Category Archives: Team Commentary

By Rowland Brown

On the 28th of June, we sent the below out to a number of clients, as we amended our views on the regional fixed income space:

The situation in the UK is being massively overplayed in our view, as have been the market reactions. There is unquestionably a great deal of uncertainty in play at present, but a lot of this appears to stem from the wholly inaccurate view that Britain has to leave the EU NOW and has no plan as to how to go about this. In reality, Britain will choose when it wishes to invoke article 50, having gauged the will of the people to do so, through the referendum. The referendum is a domestic matter. The decision as to when this article is invoked is a domestic matter. It is not the business of the EU any more than the referendum was their business. Once triggered, the EU will take over, and the eventual British exit will be configured.

Britain thus has time to develop its side of the strategy to exit from the block. Given that an IN vote was broadly expected, it is hardly surprising that detailed plans have not been drawn up as to the process given that the OUT vote ultimately succeeded. Moreover, there doesn’t appear to be any good reason as to why there should have been such a plan – there is no rush to invoke article 50.

Great panic has befallen the country, largely because of the vast unknowns, with most people appearing to assume the worst. Many seem to expect the sky to come tumbling down any minute, while others expected to be denied entry into mainland Europe on their upcoming summer holidays. Few seem to have grasped the fact that nothing has changed, at least for now. Leadership through the uncertainty, has been all but non-existent. Cameron, still the official leader of the country in theory, has shown little practical leadership since Thursday night. Nevertheless, the uncertainty that has been allowed to prevail will likely drive a slump in consumer and business confidence, driving reduced consumption and investment activity in the UK in the immediate future. A conspiracy theorist (which I am not), would perhaps dare to suggest that this was a concerted effort to ensure that the disastrous economic predictions of an exit vote materialise. More realistically, however, it appears that Cameron is just not yet ready to give up the hot seat, but also not able to fill it. And understandably, few seem desperate to take it from him.

Nevertheless, all of this, particularly the expected growth slowdown, makes it likely that we will see interest rates stay lower for longer, and will probably see a rate cut in the UK before year end. Similarly, it appears less likely that the US will hike rates again this year (in fact, the market is pricing in an increased probability of a cut in Q3 or Q4 2016). Lower for longer makes fund flow reversals out of advanced economies into EM likely, and we may just see some significant EM currency strengthening over coming months.

For the region, this would be good news, at least in the short term. Inflows would obviously drive a stronger ZAR, which would in turn improve inflation expectations in South Africa, and would likely mean that we have reached the top of the interest rate cycle (although there is a slight chance we will see one more hike should this ZAR strengthening take time to materialise). This would provide a more stable footing for South Africa from a macroeconomic perspective, and may help to delay or avert a rating downgrade (perhaps an outside hope). In turn, we expect to see an increase in demand for SA government bonds in the second half of this year, resulting in stronger pricing. With benchmarks strengthening, Namibian yields will also likely see some compression.

This view has been playing out to the T over the past two weeks. Last week saw the largest EM debt inflows on record, as foreigners crowded into attractively priced EM debt on the assumption that interest rates will remain on hold in the US and Eurozone, and come down in the UK before year end.

As we suspected, following the knee-jerk on the USD, the Rand has been gaining back lost ground. In addition, the GBP has tanked, resulting in relative Rand strength. This Rand strength is unlikely to wane soon in our view, and we may just see strong buying pushing the rand back below 14 to the USD again.

Moreover, bonds prices have started to pick up, and yields right across the SA curve have been coming down. We expect this trend to continue going forward, at least for the next few months. The reason for this is simple – SA (real) yields are incredibly attractive when compared to much of the rest of the world. As the UK and Eurozone outlooks deteriorate, and as the Rand strengthens (and thus SA’s short term outlook improves), SA becomes relatively more attractive. Yields around 9% (real of 2.5 – 3%) on 10 year paper remain attractive when much of Europe’s debt is trading negative (both nominal and real), and for first movers, there is likely to be a pleasant FX gain on offer as well.

