OCTOBER 2018 PROSPERITY IN THIS CLIENT NEWSLETTER. Economic and market overview Global equities

Transcription

1 OCTOBER 2018 IN THIS CLIENT NEWSLETTER Economic and market overview Global equities

2 INTRODUCTION The Starbucks logo is a unique design that unfailingly catches the interest and attention of onlookers. The logo has undoubtedly contributed to the company s success worldwide. The original Starbucks logo was the image of a twin-tailed mermaid, or siren. Greek mythology has it that sirens lured sailors to shipwreck off the coast of an island. In Homer s Odyssey, when Ulysses is sailing home from Troy, he is warned that he will sail past the island of the Sirens. Their singing was fabled to be so compelling to sailors who, unable to control their impulses, jumped overboard to their deaths. Unlike his predecessors, Ulysses understood that he was human and fallible, and probably unable to control his response to the Sirens call. So he asked his crew to bind him to the mast with ropes. And so, when the time came, he could hear the Sirens call, but do nothing about it. As for his crew, they were instructed to put bees wax in their ears so they could see but not hear the Sirens. October was a month where investors would have done well if they heeded Ulysses example. This is when having a professional portfolio manager as part of your crew can really save you from your own impulses. Jumping overboard and selling your equities when markets are in turmoil is the most certain way to destroy wealth. The sirens were sounding in media headlines all month long warning of impending doom especially the negative impact on companies from trade wars and rising US interest rates. While these concerns are not without merit, the sentiment was overly negative during the month. Interestingly, October is statistically the month with the greatest propensity for increased volatility. Many of the major historical equity market pullbacks have occurred in October. Yet, with a few notable exceptions, the market recovered most, if not all, of the losses within a short space of time after these Red October events. This time markets pulled back over 10% during the month, but towards the end of the month some recovery was already evident. Notably Starbucks, a long-term holding in our Global Equity Model Portfolio, rallied 10% on excellent results posted on 1 November. If you invest for the long term without being aware of your probable emotional responses along the way, you re likely to end up failing, and failing expensively. Your best safeguard is having a clear investment strategy and a professional portfolio manager at your side to help you achieve the best possible anxiety-adjusted returns. The time to buy is when there's blood in the streets Baron Rothschild ECONOMIC OVERVIEW October was one of the worst months on record for global equity markets. Although the underlying economic picture remains solid, investors appear to be concerned that growth will slow in the near future, possibly due to some combination of tighter monetary policy and the impact of trade tariffs. Coupled with this, in the US the boost from fiscal policy is expected to fade next year. The International Monetary Fund s (IMF s) latest World Economic Outlook shows that global growth in 2018 and 2019 is likely to be slightly below what was predicted in April. However, the 3.8% real growth expected in both years is still solid compared to the preceding years. While the IMF warned about high global debt levels, interest rates remain historically low (even in the US) and borrowers are generally still in a position to service debts, outside of isolated cases like Turkey. US economic growth was 3.5% in the third quarter (3% year-on-year). Consumer spending was strong in the quarter and should remain solid as consumer confidence is still high. Residential investment (homebuilding) contracted in line with a cooling property market. Investment by businesses was weak in the third quarter. It is clear that the cuts in December have not yet stimulated a surge in capital spending by firms, who have largely passed the gains on to shareholders. Eurozone GDP growth disappointed in the third quarter, slowing to 1.7% year-on-year. However, this is still in line with the long-term average growth rate of the Eurozone economy, after several quarters of aboveaverage growth. Slowing growth in the Eurozone creates a headache for the European Central Bank (ECB), which left policy unchanged at its October meeting. The ECB still plans to end its large-scale bond purchase programme (quantitative easing) at the end of the year and start hiking rates mid However, despite all its efforts, core inflation (excluding food and fuel prices) remains around 1%. Against a volatile global market backdrop, many investors hoped that the local Medium Term Budget Policy Statement (MTBPS) would provide reasons to be more optimistic about local prospects. This was not the case. Investors were expecting Finance Minister Tito Mboweni to announce a larger budget deficit for the current year than the 3.6% pencilled in in February. However, what the market was not prepared for was that deficits for the next two years would be widening, instead of narrowing. The deficits for the 2019, 2020 and 2021 fiscal years are now expected to be 4%, 4.2% and 4.2%, respectively. This means that the debt to GDP ratio will stabilise at 59% instead of 56% and only by As a result, interest payments will grow by 11% per year over the next three years, faster than any other item in the Budget, even the wage bill, which is set to grow at 7.2%. The MTBPS was neither bond-friendly nor ratings-positive. S&P, Fitch and Moody s have already noted their concern, but no immediate downgrades are expected. MARKET OVERVIEW Following the lead of global markets, the JSE currently in its longest downward business cycle in more than 70 years ended October down by nearly 6%. More than a third of the shares listed on the JSE have declined by more than 15% during In the US, the Dow Jones and S&P 500 fell 5% and 7% respectively. The NASDAQ ended October 9% lower, its largest monthly decline since November Rising interest rates, a trade war between the two largest economies in the world and a slowdown in global growth are some of the reasons for the global selloff in October and there is a very good chance of seeing the Fed raise interest rates in December. Stock markets in Asia and Europe also suffered major declines. The CBOE Volatility Index (VIX) rose by 76% for the month, indicating the magnitude of the volatility experienced by global markets. On the commodities front, brent crude saw its largest monthly decline since July 2016, falling nearly 9% as OPEC, Russia and the US have increased their output and more than made up for the decline in Iranian shipments as sanctions are about to take effect. Gold rose slightly off its 2018 lows to end the month around US$1 214 per ounce. The local exchange rate had an equally volatile month, with the rand trading between and against the US dollar, closing at Investors in local government bonds also demanded higher yields at the weekly government auctions as demand eased fairly sharply compared to previous weeks. 1

