08 January 2020: Despite various geopolitical and economic challenges at the beginning of 2019, markets managed to deliver very strong returns for the year. And investors will be relieved to see that equity markets look set to start 2020 on a slightly better footing, as many of these uncertainties have been addressed to some extent over 2019.
However, the US-China trade war tensions have still not reached a resolution, global recession warning lights remain flashing and geopolitical risks have reared their head with the US killing of Iranian general Qassem Soleimani. Then, locally, the looming threat of a Moody’s credit rating downgrade continues to hang over the country’s head.
So what lies ahead for markets over the next 12 months, and how can investors best brace their portfolios for the challenges to come?
First, one of the greatest risks facing global markets in 2019, and specifically Britain and Europe, was the threat of a highly disruptive no-deal Brexit. With that possibility off the table, and with Prime Minister Boris Johnson firmly in the driver’s seat after the Conservative’s landslide victory in the December elections, we can finally hope for a conclusion to the Brexit saga in 2020.
Second, while the US and China continuously move around in circles in their trade-war tango, the two nations both appear more receptive to a truce compared to January last year. And with the signing of the phase one deal scheduled for next week, there has at last been some progress in negotiations, which has further shifted some of the uncertainty weighing upon global sentiment.
Additionally, 2020 is a US national election year, which typically bodes well for market performance. Historically, the US market has typically delivered a strong performance during election years, as the country’s leaders generally make a special effort to support the economy and markets ahead of the polls.
Then, where 2018 and the beginning of 2019 saw most central banks tightening monetary policy, as many as 66% of all central banks began to open the taps and ease monetary policy during the course of last year. Combined with China’s recent bout of monetary and fiscal stimulation and the management of its currency, this means that there is a great deal more liquidity in the financial system at the start of 2020, which should support financial markets.
And finally, most leading indicators suggest that the softness in global economic growth seen in 2019 is bottoming out.
Together, these factors should pave the way for a rebound in economic activity in the first half of the year, and investors may consequently also see a rebound in risky asset prices.
However, this comes with the footnote that even if 2020 delivers another positive year for global equities, it is likely to be the last leg of the current bull market. We are rapidly approaching the end of the current economic cycle, and while the ten major global recession indicators that Citadel monitors still suggest that a recession is unlikely within the next 12 months, the storm clouds are gathering ahead, and we are preparing for headwinds to pick up over the next few years.
Investors would therefore be wise to avoid being too greedy, or they potentially risk being caught standing when the equity music stops. Instead, consider using 2020 to begin taking profits, de-risking your portfolio and introducing safer alternatives into your investment mix.
THE YEAR OF THE DOWNGRADE FOR SA?
The economic destruction of the past ten years has run even deeper than many expected, and it will unfortunately take time to turn South Africa’s fortunes around. However, as with the global economic environment, there has been some progress in tackling the issues that weighed upon local sentiment in 2019.
For example, given government and SOE’s long-standing track record of caving into pressure from labour, SAA’s management was able to resist trade union demands during the November wage strike. Instead, SAA’s management and unions reached an agreement to limit pay increases to 5.9% rather than the proposed 8%, and further added the caveat that these increases will only be paid if the airline has sufficient funds. Not only this, but SAA was further placed in business rescue, signalling that government is finally taking more of a hard-line stance on poorly performing SOEs.
Then, the return of load-shedding aside, some progress has finally been made in dealing with the management issues plaguing Eskom with the introduction of new CEO Andre de Ruyter, and we should hopefully see more action in terms of the planned unbundling soon.
That said, 2020 will be make or break for South Africa. If government fails to show real muscle in dealing with key issues of corruption and mismanagement at State-Owned Enterprises (SOEs), an overinflated public service headcount and a hideously bloated government wage bill by the February Budget Speech, then a credit rating downgrade from Moody’s is almost guaranteed.
A Moody’s downgrade seems very likely in any case, as our fiscal picture remains bleak and keeps deteriorating, and government hasn’t yet been able to get any real traction in dealing with the structural issues strangling the economy. As Minister of Finance Tito Mboweni pointed out in the October Medium-Term Budget Policy Statement, government is already well on its way to falling into an unsustainable debt-trap.
A downgrade would push government bonds onto the first step of the sub-investment grade or “junk status” ladder, and would represent a major hit to the economy, sending a shockwave through bond markets and likely seeing the currency touch R18/$ upon impact.
However, it would not spell the end for the country: the dollar is likely to run out of steam over the course of 2020, and a trade deal would also lift global sentiment and offer some support to emerging markets. So, while the rand may touch R18/$, it is more likely to average R16/$ this year.
Additionally, the current rebound seen in Foreign Direct Investment (FDI) and in Gross Fixed Capital Formation (GFCF) spending reported in the last two GDP prints of 2019 both signal that investments are slowly returning to the country. If this trend continues, and if government can finally act on implementing the right policies and reforms, we may see a turnaround within the economy in the next three to five years.
OUTLOOK FOR SA ASSETS IN 2020
Against this backdrop, the rand is likely to remain under pressure over the next few months, which, together with a global risk-on rally, should offer JSE-listed multinationals and rand hedge stocks some support.
Unfortunately, locally-facing businesses that generate revenue predominately from within the country’s borders and are directly tied to the SA economy seem to be in for another tough year.
Overall, from a valuation perspective, the JSE appears relatively attractive compared to other markets, but given the current difficult environment, investors will need the time and patience to see the positive effects of reforms come through before its value unlocks.
In terms of bond markets, with yields north of 9% and inflation below 4%, SA bonds are currently offering investors the highest real yields in the world. And given that more than R60 billion in local bonds were sold off in 2018, and around R35 billion in 2019, those foreign investors who are concerned about the country’s fiscal situation and the possibility of a downgrade have already exited the market.
However, a downgrade would likely see SA bond yields moving above 10%, which will result in capital losses for existing investors, but will also create a highly attractive buying opportunity. This would, no doubt, generate a high level of interest among those foreigner investors whose mandate allows them to invest in sub-investment grade emerging markets, and would also offer local investors highly attractive yields, especially in tax-friendly vehicles such as retirement annuities.
Maarten Ackerman, Chief Economist and Advisory Partner, Citadel