What all of this means is that we believe that we are at, or very close to, the top of the current interest rate cycle, or at least we should see rates on hold at these levels (or perhaps 25bp higher) for the rest of the year. This should prove positive for the economies of both South Africa and Namibia. Both economies are struggling to find growth at present (a short term normalization in Namibia’s case, and structural in South Africa’s case) and a little help from more stable interest rates won’t go amiss. Lower or more stable rates will help corporates, households and government when it comes to funding consumptive and investment activity. Moreover, lower rates and a stronger exchange rate will reduce consumer price pressure, thus allowing for a little more discretionary disposable income.

Broadly speaking, we feel that all of the madness that has ensued following the announcement of the Brexit vote has not been, and is unlikely to be, as unfavorable for Namibia and the region as many are making it out to be. In fact, we believe we may have been thrown a bit of a lifeline. Time, however, will tell.

Something’s got to give!

By Rome Mostert, CFA

We’ve had a week and a half (both literally and metaphorically) of trading since the #Brexit referendum. Since then we’ve seen asset classes move with great vigor in all directions and ultimately end up surprising most market participants as to their ultimate direction:

• Equities – Over all stocks have been fairly neutral, with major US indices tracking back to their pre Brexit levels. The bulls stood firm in London with the FTSE 100 more than retracing its initial slide and now trading the highest it’s been in nine months, and from a technical perspective, it seems set to go higher. However, the FTSE performance in Sterling is no big surprise given that approximately 70% of the earnings of the index are not GBP based, so the index offers exceptional hedging qualities on the exchange rate. In Europe it’s been a different ball game, with both the DAX and CAC still respecting the most recent downward trends while lower lows and lower highs continue to shape the current theme. Performance across EM has been mixed, however the dollar laggards of 2015, like Brazil and South Africa, have stood steadfast among international peers.
• Treasuries – US bonds have rallied aggressively since Brexit day with the yield curve (10yr minus 2yr) continuing to flatten as the 10yr yield is coming off at a rate much faster than that of the 2yr. The US yield curve is currently at 80bps and appears to be moving towards becoming more flat, or possibly, inverted. A particular surprise, however, is the strength in both equities and bonds at the same time, but more about that later. In Europe yields have continued to slide with negative yields through 50yrs in Switzerland, 15yrs in Japan and Germany, 8yrs in France, 6yrs in Ireland and 3yrs in Italy and Spain. In the UK yields initially spiked as rating agencies downgraded Britain, however has since more than retraced and continued its downward path and is now the lowest since the financial crises (take that S&P, Moody’s and Fitch!) The positive UK 10 yr yield (at 0.84%) in light of a 9% weaker pound (versus Euro) is starting to look fairly attractive from European perspective despite the ratings tantrum! With the ECB continuing to crowd the Eurozone debt market, GBP debt might be an interesting punt for European fund managers. The US 10yr yield, however, continues to offer real tangible value (compared to the UK and European yields) at a yield of 1.45%.
• Currencies – The direction of the pound has been singular, weakening against virtually every global currency over the past 10 days. The dollar versus the Euro, no major direction change has taken place with the dollar still within its 18-month long consolidation after a long bull trend. EM currencies have mostly strengthened after hitting oversold levels late 2015 following home-grown issues, FED rate hikes and a related selloff.
• Commodities – Let’s first think dollar, as is always the case when talking commodities. For a few years now the FED has prepared the market on the inevitable hiking cycle that is coming. In December 2015 we saw the first 25bps hike and at the time a number of increases were expected for 2016. Since we’ve seen the FRA curve flip a 180, with the probability of a FED cut in 2016 at 10%, now larger than that of a hike at 0%. In fact, a lot of the asset allocation that we’ve seen over the last week and a half (increased correlations, rising equities and bonds) suggests that the market is pricing in a probability of QE4, or more global monetary easing of a different sort, or from a different country. With a weaker dollar back on the table, as opposed to previous projections of a stronger dollar on the back of a rising Federal Funds Rate, commodities prices are set to rise. In fact, with commodities completely overshooting to the downside while fear took control of the asset class, significant upside seems warranted. Especially in high beta juniors.
• Volatility – Volatility has been extreme over the past week and a half. On Brexit day (Friday the 24^th of June) the VIX spiked 49.3%, recording the 5^th largest single day percentage point increase ever. The following week the VIX decreased 40%, making it the largest weekly percentage point decrease ever, which includes a 21.4% decrease on Tuesday the 28^th of June, the 9^th largest daily decline ever.