3 GLOBAL EQUITIES BANK OF AMERICA During the third quarter, Bank of America delivered its highest quarterly pre-tax earnings result in the Bank s history. Responsible growth, backed by a solid US economy and a healthy US consumer, were cited as the main contributors to this positive result. Diluted earnings per share grew 43% to US$0.66; total revenue rose 4% year-on-year to US$22.8bn; and net income rose 32% to US$7.2bn. A lower tax rate contributed significantly to the income growth as the bank s tax rate was 20%, compared to 29% in Q Performance was further aided by continued growth in deposits, client balances in wealth management, solid loan growth, and disciplined expense management. Bank of America s management have been able to drive higher operating leverage over the past few years and we believe there remains scope to further reduce expenses and improve the Group s efficiency ratio, which will drive earnings higher. Due to the large contribution from consumer banking, Bank of America s balance sheet is highly sensitive to higher interest rates. As US short-term interest rates increase, we expect the bank s net interest income to increase ahead of peers. The Group is well capitalised, which best positions them to navigate the uncertain global environment. Recently, the Group has begun to show strong growth in deposits, taking market share from peers. We expect this to continue on the back of their leading mobile offering, which creates opportunities to deepen customer relationships and benefit from an improving US economy. JOHNSON & JOHNSON Johnson & Johnson reported third quarter results that were above analyst expectations. With the exception of the Medical Device segment, which marginally declined, the Group s other segments reported revenue growth that was supported by good performance from recent acquisitions and solid uptake of new drugs. Group revenue for the period was up 3.6% to US$20.3bn and adjusted earnings per share rose 7.9% to US$2.10. The Group also upped its guidance for the full year to between US$81bn - US$81.4bn for sales and US$ US$8.18 for earnings per share. The guidance reflects operational revenue and earnings growth of about 6.5% and 11.8% respectively. Johnson & Johnson is the world s largest healthcare company and offers exposure to a diverse portfolio of treatments for ailments in immunology, infectious diseases, cardiovascular and oncology. This diversification will continue to support stable earnings and dividend growth. The Group has a leading consumer segment with a focus on baby care, beauty, women s health and oral care. We believe that this segment is defensive (high brand loyalty) and has scope for revenue growth within specific emerging markets. Johnson & Johnson is highly cash generative and invests about 13% of sales into research and development, which we believe creates a significant moat around the pharmaceutical segment. This is one of the key reasons why the Group has some of the leading drugs in the markets it operates in. MICROSOFT Microsoft released first quarter 2019 results that exceeded analyst expectations as revenue and earnings were boosted by strong performances from all three operating divisions. During the quarter, revenue rose 18% year-on-year to US$29.1bn (constant currency) and adjusted earnings per share increased 33% to US$1.14. The Group s operating margin expanded by 3% to 34%, aided by cost control across R&D, Sales and Marketing. Cash flow from operations increased 10% to US$13.6bn. The migration from on-premises to cloud services is a key medium to long-term trend within the IT sector. In our view, Microsoft is the global leader within this sector with its offerings Microsoft Azure and Office 365. Integration is the key for Microsoft s long-term success as it adds extended shelf-life to existing software through increasing compatibility and enhancing functionality. Azure and Office 365 are the centre of this, building on their large installed user base will allow Microsoft to continue growing revenue, margins and earnings while tucking in additional functionality and features. Additionally, Microsoft is finding innovative ways for Artificial Intelligence (AI) to enhance existing software suites, critically embedding AI into Office 365 applications to drive efficiencies. LinkedIn, although still relatively small in the portfolio, has the power to draw even more individuals into the Microsoft ecosystem as users now number 575 million. ALPHABET While Alphabet s revenue growth during the third quarter was below expectations, earnings (supported by a lower tax rate) surprised on the upside. Both diluted earnings per share and adjusted net income rose 36.5% year-on-year to US$13.06 and US$9.1bn, respectively. Revenue increased 21% to $33.7bn, marking the 35th consecutive quarter that Alphabet was able to achieve revenue growth of above 20%. Traffic to Google websites and paid clicks continue to support revenue growth. Despite the strong growth in internet advertising we have seen over a number of years, online advertising still contributes around 40% of total advertising spend. Google is well positioned to benefit from the continued secular trend from traditional to online advertising. The Group s core search business continues to have a dominant and increasing market share. While growth in desktop search has tapered off, the outlook for mobile is attractive. In time, there will be better pricing for mobile advertising relative to desktop, resulting in improved group margins. 2

