Quarterly Review – Q2 2020
After the tumultuous coronavirus-driven crash of Q1 2020, the second quarter provided just as much excitement with the pendulum swinging back strongly. From the precipitous declines in excess of 20% in the first quarter, equity and commodity markets rallied sharply and recovered much of these losses. What became evident is that equity investors are feeling far more confident in the shape and hence speed of the global economic recovery, thanks to the mountain of stimulus being provided by the central banks.
A summary of asset class performance (in rands) for June, Q2 and Year-to-Date 2020 is shown in the table and chart below. Noticeably there is no red-shading for this quarter with the strongest gains seen across risk assets with global bonds and cash the underperformers. The clear winner for the quarter being Resources driven by commodity prices that have responded to the quick recovery in Chinese manufacturing data. Also noteworthy is the rebound in ailing SA property stocks, however still languishing in their YTD returns. The Mid-Cap space continues to lag, predominantly due to their exposure towards SA domestic names, (banks and retailers).
Three Year Asset Class Returns Matrix (in rand terms)
Q2 2020 KEY MARKET DRIVERS
Just as the first quarter of 2020 brought about a swift market crash that no-one saw coming, so did the second quarter bring about just as swift a recovery that many did not foresee. The JSE recorded its best quarter performance since 2001 and the drivers of this rebound in sentiment are all largely global-related. The domestic macro-economic backdrop remains a severe drag and once again highlighted in the June Supplementary Budget speech given by our Finance Minister, Tito Mboweni.
1. Biggest global peacetime recession
- The Covid-19 pandemic that necessitated a global lockdown has precipitated into the biggest peacetime recession in over a century and possibly ever experienced. From previous forecasts of global growth of between 2.5% and 2.8% for 2020, economists are now expecting a global contraction in the region of -3.5% to -4% in 2020, with Developed Markets expected to slump in the region of -5%.
- Although the low point has probably already passed for many developed economics as expectations have largely caught up with the true depth of economic damage that is likely to be suffered. However, the pace and nature of recovery remains more uncertain than usual.
- Many economists are beginning to suggest a V-shaped recovery is a possibility particularly when data out of China has shown encouraging (although uneven) signs of a return to normal levels of business activity (more so on the manufacturing side).
2. Central Banks to the rescue
- No single playbook will be able to address all of the economic fallout from the global pandemic and its impact, however policymakers have certainly not held back.
- The amount of stimulus we have seen to date in response to this crisis is unprecedented – the fiscal, monetary and political responses globally have led to a world awash with liquidity. Much of this liquidity has gone into the stock markets, explaining a great deal of this second quarter’s swift recovery.
- Even South Africa has taken bold steps relative to other economies with the size of its relief package. (see chart below compared to the 2008 GFC measures).
3. Low yield environment will linger for longer
- Many Developed central banks have run out of the typical monetary policy rope with interest rates close to zero, some even negative. This has led to the liquidity response discussed above that has driven optimism about the eventual recovery in markets and ultimately economies.
- However, a further key driver of markets and asset class returns continues to revolve around the concomitant low yield environment that follows the low levels of inflation as well as the inability of central banks to move the monetary needle either way. Until we begin to see a pickup in inflation or interest rates, the yield environment is likely to linger low for longer.
4. China leads the way, spurs hope of a V-shape recovery
- Just as China led the way into the coronavirus pandemic, it is showing real signs of a V-shape recovery with particular reference to the jump in the closely watched Purchasers Managers Index.
- Recent surveys as well as the first Q2 GDP data release out of China surprised analysts with strong recoveries such as that seen in the PMI, which rebounded back into expansion territory and above pre-lockdown reads.
- Chinese Q2 GDP growth snapped back from the -9.8% contraction in Q1 to positive 3.2% aided by the re-establishing of supply chains and strong manufacturing.
