Man overboard

May was an interesting month, to say the least. From South Africa’s largest decline in quarterly gross domestic product (GDP) figures in a decade, to the United States’ escalating trade war and uncertainty surrounding Brexit, the litany of headwinds could see investors looking to “jump ship”.

However, beneath the noise, it’s important to remember that many of these risks and themes were known going into 2019, and investment portfolios should be positioned to benefit from this volatility in the long term.

South Africa

South Africa’s GDP decline of 3.2% in first quarter of 2019 is concerning, with investment spending and exports – two key drivers of growth and competitiveness – reflecting the greatest fall. On the production side of the economy, the big decliners are the agricultural, mining and manufacturing sectors. That these are energy intensive and employment intensive industries speaks volumes about the precarious state of our national electricity supply. The data print does not bode well for unemployment figures which rose to 27.6% in the first quarter. (For more on the factors driving the unemployment crisis, listen here). That the government sector was the fastest growing sector in this setting should raise alarm bells of its own.

This decline in GDP was preempted by the JSE’s 4.92% decline in May. Sasol, Brait and Tongaat Hulett are down 23%, 17% and 22%, respectively, for the month; while retailer Massmart has lost 43% since January. Certain sectors stood out in respect of sharp share price falls and challenging trading conditions. The healthcare sector has lost its defensive attribute and is one of the hardest hit sectors this year, with Aspen, Mediclinic and Netcare down 61%, 46% and 37%, respectively. These previously-loved darlings are battling inflated debt, increased regulation and continuous margin squeeze. Overall, the market remains volatile and ill-suited to short-term investment views.

JSE All Share Index
Source: Bloomberg

The surprise announcements of the suspension of Old Mutual CEO Peter Moyo over an apparent conflict of interest (which he had disclosed to the board), and the unexpected resignations of Eskom CEO Phakamani Hadebe (for health reasons) and SAA CEO Vuyani Jarana (over differences around the airline’s turnaround plan), rounded off a rough month on the local market.

Global risk signals

To add to domestic anxiety, the global bond market is sending up warning signals. The yields on long-term government bonds have been falling across the board, including Japan, Australia, Britain, Germany and the United States (US), where in the last-mentioned case the 10-year US yields have fallen below the yield for the three-month note. This suggests that the bond market sees increased risk in the global economy, and this is often seen as an ominous sign of a possible recession.

10 Year Gov Bond Yields
Source: Bloomberg

One of the key reasons for market fears is the recent slowdown seen in the Chinese economy, which — should it be deep and long-lasting — could have far-reaching effects, carving an estimated $600 billion hole in the world economy (according to Carmen Reinhart of Harvard University), and in part explaining the current tensions between China and the US.

Proxy wars

Another reason is Trump’s trade war, which opened up on a new front last week, sending fresh waves of volatility through the market as investors struggle to discern threats and bombast from true intent.

Mexico

In a surprise Twitter announcement, Trump took aim at Mexico, threatening to impose import tariffs – his weapon of choice – on the neighboring country if it failed to restrict the flow of immigrants into the US.

In addition to raising risk levels in global trade and supply chains, this latest threat also raises the question of whether Trump will choose to use the threat of tariffs as leverage in foreign policy matters with other nations.

China

This announcement came off the back of a month that saw $1 trillion being wiped off the global stock markets in response to the negative turn in US-China trade negotiations.

This no longer appears simply to be an issue of trade, but one of economic policy, centering on Trump’s grievances concerning structural aspects of the Chinese economy, pitting the US against China, both of whom play the same world trade “game” but on different playing fields. Indications are that current sentiment between China and the US could be viewed as the “new normal”: a permanent state of tension between the world’s two largest superpowers.

Morphing into a tech cold war, the blacklisting of Chinese technology company, Huawei, is a clear shot across the bow. As a result, Huawei – the world’s seventh largest technology company and second largest smartphone marker – will likely lose key software and hardware from the States that it depends on.

The stakes are high. We could be facing a bipolar world in digital technology. Should the US and China part ways, other countries would effectively be forced to “pick sides” when selecting which world leader in digital telecommunications technology they adopt. And a tech war of this nature would likely have knock-on effects the world over in respect of foreign policy and direct investment that would almost certainly open on other fronts.

Brexit

Brexit is the third major cause of volatility in the world economy. Following the United Kingdom’s (UK) decision to leave the European Union (EU) in a referendum held three years ago this month, the deadline has been extended from 29 March 2019 to a date no later than 31 October 2019.

In a country bitterly divided, outgoing Prime Minister Theresa May’s successor could well follow her line that “no deal is better than a bad deal”. A no-deal Brexit would see UK-based companies that conduct business with the EU forced to comply with the rules and regulations of each individual country, as opposed to those governing the Union. While working on a Brexit deal, the UK has simultaneously been working to ensure continuity risks are mitigated in the event of a no-deal Brexit, alongside certain EU member states. Even so, and despite these precautionary steps, the impact and scale of a “no-deal” Brexit are impossible to predict.

Conclusion

In the midst of much negative market “noise”, determining what information to act on – if any – is no simple task for investors.

“Man overboard” is a seafaring term used to indicate when a crew member or a passenger has fallen off the vessel and into the water. It is also a colloquial term for when investors should exit a sinking investment.

Fear is never a reason to disinvest, and an investor’s emotions are often his or her own worst enemy. That being said, should new information emerge that undermines the investment case for holding stock in a particular company, it is foolish to allow pride or unfounded optimism to prevent you from disinvesting.

The risks and challenges facing the local and global economy are not new or unknown. Indeed, we wrote about these very issues at the start of the year. What has changed since is the level of volatility in response to recent developments, and the corresponding increase in the emotional temperature associated with these risks and challenges.

However, as always, long-term investors are well-advised to focus on the things they can change, rather than those they cannot. Unless the investment case for the stocks in your portfolio have changed as a direct result of recent developments, the best course of action would be to ignore the noise, and – in the words of the Foo Fighters – have “a little bit of resolve”.

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