4 FACEBOOK Higher average ad prices and a higher number of ads delivered contributed to a 33% year-on-year growth in Facebook s revenue (to $13.7bn) during the third quarter. Earnings per share rose 10.7% year-on-year to US$1.76 during the quarter, predominantly driven by a lower than expected tax rate. Facebook s operating margin declined to 42% as total expenses were up 53%. Following from the previous quarter, management have reiterated that revenue growth is expected to decelerate by mid-to-high single digits. This is largely due to the impact of data privacy initiatives and the fact that the high growth being experienced in emerging economies is not being monetised at the same margin as that of developed markets. Despite the strong growth in internet advertising that we have witnessed over the years, online advertising only contributes approximately 50% of total advertising spend. Facebook is well positioned to benefit from the continued secular trend from traditional advertising to online advertising, and more importantly to mobile online advertising. Across its multiple platforms (some of which are yet to be fully monetised), Facebook has 2.6bn users, who are engaged. The Group has a large amount of data on these users, which is enormously valuable for targeted advertising and content viewing preferences. We expect Facebook to continue to increase its average revenue per user over the long term, which will drive profitability. The Group is highly cash generative and reports EBITDA margins above 50%. While margins will decline in the medium term due to increased investment, we see this as being positive over the long term. Increased security and safety will guard the integrity of the platform and reduce the likelihood of punitive regulation. 3

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