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  • Writer's pictureLisa Perry

No 2. Effects on the different asset classes

The world of Equities

By now you would have seen your quarterly investment statement and possibly headed for the fridge.

Lock Downs are working for those who got in early, as you can see from the graph above, Italy and Spain seem to be making a turn and cases reported is expected to start to decrease. The US and the UK on the other hand appear to have a rather long way to go with new cases climbing by the day. China and South Korea, who acted quickly have succeeded in flattening the curve.

The Chinese economy is starting to pick up again.

(The below, just for interest what China looks like from space.)

Sell off’s in equity Markets are not new and on average happen every 10 years. These “crashes”/ “Bear Markets” (def. a fall in the market of 20% plus) are, in my mind, based of FEAR and seldom based on fundamentals; the roll on effect again, is that passive funds need to rebalance causing a bigger sell off than needed, in walks your hedge fund managers which can also impact the market through short selling and other tools at their disposal to generate returns in falling markets.

The last crash happened in 2007:

Source: Fairtree Equity Presentation March 2020

Source: Fairtree Equity Presentation March 2020

The above being based on Global Markets. In theory that SA market should take a bigger hit and should take slightly longer to recover, SA is lumped in the Emerging Market basket which is perceived to be of a higher risk, add in Covid 19 and a potentially prolonged recovery due to the imminent recession, we may have to be more patient. Bluntly put, unless the world goes to pieces and ALL economies fail, we can expect with an amount of certainty that the markets will recover; the question is when?

The answer would be when sentiment and confidence improve in world economies. However be warned that we do expect to see a reduction in divided distribution from companies, who will rather retain cash. From the many presentation I have read and calls I have been on, there is a large amount of excitement in these markets, as the experienced managers are able to buy great companies at prices they could never have imagined. The current and ongoing risks involve Covid 19 and the impact on certain sectors of the market, job loses which will influence spending, the duration of boarders being closed.

What are the positives for South African companies:

1. Companies have been sitting on cash due to political risks; that stash can be used to save jobs and potentially take advantage of new capital projects post lockdown.

2. Lending in South Africa is cheap and even cheaper globally.

3. A weak rand welcomes foreign investment.

The world of Bonds

After much research and calls; Bonds are very much a “which side of the fence are you sitting on?” Before we go into that lets understand what has happened in the bond market with the downgrade.

Foreigners have traditionally purchased South African Bonds due to the high yields available against those of developed countries (UK and US). In addition the liquid currency (ZAR) allows for free trade as well as the fairly volatile currency allows for potential gains on the rand as majority of SA bonds are help in rands.

An Example

Foreign Investor A can buy SA Government Bonds with a 10 year duration at a yield of 9% vs a US Government Bond yielding a return of 1.5% . He lends a capital amount of R1 000 to the SA Government.

3 years into the term of the loan, South Africa is downgraded to junk and Foreign Investor A is forced to sell his SA Government Bond as his mandate stipulates that he is only permitted to hold investment grade credit. He now has to sell his bond in the secondary market. However as the (perceived) risks have increased, SA Government Bonds are now trading at 11%. Why would a investor buy a bond at a yield of 9% when they can get 11%?

Foreign Investor A will now need to sell the bond at a “loss” ie sells it at R800 as opposed to the R1 000 he paid for it, therefore providing the buyer with an additional R200 should he keep the bond to maturity.

This is what has happened in the Bond Market, sellers have discounted the maturity values in order to move out of the South African Bond Market. Which goes back to the point of “which side of the fence are you on?”

Unfortunately it is not this simple as you are possibly thinking as an investor (Buyer). With no Convid-19, It would have been a great investment as the risk would have been the same from the day before the downgrade to the day after the downgrade, ie the risk of credit default would not have changed. Enter Convid-19, has the default risk increased? That will depend on how long the lockdown lasts, being the simple answer. Howvere I still believe that there is a strong case for Bonds:

1. Investor able to take advantage of the foreign sell off at below par prices.

2. Investors able to take advantage of the increased SA Government Bond yields.

3. Falling interest rates and stable inflation = real returns of est. 5% are possible.

4. The South African governance over debt is HIGHLY regulated and SA banks are sitting of heavy amounts of cash.

The will be short term volatility within the bond market and you will experience it. However, sentiment amongst assets mangers, whom I have spoken with, have a focus on short duration debt, which reduces risk. They are able to hold the debt to term and do not necessarily have to trade it in the secondary market. Apart from default risk, bonds come under attack in an increasing interest rate environment as people are able to get acceptable returns from cash with less risk and fluctuation. The opposite is true in a decreasing interest rate environment the demand for bonds with higher yield increases pushing up prices.

The world of Cash

Short and simple; the rates you get from the bank are purely dependant on the SA Repo rate (the rate at which South African banks lend from the South African Reserve Bank) as well as the duration that you hold the cash with the bank for. The longer the period the higher the rate you will get; however you will be locked in for that period. Cash is trending downwards as another decrease in interest rate is on the table.

This is also a “which side of the fence” you are sitting on as if you have debt, you will benefit from the decrease however if you are investing and reliant on the funds as income, this works against you. In addition one would look at inflation rates to determine the real return of cash. Cash has been a great place to be of recent times, providing a real return of est. 3%. Sadly these days are seeming to be in the past.

In summary, good asset managers will be able to find growth in portfolios' . This is not our first rodeo we are just performing in a new and unfamiliar arena.

What to do? Read the next blog (No 3)

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