Q1 2020 is a quarter that no-one across the globe will ever forget, even though most of us would certainly like to. Almost all asset classes (in local currency terms) plunged into a very sharp crash in March, the speed of which took most investors by surprise. One pivotal and unprecedented driver; a black swan event that no-one could have predicted (except perhaps Bill Gates a couple years back), the Coronavirus pandemic, shaped both investments as well as macroeconomics and policy response in this first quarter of 2020. A summary of asset class performance (in rands) for March, Q1 and 2019 is shown in the table and chart below. Besides cash and gold, the safety net in this historic quarter were the global asset classes, although almost all these gains relate to translation of a weak rand. Noticeably the losses far outweigh the few green blocks, with oil, property stocks, mid-caps and financials suffering severe declines over the quarter and month of March as well.
Q1 2020 KEY MARKET DRIVERS
This first quarter of 2020 has brought about a swift market crash that no-one saw coming. In reality, indicators had turned more positive by the end of December and renewed optimism mounted post the signing of Phase One of the US-Chinese Trade Deal. However, the coronavirus (Covid-19) pandemic and its impact across the globe has completely unravelled any thoughts or forecasts of an improving economic backdrop to the New Year.
1. A new dawn of volatility and crises
A new dawn of uncertainty peaked in March in response to three, somewhat interlinked shocks, that saw volatility indices spike and equity markets crash. These included:
- The Covid-19 pandemic that emanated in China in early January and spread like wildfire across the Continent and the America’s by early March. The spiralling loss of life and human crisis became a daily breaking news story that left investors shaken and emotionally unnerved.
- The second and possibly the biggest contributor to current uncertainty is trying to quantify the economic cost of the pandemic in light of a world in lockdown. One doesn’t need to wait for the traditional economic data to be released to appreciate the scale of the hit to the economy, already a few select data points have demonstrated the magnitude of the shock. For example, car sales in China fell about 80% in February. In one week in March, over three million people signed up for jobless benefits in the US, almost four times the previous record set in 1967. And that number grew the week after.
- The third shock to markets was an oil price war that began early March between Russia and Saudi Arabia after Russia rejected OPEC production cuts amid the pandemic and rapidly falling oil demand. This facilitated a 60% fall in the price of oil after Saudi Arabia announced price discounts of $6-$8 per barrel and reported it would be increasing its oil production from 9.7 million barrels per day to 12.3 million. Russia retaliated and said it would increase its production by 300,000 barrels per day. Oil prices fell as low as $22.74 a barrel (Brent) and $20.48 (West Texas), a 17-year low, and remained depressed for the rest of March.
2. Extraordinary times call for extraordinary stimulus
- A key feature of 2019 had been the monetary easing by global central bankers in order to curb the threat of economic slowdown, particularly after industrial production and trade had reached a crucial inflection point in 2018 and continued to slow in 2019.
- And in fact, central bankers had done a remarkable job in rejuvenating growth with optimism that 2020 would be a year to concrete on December’s signs of trade stabilization.
- Coming into 2020, the US Fed target interest rate was 1.75% (having cut three times in 2019), the UK’s Bank of England Rate was 0.75%, the ECB’s Refinancing Rate was 0%, the Bank of Japan had remained at negative rates -0.1% since 2016 and China cut several times in 2019 to 4.15%.
- Given that many developed nations were already sitting very close to zero (and in some cases negative) interest rates, the typical monetary response to ease the financial damage is to some extent limited and other stimulatory measures (such as quantitative easing) are being debated across central bank tables.
- The table below shows the moves in monetary policy since the beginning of the year, (excludes the Bank of England’s last cut to 0.1% on March 19th) that has seen the US cut its target interest rate to zero for the first time ever, injected $1.5 trillion into the economy (with more to come) and reduced its overnight reserve requirement to zero.
- Quantitative easing (QE) is not a new term and during the 2008 Global Financial Crisis the US Federal Reserve turned to this unconventional strategy in order to stabilize the economy. In a nutshell, QE is an expansionary monetary policy where a central bank purchases large amounts of longer-term assets. In doing so, the Fed holds these securities on its balance sheet with the intention of adding money (liquidity) directly into the economy, keeping borrowing costs down and supporting job creation.
- The US QE response to date has seen an injection of $1.5 trillion (with more to come) into the economy through repurchase agreements, a form of short-term lending. The chart below shows just how aggressive this latest QE4 program has already been and it’s anyone’s guess as to when equilibrium will return, if ever.
- Other QE measures being unveiled include the ECB announcing a new Pandemic Emergency Purchase Program which will deploy €750 billion to purchase securities. The Bank of England has also announced a bond-buying program of approximately £645 billion.
- Treasuries are traditionally the most immediate source of liquidity in the financial system, although the volatility in the yield space has also been a key feature of markets in this first quarter. The moves in global bond markets follow the raft of central bank measures to mitigate the economic impact of the viral outbreak.
3. SA – Budget, lockdown and downgrades
- On the local front, the landscape has not provided much in the way of optimism.
- The February 26th Budget laid it all out to bare – not pretty – but a fair amount to take heart. However, the optimism was short-lived.