So what is the smart money telling us?

With the latest increases in equities, treasuries and gold, more questions are being raised than answers given.

Firstly, in the buildup to Brexit investors took the conservative rout and stockpiled vast cash positions, as per BofA Merrill Lynch Fund Manager Survey suggesting cash levels of 5.7% pre-Brexit, the highest since Nov 2001. This coupled with the current “buy the dip” mentality has led to yet another V shape recovery, the umpteenth time since the 2009 start of the current bull market. So basically investors were sitting on record levels of cash that needed to be deployed post Brexit, or stood the risk of being on the wrong side of the tracking error.

Secondly, the last week’s market action suggests that there is still no maturity date set on the FED put. Despite the FOMC still guiding for higher interest rates, the market seems to be already banking on more QE, be it from the FED or BoE or #moar from Draghi or BOJ.

Thirdly, over the past 27 months we’ve witnessed the S&P (1840 – 2130) and JSE Alsi (41800 – 49000) trading in wide sideways ranges, with a number of sharp V-shape recoveries in between, as the BUY-THE-DIP strategy paid off time and time again. Equity markets have been moving sideways despite weak economic growth and slumps in earnings, which has seen valuations rise despite lackluster market performance over the past year.

Fourthly, from a technical perspective there is little blatant bullish conviction unless the market convincingly breaks through the multiyear resistance ahead.

To conclude, in the near term (next two months) as long as the US yield curve remains upward sloping (which is currently the case), we believe that the ongoing search for yield in a “risk on” environment will drive continuous fund flow towards equities and high yielding emerging market debt, continuing to stimulate the “BUY-THE-DIP” mentality.

In the medium to longer term, however we foresee that ongoing Brexit uncertainties, potential other referendums (FREXIT = FRANCE, GREXIT = GREECE, NEXIT = NETHERLANS, SWEXIT = SWEDEN, DEXIT = DENMARK, HEXIT = HUNGURY) and global economic growth concerns could further drive treasury yields lower and ultimately invert the US yield curve. Should the US yield curve invert, we will be extremely cautious of global equities that are sitting on historically rich valuation multiples, especially if this lines up with the upcoming August to October period, which includes the seasonally weak September futures close out, which has historically been a good spot to short into.

Our recommendation for now would be to hold on to cyclical high beta equities and emerging market debt, but look to sell in the near term as they head into resistance. Longer term we prefer defensive equities and valuation as a style which includes attractively priced resource stocks and perhaps the listed British property stocks. On the fixed income side, we will be continuing to hold long duration (which we’ve been holding ever since Nenegate), looking to switch to short duration around the R186 pivot range of 8.0% to 8.5%.

OPINION PIECE: By Rowland Brown

Brexit: A storm in a teacup: What you get when you mix two of Britain’s favourite things – poor weather and tea.

On Thursday, Britain voted to leave the European Union, taking markets and many people by surprise, after polls suggested a strong win for the “Bremain” vote was more likely than the “Brexit” vote. Subsequently, emotions have run high. That the vote has been polarizing no doubt can exist, but the reaction thereto has been peculiar, with many British people appearing determined to set aside the democratic outcome of the vote. Nevertheless, it looks like the process of Britain packing its bags will go ahead, despite the current uncertainty as to how, when, and who will take the lead through the process.