5. Vaccine hopes keep the rally alive
- The race for a Covid-19 vaccine gathered pace in the second quarter with encouraging results from a handful of prospects. Around 180 research teams from across the globe are working on developing the first vaccine, however four noteworthy and leading trials have emanated from:
- US biotech company Moderna is set to begin its third phase of clinical trials in July / August with tantalising results to date
- The French pharmaceutical firm Sanofi expects to receive certification for a vaccine for release in early 2021
- The University of Oxford’s researchers have begun their second phase of human trials with positive results so far.
- German-based biotech company, BioNTech, has also received approval to test a viral agent on human volunteers. The company has teamed up with US giant, Pfizer, to produce up to 100 million doses of the vaccine by year-end.
6. The most “crowded trade” in recent history arouses retail investors
- The equity rally so far has been lop-sided with mega-cap growth and tech stocks trending to new highs, whilst the rest of the pack have largely been stuck in a range for the last two months and are not pricing in a cyclical rebound yet. This crowded “FOMO” trade (fear of missing out) trade has aroused the interest of retail investors around the globe and which has contributed to the ongoing push of these firm favourites in the second quarter.
- This has resulted in the outlandish concentration of the FANMAG brat-pack (Facebook, Amazon, Netflix, Microsoft, Apple and Google) that has never been so exacerbated. These six stocks now make up approximately 26% of the S&P500 global market capitalisation. Performance from these six global tech companies has completely outstripped the market and resulted in the Nasdaq 100 index scaling new record highs.
7. SA – Headed towards a debt cliff, quite possibly?
- As scribed in these quarterlies relatively often these past several years, the local economic landscape has not provided much in the way of optimism or support to markets.
- Our Finance Minister, Tito Mboweni gave an interim or supplementary budget speech in June after the effects of the pandemic necessitated a rethink on state finances, relief measures and revised budgets. The picture was not pretty. In fact it was dire.
- The stark realities of the “bridge budget” included:
- A revenue shortfall of R304bn
- A budget deficit growing to 14.6%
- Debt to GDP ballooning to 81.8% and rising
- GDP for 2020 projected to be -7.2%
- Inflation to remain around 3%
Given the fiscal cliff faced by South Africa, the Rand did well to recover its April-May record weak levels against the US dollar and found solace in the increasing risk appetite presented by improving global indicators as well as soft dollar.
Q2 – TIMELINE OF KEY EVENTS AND THE SHAPE OF ASSET PERFORMANCE
Q2 Sector and Stock Performances
- Last quarter’s biggest casualty was this quarter’s biggest winner – Sasol rebounded a whopping 258% (from -88% in Q1). With Brent crude recovering from below $20/bbl to $41.15/bbl by quarter-end, Sasol turned FCF positive and the balance of risk and debt obligations shifted. With OPEC+ seemingly underpinning oil around $40/barrel, the chances of Sasol now being able to cut costs, complete disposals and if necessary raise equity in order to re-capitalize its balance sheet have increased materially.
- Gold and mining stocks rallied sharply in this quarter as mines were the first to reopen following Level 5 lockdown and in response to the quick pick-up in Chinese demand as its manufacturing recovered and supply chains re-established. Harmony, Gold Fields, AngloGold, Anglos and BHP Billiton all posted increases in excess of 30% with the gold miners surging in particular. The low yield, uncertainty and large amounts of central bank stimulus provide a conducive environment for gold.
- Aspen remains a firm favourite in the Healthcare sector, the stock rose 55% in the Q2, as it benefitted through the pandemic from increased demand in its anaesthetics and thrombolytics divisions. Concerns over shortages for anaesthetics in Europe (Aspen is the world’s largest anaesthetics supplier ex USA) helped offset the negative impact from delayed electives.
- RMB Holdings unbundled its FirstRand stake to shareholders in the ratio of 1.31 FSR shares for every RMH share held.
- SA property stocks staged a modest recovery in Q2, however the sector remains well down for the year to date. In contrast, the once darling of the global JSE-listed property stocks, Intu, announced it had been placed under administration and the stock suspended from the JSE. The first Covid-19 large casualty on the JSE.
