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Global equity market volatility MEETS the SA bond market – Buy

No one is surprised at the current global equity market volatility and some might even argue that a contraction was always on the cards as valuations had become stretched while supporting economic data was looking less than commensurate. Traditionally at times like these, fixed interest assets become a safe haven for investors fleeing falling share prices. This was however not the case when many markets across the globe experienced record equity declines on Monday, 24 August.

Heavy trading, particularly on US bourses saw what has come to be called a ‘flash crash’ – stock exchanges try to ease panic selling by inserting circuit breakers at various index levels which when triggered halt trading for 15 minutes. The theory is that this will stop the panic. But of more interest is the effect that this had on our own local bond markets resulting in good buying opportunities for the astute fixed income manager. Wikus Furstenberg explains. – Candice Paine

The special podcast is brought to you by Futuregrowth Asset Management. I’m sitting with Wikus Furstenberg who is a fixed interest portfolio manager. We’re going to talk a little bit around the flash crash that happened on the 24th of August in the States and how that impacted on the South African bond market. Just to put it in perspective, the flash crash is where there are certain circuit breakers that are inserted into the market, to stop panic selling at certain levels. We saw this play out in the American market last week on the back of fears out of China; that growth was slowing. They had devalued the Renminbi and people thought, once again, the world was coming to an end. Wikus, what did this do for the South African bond market?

Candice, we actually saw yields rising – testing higher levels. Just to maybe put that in perspective, last week the 186 (the government bond that matures in 2026) yield moved from an interim month low of about 8.4% to just over 8.5%, so it’s about a 40 basis point move. Most of that was linked to what you mentioned.

Okay, so that 40 basis point in the bond market is big and that would be people selling out of the 186. Why would they be doing that?

In this case, it was obviously linked to…you mentioned China. It’s linked to the fact that South Africa’s a net exporter of non-energy commodities, with China being one of its biggest destinations. It’s all linked to fear about China and its potential implication for us as a net exporter of commodities.

Of course, I think against that background is also the fact that we are still running a current account deficit although it has narrowed over the last two years, especially the first half of this year – there’s that market perception.

I think the market overreacts to these sorts of things and becomes really sentimental about these things. I think that the last week or so, the market also ignored the fact that the oil price dropped sharply, so it’s not just about commodities. I think one should look at energy versus non-energy commodities in South Africa’s case.

Is the assumption, when selling of this nature happens, that its foreigners selling out of an emerging market?

Well, I think it’s easy to jump to that conclusion. We know that foreign investors were net sellers of SA bonds in August. If you look at official JSE data, it looks like round about 3-billion.

Of course, there are local players as well, so it could very well be local players and not just foreigners but we’ve seen foreign investors selling assets globally (including emerging market assets and local currency bonds). South Africa was obviously, impacted by that as well.

What is the thinking behind that? Our local bonds are giving you quite a significant real yield; so that is the yield above inflation. The SARB has also demonstrated how dedicated they are to keeping inflation within the three to six percent band. When you look at that, versus what you’re getting in developed markets, it’s almost a no-brainer that you’d want to be in the South African market. Is this fear temporary? Do they think they’re coming back? What would a portfolio manager’s thinking be when he’s selling?

It’s my view that that these people use panic to respond to panic.

Explain that.

We’re always told that the South African bond market is relatively liquid. Typically, what happens if you have a global event like this, people tend to follow a sort of risk aversion approach and if they do that, they think it’s best to avoid those assets, which, even in the short term, will give you a capital loss – especially if you consider what the currency’s going to do.

Bear in mind that if you look at the local currency bonds, they need to take into account what’s going to happen to the Dollar returns as well because they invested in Rands. If they have the view that the Rand is going to depreciate because of this link to China and commodities etcetera, they need to sell assets.

What they did in this case was to sell SA bonds. It’s also relative play. At the same time, what we all saw happening was strong demands for US treasury, for instance.

Yields there went the other way – a clear indication that there’s some risk aversion trait at play here – selling emerging market bonds, including South Africa even though local currency yield is significantly higher than was offered by most of these developed markets. They just went for the lowest risk, though. I don’t necessarily think it’s a clever trait. It’s a short-term trait, but it happens. The sell-off that we saw in August is actually, very small if you compare it to what happened in May/June 2013.

What happened then?

Remember, we had the Bernanke ‘taper’ when Bernanke mentioned ‘at some point, we need to think about removing quantitative easing and start that process’. We actually, all knew about that and they sold. The 186 is the same. The 186 yield, over that period, went up by almost 200 basis points. The same happened earlier this year.

Remember when we had the oil price dropping and then turning around in January. From that low, the 186 until recently, moved by about 150 basis points so it’s the sort of volatility, which we actually experience often in this market. The 40 points that we saw last week, isn’t that much. It’s still a big move, but relative to recent previous moves, it’s not that big.

If you’d been a smart foreign investor sitting on the side, you should actually have bought into our market when yields moved because in fact, the currency had weakened too, so you’re taking some of that currency risk off the table and you were getting the improved yield.

Indeed.

What did you do in your portfolios?

Well, we’re obviously longer-term investors, so we actually used weakness to add to our positions. We’ve been buying into bouts of weakness. We’re waiting for this. We have a large portfolio that we have to move, so it’s not easy for us to wait until it’s too late. We therefore opted to add to our exposures over the last two or three weeks.

Okay, and that’s what you’d want your portfolio manager to be doing – buying when the price is low. Wikus, thank you so much for this fascinating insight into how international markets impact on South African bond markets.

You’re most welcome, Candice.

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