By Reza Hendrickse, Portfolio Manager at PPS Investments

After a bullish start to the quarter, equity markets began to struggle, amid political and regulatory risks in China and the US, coupled with renewed inflation worries, slower growth concerns, and potential systemic risk from Chinese property developer Evergrande’s potential default.

In the US, policymakers released details of a multi-trillion-dollar spending and tax plan, with the prospect of higher taxes weighing on markets. Events in China, with the State reinforcing its power, also worried markets, causing foreign investors to question its investability. In addition, markets are becoming increasingly conscious of the US Fed’s intention to scale back stimulus, at a time when inflation has some upside risk (given post-COVID supply chain bottlenecks and rising energy prices) in the face of a moderation in global growth. 

In South Africa, economic growth received a boost from the Statistics South Africa (Stats SA) rebasing, while the commodity price drop weighed on equities, and a flattening of the third wave curve saw lockdown restrictions being eased.

How did the markets perform?

Despite volatile conditions, the South African (SA) equity market, as measured by the FTSE/JSE Capped SWIX, rose this quarter (+3.2%). Financials (+12.7%) were the best performers, in addition to small and mid-capitalisation shares, with conditions favouring stocks with larger valuation underpins. Resources stocks on the other hand fell this quarter (-3.8%), as industrial metal prices came under pressure, particularly iron ore and the platinum group metals (PGMs). Lower Chinese steel production, supply bottlenecks affecting PGM demand and general global growth fears all contributed to the weakness. Industrial shares were also down for the quarter (-5.3%), with Naspers and Prosus weighing particularly heavily, given the impact of China’s increased regulatory scrutiny affecting shares, such as Tencent. Outside of local equities, SA government bonds also posted gains, with inflation-linked bonds (+2.0%) outperforming nominals (+0.4%), and SA listed property advancing further (+6.5%).

Foreign equities were up in rand terms this quarter (+4.3%), mainly due to the dollar strengthening (+5.4%), as is often the case when global growth softens. Developed markets (+5.4%) outperformed emerging markets (-3.2%), with China’s regulatory intervention triggering a sell-off. This was compounded by COVID-19-related supply disruptions in the region, an electricity shortage and the tenuous debt position of Chinese property developer, Evergrande, denting sentiment. Global bonds were flat in dollar terms, but up in rands (+4.1%), with falling bond yields reversing higher during the quarter, given the hawkish Central Bank comments. Global listed real estate (+4.8%), marginally outperformed both equities and bonds this quarter, continuing its strong run. 

How are the portfolios positioned?

Our multi-asset portfolios remain positioned to benefit from expansionary economic conditions by holding an appropriate amount of domestic and foreign equity. Even though global growth has probably peaked for now, the environment is still supportive of equity markets. Growth assets may not deliver the magnitude of outsized returns, such as those produced in the pandemic rebound, but we expect reasonable returns nonetheless, knowing that maintaining sufficient exposure to equity markets through the cycle increases the likelihood of clients achieving their long-term inflation objectives.

This quarter we altered the mix of equities across client portfolios by shifting from neutral to an overweight SA equity house view position, while reducing the overweight to foreign equities somewhat. Importantly, we remain positive on foreign equities, and in our managers’ ability to continue adding value abroad, however we no longer believe we should be as aggressively overweight relative to our long-term strategic asset allocation (SAA). Similarly, while there are still short-term risks to SA equities, we are of the view that there is sufficient medium-term visibility to warrant an overweight to this attractively priced asset class.  

This quarter we also reduced our SA property underweight, given our view that negative rental reversions are reaching a plateau, while valuations have improved substantially. The sector still faces some challenges, however, we await further evidence of a more durable recovery. Lastly, we continue to view the structural improvements locally as being supportive of our high conviction overweight SA bond position, and we continue to witness an improvement in SA’s risk profile compared to the recent past. Clients will know that all our house view decisions are made within a robust investment framework that ensures portfolios remain sensibly diversified.