- Stock and sector laggards, besides Intu Properties, were largely domestic names – many in the retail and financial sectors. With the impact of the nationwide lockdown still unfolding across the SA retail, hospitality, tourism and consumer sectors, the negative repercussions will remain a stumbling block for most of these companies. Although well managed and capitalised, the SA banks will take the brunt of the ailing consumer, rampant unemployment and poor macro environment with bad debts a significant concern going forward.
GLOBAL MARKETS AND COMMODITY PRICES
Global equity markets recover sharply with the tech-laden Nasdaq and SA (in $-terms) leading gains
Commodity prices and Emerging Markets bounce as China returns to growth and OPEC+ agree to supply cuts
- With China swiftly bouncing from a Q1 GDP contraction of -9.8% back into growth in Q2, commodity prices and other emerging markets took their cues from this remarkable V-shaped recovery.
- Oil has seen the biggest swing of all commodities in 2020 with the price of West Texas flirting in negative territory for the first time ever in April. Although the reasons for this unchartered move to having to pay someone to take oil off US producers were somewhat technical (storage incapacities coupled with a lack of demand) the underlying weakness was all related to a global recession, flailing demand and over-supply. After a couple of false-starts and heated negotiations, OPEC+ finally resolved to cut supply in order to sustain a better balance. This helped prices stabilise above $30/barrel and more recently settle above $40/bbl.
- Gold has remained a firm favourite, both in Q1 and Q2. Its safe-haven characteristics in current conditions continues to buoy interest in this non-yielding asset. Central bank stimulus, ballooning global debt, low and negative interest rates, uncertainty and global recession all contribute to the allure of gold. Furthermore the hint or threat of unexpected inflation in the future, following the mass of stimulus that has hit markets, will likely continue to bolster investor demand in gold.
- Platinum and palladium prices have dove-tailed as substituting between the two metals is the result of the tremendous drive towards electric vehicles in the pursuit of cleaner and more efficient vehicle technology.
Oil prices bounce off historic lows, however still down over 30% for the year-to-date
Gold is boosted by its safe-haven characteristics, platinum struggles in the recession aftermath
Iron ore prices back in positive territory for the year as Chinese PMI demand rebounds
LONGER PERIOD ASSET RETURNS
Although we’ve seen a tremendous recovery in risk asset prices in this second quarter, SA equity has noticeably underperformed expectations over the last 1, 3 and 5 years with only the 10 year return beating cash and bonds. The other big standout when looking at the annualized returns in the charts below is the relative outperformance of global asset classes relative to their SA counterparts. This once again highlights the significant benefits of diversification across the asset class spectrum as well as across geographies. For example, an investment in global equity over all periods has significantly benefitted the South African investor.
SA risk assets have detracted from returns whilst global assets (in rand) cushion the blow.
“Balanced Fund” returns combat volatility in times of uncertainty
THE SA MACROECONOMIC ENVIRONMENT CONTINUES TO DETERIORATE
SA entered 2020 already in technical recession and contracts a further 2% in Q1
Following the two rate cuts in Q1, the SARB cut a further 100bps in April and another 50bps in May with the repo at 3.75% at quarter-end
Inflation fell below the target band (3-6%) to 2.1% in May as demand slumped
Business confidence falls to a record low whilst Consumer confidence plunged to -33 as the Coronavirus nationwide lockdown crippled businesses and consumption
SA unemployment rises above 30% and forecast to worsen over the remainder of 2020
SA Purchasers Managers Index bounced off lows in May as manufacturers re-opened
April Manufacturing data shows how just bad the collapse in production actually was
Retail sales collapse and recover as lockdown eases, but remain depressed
LOOKING AHEAD – A long and bumpy road
What transpired into the fastest market sell-off in recorded history was followed by the quickest ever rebound.
Multiple economic indicators suggest that the global economy began recovering in May, is gaining momentum and may return to pre-pandemic levels by year-end.
