Hindsight is 20/20 – it’s easy to know the right thing to do after something has happened, but it’s hard to predict the future. Enter the year 2020, and that saying has never been truer in the area of investments, says Victoria Reuvers, director and senior portfolio manager at Morningstar Investment Management South Africa.
It’s no secret that the past few years have been hard on South African investors, and there are some noticeable dark clouds looming on the horizon in 2020, according to Reuvers.
“Unfortunately, the rand remains weak and a Moody’s downgrade remains likely. On the global front, the trade war between the world’s two largest economies continues and the US will soon start to gear up for its next presidential election.”
What are the key hindsight “20/20” lessons to take into 2020?
Every year holds bad news, dramatic headlines and things to worry about. It is safe to assume that 2020 will be no different. When investors are faced with negative or sensationalist news, it’s hard not to worry and/or not to react.
“Even though acting on these calls to action may give investors a sense of control in the short-term, it is the surest way to destroy wealth in the long-term. It would serve investors well to remember that concerns and uncertainties surrounding the future, is most likely already priced into any associated assets,” Reuvers said.
Steer clear of regret and envy
There have been many quick win strategies and “hot tips” over the years and this will likely continue. As long-term investors, Reuvers said that Morningstar tends to steer away from “hot tips” and rather remain focused on fundamentals.
“Although that might mean missing out on the occasional quick win, we prefer to stick to our knitting and stay true to our long-term view.”
Morningstar outlined some of the possible 2020 events that are worrying investors and what the impact could be on portfolios:
What would a downgrade mean for South Africa?
A downgrade to sub-investment grade from Moody’s would result in South Africa losing its place in the Citigroup World Government Bond Index (WGBI).
This could translate to a forced selling of South African bonds by international investors that are mandated to only hold investment-grade bonds. The rand could potentially weaken against the US dollar due to foreigners selling local bonds, Morningstar said.
“With that said, the WGBI is not the only government bond index. Should South Africa fall out of the WGBI, it would be included in several other global indices that only include countries that are sub-investment grade.
“In other words, as some investors would be selling South African bonds, there would be a host of foreign investors that would be buying local bonds.
“At a portfolio level, there may be a short-term movement in the currency and bond yields might spike but over the medium-term this would settle, and the current yields would have more than priced in this risk. In so doing, investors would be compensated for an overly pessimistic outcome,” Reuvers said.
If the downgrade will have such a big impact on government bonds, should I remain invested?
Market pricing suggests that a downgrade has already been priced into South Africa bonds (given that they are offering investors a real yield of close to 4%.
“It is possible that yields creep higher on the day of the downgrade, along with a weaker rand,” the portfolio manager said.
“Remember, if bond yields rise, it results in capital losses for bond holders, however, investors are being paid roughly 9% a year in yield to compensate for this potential risk. Rising yields could also create buying opportunities for investors.”
She said that once South Africa is downgraded, investors who invest in sub-investment grade options will start allocating to South African bonds. This, combined with the fact that nearly 60% of European debt is yielding negative returns, would be a good
Morningstar pointed to good value in South African government bonds as well as select South African equities, which appear to have the pessimism and bad news priced into it already.
I’ve been told for the past three years not to move to cash, where you could have gotten 7% a year. Why should I remain invested and not move to cash now?
Reuvers said that having a portion of your investments allocated to a cash component is part of a well-diversified portfolio.
Historically, over the long-term, equities continue to outperform cash. “Cash may provide security in the short-term, but one must remember that it also has its risks. Cash is subject to inflation risk, and if the value of your investments does not keep up with inflation, you will lose value and purchasing power.”
Conservative investors in a cash plus or a cautious portfolio still have to manage growth assets and ensure that the yield of the total portfolio is in line with that of a money market, Reuvers said. If an investor has longer than a 12-month time horizon, he/she is likely to get capital growth from the underlying assets.
The below graph illustrates the rolling five-year return of the JSE relative to the rolling five year return of cash and highlights how unique the last few years have been, with cash outperforming equities for a sustained period.
“However, it is clear that equities deliver substantial returns over cash over the long-term,” the portfolio lead said.
What will 2020 hold for equities?
Reuvers said that investors should remain disciplined, focused on valuations and identify opportunities in unloved, well-priced asset classes. “In this context, volatility in market prices should be welcomed.
“A drop in price can create opportunities for managers who hold cash to buy assets that are significantly under-priced relative to their long-term fair values, thereby sowing the seeds for future returns.”
Morningstar said that the biggest concern at the moment is the impact that trade wars are having on global growth. This remains a severe area of concern as global world trade accounts for roughly a third of the global GDP. A slow-down in world trade will impact global growth, which will affect all countries and economies.
The financial services firm noted that currently, in the global landscape, large cap US equities are looking expensive, so it has been building exposure to unloved areas of the market such as UK equities, Japan and US cash.
A tried and tested philosophy of not overpaying for assets that people have fallen in love with (as a result of some form of sensationalism) has rewarded investors handsomely in the past.
“Keep an eye on the fundamentals – often bad news is in the price, offering an attractive entry point for long term investors. This is, however, easier said than done. It is much easier to buy something that makes you feel good – even if it’s expensive and unlikely to repeat its recent return run,” Reuvers said.
“When thinking about the valuation opportunity in select South African equities that have been battered over the past five years, it is impossible to predict when unloved areas of the market will turn around and deliver returns – nobody rang a bell on the 9th of March 2009 and said the crisis is over, let’s go markets.”
Looking at the next decade
President Cyril Ramaphosa’s investment drive to raise $100 billion worth of investments into South Africa, continues to be keenly watched by South African market participants and businesses. At the 2019 Africa Investment Forum, 56 deals worth $67.6 billion made it to the boardroom discussions at the forum.
According to the Africa Investment Forum statement, this is an increase of 44% compared to last year. Of the 56, 52 made it to approval. The deals secured investor interest worth $40.1 billion. “Rectifying the economic decay and low confidence that has built up over the past decade will take time. Make no mistake, this will be a multi-year process, but it has started,” Reuvers said.
“While market conditions are both challenging and uncomfortable, it is exactly times like this that investors should be encouraged to stop, pause, and use evidence and perspective as their guide.”