- The budget per se was market friendly in that it switched focus from fiscal to growth levers. By taking a hard line stance on the fiscal side and not raising taxes, Finance Minister, Tito Mboweni had recognised that the only effective way to provide some future alleviation in the current crisis was to focus on growth. And he can only do this through addressing public debt and tackling the public sector wage bill. This paradigm shift on the part of government was viewed as a good first step towards acknowledging the real issues and starting to address these was immensely positive.
- Also a strong feature over this quarter has been the decisive and swift actions of our South African President, Cyril Ramaphosa, in handling the crippling effects of the coronavirus. No doubt much will be written on the impact of lockdowns over the coming months and longer, however Cyril’s announcement on March 15th of shutting schools, followed by March 23rds announcement of a nationwide lockdown for originally 21-days was the seemingly right course of action. It did instil a fair amount of confidence in his leadership.
- The 2020 Budget (coupled with the changing global landscape) was not enough to prevent a credit downgrade by Moody’s on March 27th that saw South Africa’s sovereign credit rating fall to sub-investment grade.
- What does this mean for the country? Higher borrowing costs for government will impact spending on muchneeded social and economic programmes. South Africa also loses its status in various global bond indices and thus large institutions will be prohibited from buying the country’s bonds. This is likely to see large forex outflows as foreigners exit the SA bond market, although again, this had already been pre-empted.
- Adding salt to the Moody’s wound, Fitch downgraded SA’s credit rating further down the junk scale on April 3rd.
SA’s five-year credit default swap spread (CDS) and a measure of a country’s riskiness, spiked to levels seen in 2009 although did not reach the peaks seen by Russia and Brazil in response to their credit downgrades to junk status.
What does this mean for investors? The downgrade had largely been priced into markets and thus ultimately did not invoke a significant negative or knee-jerk reaction, certainly in light of the new dawn of crises unfolding. A sell-off in the rand did ensue, although with so much else going on, it would be hard to lay blame solely on the downgrade. We have subsequently seen the currency stabilize and reverse some of the depreciation seen leading into this quarter-end downgrade.
Q1 Sector and Stock Performances
- There were very few winners over this quarter, most noticeably Tobacco, (British American Tobacco) eking a 2.3% gain for its defensive and rand hedge qualities as well as strong dividend yield and balance sheet.
- The list of losers is large, however Chemicals stands head and shoulders above other sectors (see comment below on Sasol). The next worst are largely all pandemic and lockdown casualties such as Travel & Leisure, Real Estate, Industrial Transport, General Retailers and Banks.
- A clear sector and stock bias is evidenced through very weak SA Inc (domestic-focussed companies such as Nampak, EOH, Tsogo Sun, Famous Brands, Fortress REIT) versus more stable performances from those companies that generate revenues externally (Prosus, Naspers, Reinet, British American Tobacco).
- Sasol (-88%) was the biggest casualty this quarter due to its very extended debt obligations (Lake Charles capex and cost overruns) as well as the oil price shock. Given the precipitous fall in the oil price as well as declining oil demand, Sasol will have to raise cash or sell assets in order to pay down its gigantic US debt burden.
LONGER PERIOD ASSET RETURNS
Q1 2020 has knocked SA risk asset returns not only in the very short term but has understandably detracted from longer term averages that now see local equity and property having lost money over the past 1, 3 and 5 years. Hard to fathom that holding cash over the past 5 years has shielded you from the vagaries of our other SA asset classes. The standout disappointment over almost all periods since 2010 has been SA property. Previously the darling of the JSE, this significant downside has been skewed over the past two and a bit years. What the charts below continue to highlight, is that diversification across the risk asset class spectrum is your biggest cushion against uncertainty, and as evidenced, diversifying across geographies is also important. An investment in global equity over all longer periods has significantly benefitted the South African investor.
THE SA MACROECONOMIC ENVIRONMENT
LOOKING AHEAD – Darkest before the Dawn
The coronavirus is guaranteed to throw the world into recession, but economists are grappling with what the recovery looks like thereafter. The base case for forecasters is that a recovery, perhaps even an ambitious V-shaped one, gets under way in the second half of 2020. But as the pandemic spreads through Europe and the Americas, and the wide range of knock-on effects comes into clearer view, caveats to that snapback to growth are piling up. Underlying all forecasts is the simple fact that economic outcomes hinge on something that’s beyond the professional competence of most economists to forecast at this juncture: the trajectory of the disease itself. There is no certainty that the virus will be eradicated by the end of the second quarter, and strong chances that it won’t. If it lasts through the Northern Hemisphere’s summer months, then all the economic effects are likely to be amplified.
Thus rather than postulate the extent of what, how and when that recovery unfolds, investors can take some level of comfort that we at PortfolioMetrix continue to monitor and assess this daily changing landscape. It is times like this that the PortfolioMetrix methodology and risk-based approach has to provide some confidence and trust in staying composed, diversified and that this time shall surely pass. And with it, comes opportunity and clarity that continues to instil optimism in the long-term potential of all our portfolios going forward