After the first quarter, as global COVID-19 cases were skyrocketing and businesses were shuttering, an economic outlook that called for a near-term recovery would have seemed far-fetched. Yet, as July begins, multiple indicators suggest that growth began to rebound in May and even gained momentum throughout June.
While the economics team at Morgan Stanley Research is closely watching the effects of a recent surge in new U.S. COVID-19 cases, data suggest that the global economy could regain its pre-pandemic levels in four quarters, with developed market economies fully retracing their growth path in eight quarters.
“We believe this will be a sharper but shorter recession, and recent upside surprises in growth data and policy action have increased our confidence that this will be a deep V-shaped recovery,” says Chetan Ahya, Morgan Stanley’s Chief Global Economist.
All Eyes on Cases and Cures
No doubt, the pandemic’s unpredictable path remains a key risk to forecasts. New cases of infection globally have recently set highs, as various regions started to reopen, particularly in the U.S. For the moment, however, the growth in new infections appears to be manageable—though the situation remains fluid.
At the same time, biopharmaceutical companies are continuing to make progress on treatments and possible vaccines. “As testing and tracing capacity ramps up, we believe the public health authorities are in a better position to manage the outbreak and a potential second wave,” Ahya adds.
Consumer spending plays no small role in driving an economic recovery and over the past several months, consumers seemed to have adapted, leading to a reduced drag on overall spending. Online shopping in the U.S. has shifted into high-gear, with e-commerce adoption two years ahead of where it was previously tracking.
Although firmer forecasts have allowed economists and strategists to begin plotting what the ultimate economic recovery looks like, the range and shape of this recovery remain hotly debated. With some encouraging and early signs of recovery out of China and other key regions, the likelihood of a swift recovery becomes more tangible.
However, we are already seeing that it won’t all be plain sailing from here. Although largely suppressed in much of Asia and Europe, many emerging markets, including South Africa, are still seeing surging virus cases and deaths whilst the US is seeing significant flare-ups and a resurgence of infections. And although we are getting better at treating Covid-19, we are not yet close to a cure or mass distribution of a successful vaccine.
Away from the corona-crisis, other risks also pose threats to market uncertainty and volatility. US/China friction continues whilst the US election of November draws closer. President Trump’s re-election chances have been severely damaged by a perceived mishandling of the crisis, but there are still four months to go and it’s unlikely he’ll fade gently into the sunset. His election strategy appears to be centred around stoking division and deflecting attention and blame in order to fire up his voter base which could negatively impact markets up to and beyond the election. A Biden presidency brings risks too: higher taxation for US companies and possibly beefed up anti-competition actions which could damage many of today’s market leaders (like Amazon, Google and Facebook).
And of course, closer to home, we are facing possibly the deepest recession and government indebtedness in recent history. This fact alone necessitates a broader and more diverse investment rethink than purely placing all eggs in a SA-centred investment.
Further out lies one potential risk that has not caught the market’s attention as yet – inflation. Right now, we are going through a disinflationary period (falling inflation) as the demand shock of the corona-crisis causes prices to fall. The truly massive stimulus provided by central banks and governments is the right response to try to jump-start the economy and protect jobs, but it is increasing the amount of money sloshing about in the economy.
Suffice to say, whatever the shape and speed of the global economic recovery, the world will mend and PortfolioMetrix is positioned for this eventuality. In the face of such market uncertainty, we continue to stick to our primary defence of diversification and not diving dogmatically down any particular theme, sector or style.
PortfolioMetrix (Pty) Ltd is an Authorised Financial Services Provider in South Africa. The information contained is given for information purposes only and is not intended to constitute financial, legal, tax, investment or other professional advice and should not be relied upon as such. Investments can go down as well as up and past performance is not a guide to the future. Data sourced from Bloomberg, RMB Global Markets, Rezco Asset Management, Morgan Stanley, Citgroup, Prudential Asset Management, Deutsche Bank and SA dailies