2019 has been a challenging year for asset managers and their clients. Confidence in South Africa remains dismal, and global macro risks have risen amid trade wars and a slowing global economy. This has seen a very aggressive sell-off in parts of the global equity market, and especially in the case of out-of-favour stocks and sectors.
Conversely, global investors have been comfortable to allocate capital to global bonds (despite negative-yielding debt now totaling $14.8 trillion) and perceived safe havens in equity markets, primarily defensive and tech stocks.
Locally, the JSE has seen very strong performances by gold and platinum shares on the back of sharp increases in the rand prices of precious metals. The rand price of palladium, for example, has almost tripled over the past four years.
At these levels, PSG Asset Management sees no margin of safety in further investment in South African gold and platinum shares. “Market participants appear to be speculating on further precious metal price increases,” says Greg Hopkins, Chief Investment Officer at PSG Asset Management.
Why a ‘fail safe’ could fail
“We are currently seeing extreme divergences in the valuations of popular securities compared to those investors are shying away from. This presents risks as well as opportunities,” says Hopkins.
He notes that investors seeking a smoother ride by switching to cash or buying high-quality counters at any cost may find that this ‘fail safe’ proves to be the opposite over the longer term.
“Missing out on the gains from a market recovery can dramatically erode an investment outcome. Similarly, buying stocks at lofty valuations underpinned by high growth expectations may result in losses if expectations prove to be unsustainable. This ‘safe haven’ approach is thus far from low risk,” he says.
Many credit instruments no longer offer sufficient margin of safety
Overall, investment markets continue to be event-driven, with trade wars and related global growth concerns driving rate cuts by the US Federal Reserve. This has led to a sharp downward move in US bond yields for the first time since 2007, and an inversion of the US yield curve (with 2-year bonds trading at a higher yield than 10-year bonds) in August 2019.
“The indication from the US bond market is that US growth and inflation are expected to be lower going forward,” says Hopkins.
Locally, South African bond yields increased marginally across the curve over the quarter, but performance year-to-date remains solid, driven by declines in bond yields relative to their elevated starting yields (cheap valuations) in late 2018.
However, credit spreads have continued to contract as market participants search for yield. “We believe many credit instruments no longer offer a sufficient margin of safety,” Hopkins says. “Where we have seen credit spreads tightening, we have been selective sellers. We continue to hold credit where we see low probability of default risk and where spreads are above our estimates of fair value.”
Local money market yields attractive
From highs of around 9.5%, five-year negotiable certificates of deposit (NCDs) are now yielding around 8.1%. “Yields in shorter-term instruments have declined over the past year, though actions we took in previous years to lock in those previously higher rates are benefiting our current portfolios,” Hopkins notes.