard deviations away from its theoretical value (our adjusted PPP value). While one would be naïve to think it will revert to the mean anytime soon, there’s no reason why tried-and-tested financial laws won’t continue to apply as they always have. In our view, if inflation doesn’t spiral out of control, and as long as the South African Reserve Bank remains prudent in terms of policy formulation, the rand could well end the year at around R13.50 to the US dollar, with the currency fading towards PPP over the next three or four years.
We tend to heed the forecasts of economists on this question, but it’s sometimes sobering to hear the views of business leaders. In the words of Johann Rupert: ‘Economists are discussing if it’s a “V-shaped curve”, or a “U-shaped curve” – it’s all meaningless. What they don’t get is that this isn’t just a pause – it’s an entire reset of our economic system.’
While none of us can predict how events will unfold over the next few months or what the shape of the recovery will be, in our view Mr Rupert isn’t wrong on the last point. We may well be looking at a completely different narrative and economic landscape going forward.
However, if the last 150 years are anything to go by, economic cycles as we’ve always known them will continue to remain part of that landscape. Investors will still implement measures to grow from low points, and they’ll remain flamboyant at the top of cycles. Humans are emotional beings – if they’re optimistic, they’ll invest money, which will generate economic growth. If they’re pessimistic, they’ll retreat into their shells and postpone their investment decisions, which will result in a downward cycle.
In the case of financial markets, human fear and greed will remain an integral part of the cycle and will continue to dictate asset prices. When we emerge from the COVID-19 crisis, it will certainly be worth heeding the oft-quoted words of investment guru Warren Buffett: ‘Be fearful when others are greedy, and be greedy when others are fearful.’ It might well be time to incorporate a little more – calculated – risk into an investment portfolio while maintaining sufficient diversification in terms of asset classes across geographies.
See the article by Investment Analyst Renier de Bruyn on the impact of COVID-19 on the South African banking sector.
We’re often asked why we don’t hold gold shares in our clients’ portfolios, since gold is touted as a ‘buffer’ or hedge against risk in an economic crisis. While it’s true that gold shares do perform well in times of extreme uncertainty, they generally tend to lose these gains as soon as the crisis has passed. So if you didn’t already own gold before the event, it won’t do much good to purchase any during a crisis, since the proverbial horse would already have bolted.
In our view, there are better ways of protecting a portfolio during periods of extreme market volatility. Global bonds have traditionally been seen as shock absorbers in multi-asset class portfolios and remain an excellent risk diversifier. And while cash as an asset class has never been a long-term investment proposition, it does sometimes offer reasonable security over the short term.
See the article by Investment Analyst Christiaan Bothma on the collapse in oil prices and how it impacts the stocks we hold in our clients’ portfolios.
When we construct a multi-asset class or balanced portfolio, we combine different asset classes, across geographies, in such a way as to balance risk versus potential return. We’re guided first and foremost by valuation – we take profits when the good news is already reflected in the share price, and look for assets of which the price doesn’t yet reflect the potentially better prospects for those assets.
If we can buy a decent quality counter at the right price, it doesn’t really matter where it’s listed – in South Africa or elsewhere. And we’re seeing that many South African assets are for the first time now much cheaper than their offshore counterparts.
Of course, we can’t ignore the fact that our currency has been blown out four standard deviations from its theoretical value. Investors often get the timing wrong when taking money offshore on the back of currency movements – contrary to general investor sentiment, we advise against taking large stashes of cash offshore when the rand hits a low. The best time to take money out is when South African assets are no longer cheap, and our currency is well-behaved – which is not now.
Having said this, it remains important to consider your overall portfolio structure. For our discretionary clients for whom exchange controls aren’t an issue, we currently have around 40% exposure offshore (in portfolios not restricted by Regulation 28 of the Pension Funds Act). If your portfolio is heavily tilted towards South African assets, you may well need to increase the offshore component – gradually. We recommend a considered, phased approach. There’ll always be upward lurches in the cycle, so it’s best to wait for these bouts of rand strength to move some funds offshore, over time.
In our view, global bond yields remain unattractive. Despite low prospective returns in the global bond market, however, the increased risk in financial markets do justify some exposure to bonds in our clients’ portfolios.
The local bond market, on the other hand, continues to offer attractive returns, over one- to three-year periods – since our government is still likely to honour its interest and capital commitments over this time frame. Our main concern is the government’s fiscal position, which has deteriorated significantly over the past decade and is likely to continue to do so both during and in the aftermath of COVID-19. Despite reasonable return prospects over the short term, we’ll therefore continue to exercise caution and are unlikely to take an aggressive position on South African government bonds.
Before COVID-19, we argued that the global economic upcycle, and the equity bull market, were in an advanced stage – but not in bubble territory. We cautioned that valuations were elevated, which is generally associated with higher risk. We therefore positioned our clients’ multi-asset class portfolios to be marginally underweight in equities, with higher cash levels. As we’ve said before, however, in the face of an external shock of the magnitude of COVID-19, no portfolio will have enough dollar cash. Although the positioning in our client portfolios was reasonably defensive, they were not immune to the sell-off in risky asset classes.
Even when markets are at their most volatile, however, we strongly believe that putting the impact of COVID-19 into proper perspective and managing uncertainty, combined with consideration for the valuation of financial assets, should continue to drive our investment strategy. What matters is whether price changes for any asset or asset class are proportional to the worsening of fundamentals. In other words, if the decline in asset prices is deeper than what we think the economic fallout might be, then in all likelihood the true value of these assets is higher than their market value, and then we should acquire some of these assets. This is the call we need to make.
In our view, some financial assets are currently trading at extremely deep discounts, and are providing attractive buying opportunities. We have therefore decided to use some of the cash in our equity portfolios to add to local equities and to reduce the underweight in equities in the multi-asset portfolios. In short, we’re using the opportunity to acquire quality assets at material discounts to intrinsic value.
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