Record numbers turned out to vote, with 72% of the voting age population taking part in the democratic process. The young, urban and the relatively more wealthy voted to stay, while the more elderly, rural and disenfranchised voted to go. England and wales voted to go, and Scotland and Northern Ireland voted to stay. Many young voters are now claiming that the elderly sold the young down the river, despite the fact that the youth turnout was the lowest in the country (18-24 with 43% turnout, 25-35 with 54% turnout, compared to an overall turnout of 72% and a 65+ turnout of 78%).

The reason this reaction is peculiar is that there really is no clear reason as to why leaving, or staying, in the European Union is a terrible idea. The fact of the matter is that the decision to leave, and its claimed implications, are unlikely to be nearly as tragic as they are being made out to be, and in honesty, Britain may actually stand to benefit from the decision.

Why I say this is simple: the European Union is a fancy trade agreement, not a panacea to prosperity. Like all trade agreements, it has certain terms and conditions, such as those around standards and worker and human rights within the block. As a result, some laws are shared, and like some other agreements, the EU allows for free movement of labour between member states.

However, many of the arguments as to why the Brexit vote is such a tragedy, are simply peculiar in nature. The idea that Britain will now become a global outcast that no one will want to trade with is blatantly absurd. This appears to have formed much of the foundation of the argument as to why the Brexit vote was a bad idea, however it finds itself unsupported in real evidence. As the 5th largest economy in the world, one of the 20 richest countries in the world (on a GDP per capita basis), a permanent member of the UN Security Council, a nuclear power and the largest contributor to NATO in Europe, there is simply no way that other countries will not want to trade with them. You add to this the commonwealth and the likelihood that Britain will be able to negotiate multi or bi-lateral agreements with commonwealth countries (many of which are large and fast growing), giving it preferential access to their markets (and not have to compete with other European countries in these markets), it becomes incredibly hard to buy the bulk of the Bremain voters trade claims. Moreover, since the vote took place, many nations have already expressed their interest in continuing to trade with Britain on a preferential basis, including a number of countries within the EU.

The same, in reality, applies to the movement of labour within Europe. Many of the doomsayers have taken the position that the Brexit vote will mean that the movement of labour between Britain and Europe will be severely constrained, but once again, this is an absurd assumption. Unless mainland Europe intends to be petty, and cost itself in a manner it cannot afford economically, they will not suddenly block the movement of labour from the UK to the mainland, and neither will the UK do the same for the members of European countries wishing to visit their island. This is currently the situation with Switzerland, also not a meber of the EU (and doing fairly well for or despite it!) and it seems unlikely that the UKs approach will differ materially.

It is perhaps true, however, that immigration and the misguided fear of major inflows of immigrants was a contributor to the Brexit votes success, however, the idea that a crackpot like Nigel Farage is now going to rule the British Isles, is as absurd as the aforementioned claims. 52% of the population voted out of the European Union, they certainly did not vote for Farage. And, most importantly, many of the Brexit voters are highly unlikely to have voted for Brexit based on immigration concerns. This further reinforces the view that the rules around the movement of labour are unlikely to be dramatically altered, but rather lightly adjusted. Britain will simply take more control of its borders, but won’t suddenly become disinterested in the plight of the less fortunate, be they economic or conflict refugees or immigrants.

The reality, in my view, is that much of what Britain benefits from the EU it will manage to hold onto anyway (or substitute for with other trade agreements), while much of what is detrimental to Britain from the EU will be done away with, or at least Britain will have more control over. This is true of trade, true of immigration, and true of legislation.

Markets

The one argument against leaving the European Union that does hold water, in my view, is that we are in for a period of increased uncertainty. It appears that both the markets and the Brexit campaigners were caught unprepared for the outcome of Thursday’s vote. The fall in the GBP seen at the close on Friday was a 6+ sigma event, and it doesn’t look likely that this selloff is quite over yet.

