Sell in May and go away?

Dave Mohr, Chief Investment Strategist ar Old Mutual.

Izak Odendaal, Investment Strategist at Old Mutual Multi-Managers.

There is an old saying in equity markets: “Sell in May and go away”. However, if you followed that strategy at the beginning of May this year, you would have missed out on the Wall Street indexes, the UK FTSE and Germany’s DAX hitting all-time highs. The MSCI World Index also reached a record high. Over the last 12 months, this index has generated a magnificent 17% in US dollar. Global equity markets have been supported by growing evidence of a broad-based improvement in economic growth and company earnings prospects. Local investors have probably not noticed these strong returns in their rand-based investment reports due to an almost 20% surge in the rand against the US dollar - so in rand terms those international returns were slightly negative.

The S&P500 was driven to a high by surging global technology giants (sometimes abbreviated as the FAANG stocks, for Facebook, Apple, Amazon, Netflix and Google). European equities were also buoyant in May. The Eurostoxx 600 returned 1.8% in May. Year-to-date, it has returned 10%, supported by the fastest growth in the Eurozone in six years and declining political risk. Following years of depressed economic conditions, the Eurozone has lots of potential to keep generating solid growth. Furthermore, the European Central Bank (ECB) indicated that monetary policy will continue to underpin the economic recovery with low/zero interest rates and ample liquidity. Therefore, Eurozone equities probably have the potential for more solid returns over the longer term.

The UK FTSE100 surged 4% in May, hitting a record-high level, assisted by some renewed pound weakness ahead of the UK general election. Many of the companies on the FTSE earn their profits outside the UK, so their share prices benefit from a weaker pound.

In Japan equities had a positive month despite the yen being flat against the dollar. The Nikkei 225 returned 2%. Japanese growth numbers have also improved this year.

Emerging markets outperformed developed markets again, with the MSCI Emerging Markets Index returning 3.4% against the MSCI World Index’s 1.6% (in US dollars). Year-to-date, the former leads the latter by 17% against 9%. The MSCI China Index gained 5% in the month, leading the charge. However, Brazil suffered a 4% decline after a fresh political scandal. Over the past 12 months emerging markets delivered almost 30% in US dollars. Even after subtracting the massive appreciation of the rand over the period, emerging markets delivered a real return of about 2% in rands. Current valuations for emerging markets are still relatively attractive and our strategy funds remain overweight emerging markets equity.

Global bonds were positive in May as bond yields drifted lower in reaction to muted inflation. The Citigroup World Government Bond Index returned 1.4% in May, lifting year-to-date returns to 4%. The US 10-year Treasury yield declined from 2.4% at the start of the year (and 2.3% at the start of the month) to 2.2% at the end of May. This despite the Federal Reserve signalling its intention to hike interest rates in June and considering to reduce the bond holdings on their balance sheet. The UK’s 10-year Gilt Yield fell below 1% on renewed uncertainty ahead of the elections and the formal start of Brexit negotiations. The German 10-year Bund Yield also declined to 0.29%. For a local investor, global bond yields are not attractive and our strategy funds avoid this asset class.

Global property was marginally positive in May with the FTSE EPRA/NAREIT Developed Index returning 0.5%. Year-to-date, the index has returned 4%, with property developers outperforming by a wide margin.

The euro jumped against the dollar, rising from $1.08 to $1.12 during the month, supported by a better growth outlook and the expectation that the ECB might reduce monetary stimulus sooner than thought. At the start of the year, the euro was as low as $1.05 and many commentators held on to the view that it might fall to parity against the greenback.

The oil price was volatile during the month, running up sharply in anticipation of a further production cut by the Organisation of Petroleum Exporting Countries (OPEC). However, the market was disappointed when OPEC (along with Russia) only extended existing cuts by nine months. Meanwhile, US shale production continues to increasingly benefit from rapid technological advances that have reduced operational costs, allowing them to survive at lower oil prices (in contrast to the inefficient national oil companies in many OPEC countries that have the additional burden of funding bloated government budgets). Other commodity prices were mostly negative during the month. Precious metals, gold and platinum were marginally better, while corn and wheat retreated. Iron ore prices lost more than 15%.

