Highlights of the quarter
Equity markets, both local and global, recorded new all-time highs this quarter. Equity returns broadened as US tech shares lagged, while emerging markets were spurred on by China, which announced new stimulus measures. A twist in the US presidential race saw Joe Biden announce his withdrawal and endorsement of Kamala Harris as the Democratic candidate, presenting Donald Trump with a stronger challenger. The US Federal Reserve and South African Reserve Bank commenced their much-anticipated interest rate cutting cycles at quarter-end.
Markets
South African equities (FTSE/JSE Capped SWIX) posted another strong quarter (+9.6%), lifted by the constructive outlook for domestic assets. Financials were up strongly (+13.9%) driven by the banks, which contributed almost half the market’s gain. Industrials performed well (+11.5%), with Naspers/ Prosus being notable contributors, as well as retailers. Resources lagged (-1.1%), with notable weakness from Sasol and select PGM counters.
The FTSE/JSE All Bond Index delivered another solid gain (+10.5%), outperforming the SA equity market this quarter. Long-term nominal bonds performed particularly well, with the SA ten-year yield breaching below 9%. Domestic bond yields have been driven by the continued fall in US treasury yields as well as improved domestic fundamentals. Year-to-date SA nominal bonds have marginally outperformed SA equities (+16.7% vs +15.9%).
Global equities (MSCI All Country World) were up in dollars but less pronounced in local currency terms (+0.6%), after the dollar weakened against the rand (-5.6%). Within global equities, developed markets underperformed emerging markets (+0.4% vs +2.6%), where China was a notable contributor following Central Bank policy easing. Global bonds were up modestly in rands (+0.9%), with US Treasuries rallying in the lead up to the US Federal Reserve’s interest rate announcement.
Economy
Global economic growth is stable with the IMF forecasting 3.2% growth this year and 3.3% next year. Growth across regions remains diverse, with strong but slowing US growth holding up advanced economy growth (1.7% in 2024). Germany’s recession still weighs on the Euro Area, while Japanese growth has softened.
Developing economies on the other hand are growing at a brisk pace (4.3% in 2024), despite the slowing Chinese economy. Chinese authorities have been unsuccessful at reigniting domestic growth, and this quarter a raft of monetary easing measures was announced, with a further commitment to additional fiscal measures. Outside of China, India is expanding rapidly, while growth remains resilient elsewhere.
SA has seen muted growth so far this year, but the rise in consumer confidence suggests a pickup is brewing. GDP data shows the South African economy stood still in Q1 and grew only modestly in Q2 (0.4% quarter-on-quarter), resulting in first half growth falling short of expectations. This is despite over 200 loadshedding-free days this year. With election uncertainty now out of the way however, there could be some pent-up investment and spending on the way, given lower inflation, interest rate cuts, and the temporary boost from two-pot withdrawals.
The path of global inflation remains down, though the pace of disinflation has generally been held back by sticky services inflation. Price pressures have been disparate regionally, prompting mixed Central Bank responses. In the US, inflation is above target but cooling, whereas in Japan, above-target inflation has accelerated. The Euro Area on the other hand, like South Africa is on target, while inflation is chronically low in China, where deflation is a growing concern.
The Monetary Policy Committee of the South African Reserve Bank cut interest rates in September, for the first time in four years. The Committee opted for a 0.25% cut. Although welcome, this proved an anticlimax given the US Fed had cut by 0.5% a few days prior. The market is pricing in a little over 1% in further rate cuts from the SARB by the end of 2025, and closer to 2% from the US Fed.
The Fed has more room to cut because current short-term rates are well above its “neutral” level, whereas in SA, policy is less restrictive. The larger initial cut also speaks to the Fed paying greater attention to the second objective of its dual mandate, maintaining maximum employment (in addition to controlling inflation). Markets (and the Fed) have been keeping a close eye on rising US unemployment, which some see as a sign of an oncoming recession, contrary to the consensus “soft-landing” view.
Outlook
We remain broadly constructive on the macroeconomic outlook while acknowledging risks are elevated. The two largest economies in the world face challenges, including doubts about the strength of their economies and the prospect of another unorthodox and unpredictable Trump presidency. Geopolitical risk is also elevated with the risk of miscalculation in the ongoing wars posing a significant threat.
With the outlook perhaps more binary than usual, we believe cautiously pro-growth portfolio positioning is appropriate, while retaining scope to dial up risk in the event of an unexpected equity market sell-off. Portfolios hold a healthy amount of cash and have been accumulating dollar cash (as the rand has strengthened) and foreign bond exposure, for an element of defensiveness.
As always, we look to continue capitalising on the opportunity set in front of us by taking a balanced view and avoiding extreme positioning that favours any single outcome. We are confident in the pedigree of our underlying managers and remain focused on producing outstanding investment solutions for our members.
PPS Portfolio Positioning
In June we upgraded SA equity to overweight in our tactical asset allocation house view framework, and portfolios have since benefitted. At the time, the FTSE/JSE Capped SWIX Index was trading around 21,000, the same level as in January 2022. The local market has since broken out to new all-time highs, with SA equities outperforming global equities significantly this quarter. SA equities have now overtaken global equities year-to-date. With valuations still attractive, and a constructive earnings outlook, we believe the SA Equity market has further to run.
We are less constructive on global equities and maintain neutral exposure for now. Although ongoing monetary easing should help support the market, we are mindful of risks in the US, a large share of the global index. These include frothy starting valuations, signs of a potential economic slowdown, and a potentially disruptive presidential election in November. We anticipate seeing better opportunities to add to global equities over the coming quarters.
This quarter we maintained neutral exposure to SA bonds, participating in the run up in the All Bond Index, which rallied even harder than SA equities. This is partly due to global bond dynamics, where US Treasuries have run in response to the interest rate outlook. Local dynamics have also been supportive, both politically and economically.
Following the strong run (+26.1% over 12 months), we now believe a fair amount of good news has been discounted. The benchmark SA bond is now trading at a premium to fair value estimates, and in line with Brazil, which has the same sovereign credit rating. We are also doubtful the SARB will cut more aggressively than what is already priced in. Taking everything into account, we tactically downgraded SA bonds post-quarter-end.
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