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Asset managers have differing views on the subject, but they all agree on one thing: investments should never be restricted to a single currency, according to to Overberg Asset Management.
Diversification is key; it is the cornerstone of portfolio construction.
In its weekly economic and market overview, OAM noted that South Africans have a love affair with offshore investing, borne out by the fact that South Africa is a net external creditor. This means that in aggregate South Africans become wealthier if the rand depreciates.
The rand’s acute volatility since the start of the year begs the question, how much should I be investing offshore?
While there is no one-size fits all answer to the question, the analysts at OAM believe that diversification in investment is key, it is the cornerstone of portfolio construction.
South Africa economic review
• The Standard Bank South African purchasing managers’ index, which tracks activity across the manufacturing as well as mining, services, construction and retail sectors of the economy, increased in September from 47.2 to 48.0. However, it remained below the contractionary 50-level for a third straight month.
There was a general improvement across the sub-indices although they all held below the 50-level. The output index increased from 44.4 to 46.4 and the forward-looking new orders index from 45.3 to 46.7.
Rand weakness and the higher oil price forced the input price index higher from 58.2 to 58.4, although weak domestic demand and a lack of pricing power meant companies were unable to pass on the cost increase. The output price index declined from 56.3 to 53.5.
Although portraying a bleak analysis of the South African economy, the longer-term outlook should improve in response to President Ramaphosa’s fiscal stimulus package, amendments to the Mining Charter and de-regulation of electricity, port and rail tariffs.
• New vehicle sales declined in September by 1.9% year-on-year following-on from the 2.5% decline in August. The depressed new vehicle sales market mirrors the sharp decline in the ABSA/BER manufacturing purchasing managers’ index which fell in August to 43.4, well below the key 50-level which demarcates expansion from contraction.
The biggest culprit was the passenger vehicle segment, which fell 2.6% on the year. Light commercial vehicle sales fell 1.2%, although medium and heavy commercial vehicle sales increased by 0.4% and 12.9%, respectively, while buses increased by 40.0%. Vehicle exports were a bright spot rising by 1.2% on the year building on the 8.1% year-on-year increase in August.
On a month-on-month basis, vehicle export sales increased 15.2% in August and a further 13.7% in September. While the weaker rand provided a helpful tailwind for exports, the opposite is true for domestic sales. The weaker rand is aggravating the fuel price, placing additional pressure on domestic new vehicle demand.
• The ABSA/BER manufacturing purchasing managers’ index (PMI) maintained its sharp August decline to 43.4, falling further to 43.2 in September, well below the contractionary 50-level. While the business activity sub-index improved slightly from 37.2 to 38.7 the forward-looking new sales orders index declined again from 39.9 to 39.6.
The employment index also slipped from 45.5 to 42.9 while the inflationary effect of rising fuel prices and a weaker rand pushed the prices paid index up sharply from 79.7 to 85.9. The manufacturing PMI is consistent, at current levels, with a further contraction in manufacturing production in the third quarter (Q3), following the 0.3% quarter-on-quarter contraction in manufacturing GDP in Q2.
The week ahead
• Manufacturing production: Growth in manufacturing production is expected to have slowed in August to around 0.5% year-on-year marking a sharp slowdown from 2.9% in July. The ABSA/BER manufacturing purchasing managers’ index (PMI) fell in August to 43.4 well below the key 50-level which demarcates expansion from contraction, indicating depressed conditions in the sector.
• Moody’s biannual credit rating review: Moody’s, the only major credit rating agency to have kept South Africa’s foreign currency sovereign credit rating at investment grade, is unlikely to downgrade despite the sluggish economic growth.
At its last review, Moody’s raised its outlook for South Africa from “negative” to “stable.” A reversal in this outlook would normally precede an actual downgrade to junk status.
Technical analysis
• The spike in the rand/dollar rate to R15.50/$ in the first week of September may mark the peak in the currency’s recent decline.
• The rally in the US dollar index has reached its medium-term goal suggesting a correction from current levels. The dollar remains below a major 30-year resistance line suggesting the bull run in the dollar may be over.
• The British pound has broken back below key resistance at £1.35/$ suggesting a trading range of £1.30/$ to £1.35/$. The £1.28/$ level is expected to provide strong resistance.
• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
• The US 10-year Treasury yield has broken above resistance at 3.0% and 3.20%, paving the way for a new 3.20-3.30% trading range. However, any further move highly is likely to meet stiff resistance, especially at the key 3.50% level.
• The benchmark R186 2025 SA Gilt yield has spiked higher to 9.30% but is expected to meet stiff resistance at this level, limiting any further likely upside. The R186 may retrace a portion of its upward move taking the yield back to the 8.80% level and thereafter 8.60%.
• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
• The Brent oil price has decisively broken above key resistance at $80 per barrel, opening-up the $100 level, which just two months ago seemed far-fetched. However, any spike higher to the $100 level is likely to be short-lived, a blip rather than the start of a sustainable trend higher.
The outlook for base metals prices is less certain after the copper price retreated sharply from the key $7 000 per ton level. A decisive break below $6 000 per ton would herald a bear market in copper and base metals’ prices.
• Gold has developed an inverse “head and shoulders” pattern, which indicates a price recovery and a test of the $1 400 target level.
• Despite the consolidation since the start of the year the break in the JSE All Share index above the key resistance level of 60 000 in December signals the early stages of a new bull market.
Bottom line
• South Africans have a love affair with offshore investing, borne out by the fact that South Africa is a net external creditor. This means that in aggregate South Africans become wealthier if the rand depreciates. This is just as well and is what sets us apart from net external debtors like Turkey and Argentina, where steep currency depreciation is a source of great anxiety rather than a windfall.
• The rand’s acute volatility since the start of the year begs the question, how much should I be investing offshore? There is no one-size fits all answer to the question. Asset managers have differing views on the subject, although they all agree on one thing: that one’s investments should never be restricted to a single currency. Diversification is key, it is the cornerstone of portfolio construction.
• While many asset managers will recommend a greater offshore allocation, the Pension Funds Act provides a useful middle ground. Regulation 28 of the Pension Funds Act limits overseas exposure to 30%, lifted from 25% in the 2018 National Budget. In discretionary portfolios some asset managers may be inclined to regard this figure as a minimum rather than maximum, although the ultimate decision rests with the individual’s personal circumstances.
• Investing in South Africa, like all emerging markets, comes with added risk. Typically, emerging markets suffer from less political and policy certainty, greater unemployment, socio-economic instability, weaker credit ratings and higher currency volatility. However, investing overseas is not just about escaping emerging market risk.
• Higher risk goes hand-in-hand with greater potential returns. Emerging markets enjoy higher population growth, a growing middle class, stronger long-term economic growth and therefore superior earnings growth and equity market returns. Although hard to believe now, following one of the worst four-year periods for the JSE in the past 50 years, in the period from 2006-2013 the JSE beat the US S&P 500 index, in dollar as well as percentage terms.
• From 2000-2016 and over the longer-term from 1900-2016, the JSE has an impeccable track record, producing a higher real return (after taking inflation into account) than any of the 20 largest developed market stock exchanges. Over the two periods, the JSE has produced an impressive annualised real return of 8.2% and 7.2%, respectively.
By comparison, US equities have produced a real return over the two periods of 2.7% and 6.4%, the UK 2.4% and 5.5%, Germany 2.2% and 3.3%, and Japan 0.8% and 4.2%. The JSE wins.
• Regardless of where one expects to find the best returns, there should always be an allocation of plus or minus 30% to global markets. South Africa contributes less than 1% of global GDP and the market capitalisation of the JSE is also less than 1% of the world market.
Global investment exposure provides access to developed markets, to other faster growing emerging markets such as India and China, to many asset classes, such as infrastructure, renewable energy and absolute return strategies, some of which are not even available in South Africa.
It stands to reason, based on the massive choice available globally (there are 5 000 companies listed on the Bombay Stock Exchange alone), that there will potentially be greater businesses with more innovative and entrepreneurial management, in external markets. It would be unreasonable to expect all the best investments in the world to be located in South Africa.
• There has been a significant increase in domestic investment outflows over the past 18 months. This comes as no surprise, coinciding with heightened socio-political instability, lacklustre economic growth, credit rating downgrades and the absence of domestic investment returns. However, unpredictability is a feature of both local and global markets.
One cannot necessarily extrapolate recent trends into the future and expect global markets to continue outperforming. Global investment allocations should be implemented according to a long-term plan rather than as a knee jerk response to recent economic conditions.
For the full report, including a look at international markets, click here.
* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable, but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
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