The local equity market was slightly down in May. A surging Naspers share price helped the industrial index to return 1.4%. Naspers benefited from yet another surge in Tencent. Naspers now accounts for around 15% of the FTSE/JSE All Share Index (ALSI) and 20% of the FTSE/JSE Shareholders Weighted Index (SWIX) and therefore has a material impact on index returns and fund managers’ relative performance. Industrials were also supported by household goods (Steinhoff), tobacco (BAT) and pharmaceuticals (Aspen) performing strongly in the month. In contrast, general retailers suffered a sharp decline on disappointing earnings reports. Mobile telecoms and healthcare services (hospitals) also struggled in the month.

Flat to lower commodity prices combined with a stronger rand pummelled resource shares and the sub-index lost 4.1%. The intended refinancing of Impala’s convertible bonds also hurt the sector’s performance. In addition, forestry & paper, the strongest resources sub-sector this year, pulled back in May. Year-to-date, the resources index is moderately negative. Resources are also down over the last 12 months.

Financials were flat in May, with strong gains from banks offset by losses in life insurers. Over 12 months, the returns from the sector lag inflation.

Local equity is the leading domestic asset class year-to-date with a 7% return, but is still lagging inflation over 12 months. The JSE is also lagging inflation over two and three years. Historically, when the JSE suffered poor returns over a three-year period the subsequent returns were typically very strong, averaging a real return of 10% or more over one, two, three and five years. This is again a reminder to exercise patience when investing in the JSE.

Also bear in mind that more than 50% of the revenues generated by the companies listed on the JSE come from beyond our borders and a strong rand depresses those earnings and the share prices of those companies. Put differently, when measured in US$ the JSE soared more than 20% over the past year!

Listed property is part of the Financials sector but is treated by most investors as a separate asset class (it constitutes about 8% of the ALSI). The FTSE/JSE Listed Property Index (SAPY) was marginally positive in May, but the year-to-date and one-year returns of around 3% are well below the outstanding returns of the past 15 years. Property companies are increasingly battling a difficult operational environment in South Africa, while the benefit of going offshore has been eroded by the stronger rand (the offshore revenue exposure of local listed property companies jumped from virtually nothing to almost 40% in the past 10 years).

Against the backdrop of improving global growth, declining inflation, a softer dollar and lower yields in developed markets, emerging market bonds are experiencing massive investor demand. South Africa, with its relatively high yields, attracted a cumulative R45 billion net purchases of bonds by foreign investors in the first five months of the year. This is despite the cabinet reshuffle and subsequent downgrades by Fitch and S&P. This foreign buying has supported the rand and the local bond market. The yield on the 10-year local government bond declined from 8.9% at the start of the year to around 8.6% at the end of May. With inflation having declined from 6.5% in January to 5.3% in April, the real yield on offer from local bonds has increased to a very attractive 3.2%.

The All Bond Index (ALBI) was positive in May, and the 4.8% year-to-date return is ahead of cash. Over 12 months, bonds returned 14%, outperforming all other major asset classes, local and international, available to South African investors.

The rand started the month at R13.35 per US dollar and followed its usual volatile pattern (amplified by local political developments) before ending the month about 2% stronger at R13.11. Over 12 months, the 20% appreciation of the rand against the dollar has wiped out most of the gains of local investors from holding offshore assets. The rand was stronger against the battered British pound in May, but marginally weaker against the euro.

Local economic data releases the past week were mostly positive. South Africa generated another healthy trade surplus of R5 billion in April, pushing the year-to-date trade surplus to R9 billion compared to a deficit of R26 billion during the corresponding period last year. Exports grew 6% while imports fell 4%. This R35 billion improvement in our foreign trade balance means that the country is less reliant on foreign capital inflows as we earn more from selling products to foreigners than we spend buying goods from them.

Following the slump in manufacturing confidence in April, May saw a strong rebound, suggesting that the sector is back on a positive growth path.

Credit growth continues to underwhelm. Household borrowing is growing at a pedestrian 3%, about half the current inflation rate and not supporting retailer turnovers. However, as consumers have scaled back borrowing, their financial position is improving. The TransUnion Consumer Credit Index for the first quarter climbed to its highest level in two years with the number of credit accounts in arrears declining while interest rates have remained steady.

Consumers can also look forward to a petrol price cut mid-week. So it’s not all bad news.

Sources: I-Net, Datastream, SARB, StatsSA, JP Morgan, Deutsche Bank.