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Investment Perspectives: Q2 Equity markets

25 July 2024 Reza Hendrickse, Portfolio Manager at PPS Investments

Financial markets remained preoccupied by the US economy’s “soft landing” potential, which refers to high interest rates guiding inflation back towards target, without causing the economy to go into a recession.

Equity market strength was concentrated in the US and emerging markets, where even South Africa was a top performer following the elections. The formation of a coalition Government of National Unity in SA marks a historic moment for the country.

Markets
South African equities (FTSE/JSE Capped SWIX) rallied in the quarter to end June (+8.2%), benefitting from the increased appetite for domestic assets. Financials were up strongly (+17.1%), with banks contributing almost half the market’s gain. Within Industrials (+4.8%), Naspers and Prosus were notable contributors, driven by the outlook for Tencent. Resources also gained this quarter (+3.4%), supported by Anglo American, which was boosted by BHP Billiton’s takeover bid, and precious metal stocks.

The FTSE/JSE All Bond Index delivered a solid gain (+7.5%), almost on par with the SA equity market for the quarter. Long-term bonds performed particularly well, with the ten-year benchmark bond yield breaching below 10%. The market is optimistic that the new government provides a window to potentially implement much needed pro-growth structural reforms; with growth being critically important in tackling the rising sovereign debt burden.

Global equities (MSCI All Country World) advanced in dollars but declined in rand terms this quarter (-0.8%), after the dollar weakened against the rand (-3.6%). Within global equities, developed markets underperformed emerging markets (-1.2% vs +1.0%), where investor sentiment was bolstered by favourable election results in India and South Africa. Global bonds were down in rands (-5.1%), with lingering inflation worries affecting the US outlook for rates.

Portfolio Positioning
This quarter our tactical asset allocation house view upgraded SA equity to overweight, after having been neutral for the prior 18-months of sideways market churn. We began increasing South African equity exposure in relevant portfolios toward quarter-end, acknowledging the confluence of factors improving the risk/reward outlook.

These include, firstly, elevated pessimism despite the political backdrop looking increasingly promising. The narrowing SA risk premium provides a potentially powerful catalyst to unlock attractive local equity valuations. Secondly, the economy is at a cyclical inflection point, with growth set to recover and monetary easing poised to provide additional stimulus in the coming months. Thirdly, forward earnings estimates show upside momentum, which is often a precursor to rising share prices.

We remain neutral on SA bonds for now, which over the short-term need time to digest the recent run up. SA bonds are nonetheless cheap and well placed given the stable inflation outlook and the prospect of rate cuts. Any uptick in the foreign appetite for local bonds, which has been lacking for several years now, could provide a further underpin over the coming quarters. On a longer-term view however, little has changed in that fiscal debt sustainability remains a key risk; unless the new political dispensation is able to implement pro-growth policy to lift growth sufficiently to sustainably address the debt trajectory.

Although global equities experienced a muted quarter from a return perspective, the MSCI ACWI remains ahead of the JSE year-to-date. We are still neutral foreign equity given elevated valuations in the US and stretched momentum. Market concentration in mega-cap technology is noteworthy, though continued strong prospects are keeping investor enthusiasm for anything related to AI high.

The strong rally in the MSCI since late 2022 leaves the market somewhat technically vulnerable near-term, however we would treat any temporary correction as a buying opportunity. As the labour market shows, the US economy is decelerating, but the odds of a severe economic downturn are low. The odds of an equity bear market are also low, given the current absence of any meaningful financial market stress.

Outlook
Although visibility has improved slightly, we still observe some conflicting signals and our guard therefore remains up, and our mindset flexible. While we remain acutely aware of global developments and their potential impact on markets, we are not over-reliant on our macroeconomic prognostication skills. As always, we look to capitalise on the opportunity set in front of us by taking a balanced and measured view, and not positioning for any single outcome. We remain focused on our edge, which is identifying manager skill, enabling astute manager selection, and consequently engineering outstanding investment solutions for our members.

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