Financial markets, much like many individuals and institutions, seemed to panic on Friday. However, markets are notoriously good at overreacting, and after a brutal sell-off on the open, the UKs FTSE 100 index ended up closing down just over 3%, back to a level it was at just three days before. Despite the supposed turmoil, it actually closed up for the week. How long this will last, however, remains to be seen.

Given that fundamentally I do not believe the vote will have a long-term negative impact for Britain, but that we will see uncertainty through the restructuring period and sentiment may drive some economic challenges, I find it hard to believe that the financial market reaction will be long lasting. However, this position may change quickly should the process of Brexit be poorly managed, or should the likes of Scotland decide to try and remain in the EU. Nevertheless, heightened volatility over the next few months is inevitable, a recession in 2017 in the UK is possible, but beyond that, the economy is unlikely to collapse, and may actually see improved growth long term (a weaker exchange rate has a funny habit of improving productivity and export competitiveness).

Europe

As much as I believe Britain will not be negatively affected by this move in the long term (but may be short term), I think the EU will lose, and may lose big. The EU has been likened to a three legged table (UK, France and Germany) holding up the other member states through direct and indirect fiscal and political support. With Britain, one of the net contributors to the EU, bowing out, a greater burden will be placed on France and Germany, and added to this, many of the smaller nations will likely stand to suffer as a result. Thus, those that remain will all stand to lose. It is possible, but as of yet uncertain, that Britain’s exit may well spell a further unwinding of the EU, and potentially, the Eurozone. While most will disagree on this, my view is that this would be a positive development for the world long term (although tragic and challenging short term). I have been a Euro skeptic since day one (monetary union without fiscal union is not possible), and I think that the sooner Europe realizes this and either integrates completely or disintegrates, the better for the world (short/medium term pain, but I believe for long term gain). Obviously this is the Euro and not the EU, but the two are clearly not completely mutually exclusive. Perhaps the demise of one will spell the demise of the other.

Scotland

All of this said, should Scotland now vote to remain in the EU, I think the whole Brexit vote will be net negative for Britain and the remainder of the EU, and of course, Scotland. While it is a phenomenally bad idea for Scotland to vote this way (leaving a trade agreement and leaving a fiscal and monetary union are very different prospects), the SNP appears to have a growing legacy of backing the losing horse. As I believe Europe will be weaker for the Brexit vote and Britain will be stronger for it, Scotland will be shooting themselves in the foot, and they would likely take the remainder of Britain down with them.

Southern Africa

For Southern Africa, we are unlikely to be unscathed. Already, the largest market in the region was on the receiving end of the same hiding that was dished out to all world markets on Friday. We may see changes to our trade agreements with Britain, and possibly with the EU (unlikely). We may see abnormal currency volatility (but we are use to high volatility), and this may result in increased inflation. At the same time we may see lower global interest rates, which may drive fund inflows to EM and lower inflation. We may see increased growth, or more likely, we may see external demand decreasing as sentiment drives more cautious consumer behavior in advanced economies. The bottom line is that we will definitely see increased uncertainty, and increased volatility, but the world will not stop, and the global economy will not collapse.

Final thoughts

British voters made a selfish decision to move away from a (fancy) trade agreement that wasn’t working for them. They did not decide to shun the economic system as we know it, or appoint Nigel Farage as their leader in chief, head of national morale or king. This decision will likely provide us with short term/medium term challenges, and heightened volatility, but it may also stand a chance of improving our long term outlook from the current picture of ever slowing global growth and ever heightened uncertainty. For now, everybody needs to calm down, and follow the facts as they develop, hope Scotland doesn’t mess it all up, and not assume Britain is suddenly going to build a wall. Let’s leave that to America.

Never before has the term “a storm in a teacup”, seemed more fitting.