A little bit of resolve
“A little bit of resolve is what I need now
Pin me down, show me how” - Foo Fighters
These are uncertain times, and uncertainty breeds insecurity. However, as French mathematician and philosopher of science, Henri Poincaré, once said, “It is far better to foresee even without certainty than not to foresee at all.” And indeed, despite the question marks hanging over 2019, understanding the various factors at play is an important first step to navigating the next 12 months.
Last year was a tough one for investors, and the volatility looks set to continue. Choppiness in capital markets, a potential global economic slowdown (led by China), increasing geopolitical frictions and growing nationalist sentiment are some of the themes to watch for in 2019. These are the top trends we are keeping an eye on this year:
The Debt Mountain: To Infinity, and Beyond!
Debt can be a blessing and it can be a curse. In small doses, debt can stimulate wealth creation. In excess it destroys wealth. World debt is sitting at a record high, just shy of $250 trillion, and a little over 300% of gross domestic product (GDP). Government (notably emerging market), corporate and household debt have grown since the 2008 financial crisis, when zero-interest rates were introduced for the first time as a stimulus measure. Heading into 2019, as central banks seek to roll back this quantitative easing and raise interest rates, we find ourselves in uncharted financial territory.
Source: Bloomberg (2019)
There are concerns that this debt has not been well-invested in either wealth-creating entities or productive initiatives. In addition, signs of pressure on credit flows in response to rising interest rates has spooked markets and contributed to volatility. The potential for personal, corporate and government defaults also has risen, particularly in instances where governments have borrowed in hard currency (Turkey is a “good” example) and where lending standards have become lax ten years after the financial crisis.
While interest rates, credit markets and investor sentiment towards various categories of debt will contribute to volatility this year, China will be the factor most closely watched. Where other central banks borrowed money post 2008, the Chinese government encouraged local governments and state-owned entities to do the borrowing. This has resulted in a complex web of debt – some of it from unregulated lenders, or so-called shadow banks. China is now hard-pressed to arrest this debt cycle without hurting growth to bring about a “soft landing”. And their old trick of navigating economic cycles through directing banks on when and how much credit to offer no longer seems to be working as well as it did before.
Election Time: May for Brexit, May in South Africa and Maybe Trump
Maybe Theresa May will get her Brexit deal over the line. Maybe she won’t. Either way, we can be reasonably sure that 2019 will be filled with lots of bluster and huffing and puffing about Brexit, but not a lot of Brexit bite.
On the other side of the Atlantic, the US elections in 2020 are already heating up, and we can expect the divisive political rhetoric that has been the mark of the US for the past few years to continue – and to continue to weigh on international relations and trade.
South Africa’s (SA’s) national elections (mostly likely to be held in May) will be a decisive moment for Ramaphosa’s presidency in terms of delivering the voter support needed to implement growth-friendly policies, reverse chronic unemployment and redress deep-rooted social and economic inequality. Critically, the required policies reach all the way from microeconomic reform, including restructuring of state-owned enterprises (SOEs), to macroeconomic programmes relating to land reform and balancing the strained national budget. While all signs point to the African National Congress winning the election comfortably, the key question remains which faction of the ANC wins out or holds sway. From a capital market perspective, Ramaphosa’s reformist faction will need a strong mandate, as there is real risk that the party will remain divided on policy, and therefore be unable either to rein in government spending or implement much-needed structural reforms.
In the run up to the elections, policy uncertainty and the lack of confidence this generates will continue to drag down the rand and hurt the near-term investment outlook. However, should Ramaphosa’s reformist agenda continue to gather momentum this year and into 2020, then the valuations of local investments make for a compelling case. Indeed, the recent global selloff, along with domestic risk aversion, supports the argument that local companies are offering a once-in-a-generation investment opportunity.
Economics: The Big Picture
The World Bank estimates that SA’s economy will grow at just 1,3% this year, leaving the unemployment rate elevated at crisis levels and keeping consumers under pressure. Faced with the need to consolidate the fiscus, and with an economy still limping out of a short recession in 2018, the government has little room to manoeuvre in terms of boosting spending or its ability to stimulate growth through tax relief. SA also faces the possibility of a sovereign ratings downgrade in 2019, although this is a lower probability than 18 months back. Under any scenario, all eyes will be on Eskom, which remains the single biggest fiscal and credit rating risk facing the country.
In 2018 President Ramaphosa set the ambitious target of attracting $100 billion in new foreign investment over five years. While the commitments were quick to come in, it remains to be seen how much of this materialises; what amount is genuinely “new” investment; and how much, in turn, is transferred into job creation and increased economic activity.
Economies across the world are expected to collectively slow this year and price inflation rise. World Bank figures, for instance, estimate a slowdown from 3.0% in 2018 to 2.9% in 2019. We could also see a possible “reversal” of fortunes for the developed and developing worlds compared to last year, as growth in China and the US slows to 6,2% and 2,5%, respectively. If so, this could provide some support for the rand, and for local bonds in particular, as SA’s real interest rate would appeal to global capital seeking yield.
Investors will need more than a little resolve to see themselves through this year. On the global stage, as trade tensions and the fast-approaching Brexit deadline play out, these will add to capital market volatility. And at home, labour tensions, policy uncertainty and the elevated risk of a sub-investment grade credit rating will continue to weight on the economy, investors and consumers.
However, as markets continue to over-react to these trends – and make no mistake, they will – astute and patient investors will be well-placed to find opportunities. The selloff in equities has already resulted in attractive valuations at the market level. The world equity market is trading on a forward price-earnings multiple of 13,5 times and a price-book multiple of 2,8 times with a dividend yield of 2,1%. Similarly, 2018’s selloff has placed South African equities in attractive territory. The local equity market is expected to produce 20% growth in earnings, and is priced on a forward earnings multiple of 12,8 times with a dividend yield of 3,1%.
Furthermore, inside of markets, the selloff has produced some intriguing opportunities. As we have learnt from twenty years of managing investments for corporate and private clients: the benefits of efficient portfolio construction, effective asset allocation and active stock selection are most evident in just such market cycles as this, both in terms of growing and protecting wealth.
So, as you set your personal and financial goals for the year ahead, resolve to have “a little bit of resolve”. At Cannon Asset Managers, we wish you every success and all of the best for 2019.