Sell in May and go away? A note on seasonal patterns in share returns and the outlook for global share markets for the remainder of 2016

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1 DSFIN monthly report: May 2016 Global financial markets during May Most global stock markets gained in May as investors continued to speculate about the timing of the next US interest rate rise. Oil prices gained, rising to $50 per barrel during the month. US equities gained against a backdrop of improving macroeconomic data. Inflation accelerated, fueling expectations of a Fed hike in June or July, in turn supporting a dollar rally. Eurozone equities posted positive returns, helped by a weaker Euro. Japanese equities gained ground and the yen weakened. Economic data was largely positive. Most emerging markets posted negative returns, especially Brazil and Turkey. China outperformed despite some disappointing macroeconomic data and concerns about capital outflows The JSE during May Despite losses in the gold and platinum sector, the JSE All Share Index closed 1.79% higher in May. Among the main Indices, the JSE Industrial Index was the only to register a gain (5.1% gains). The sector was supported by Rand weakness during the month, benefiting Rand hedge shares. The JSE Platinum Index lost 15.96%, while the JSE Gold Index was 10.72% lower at the end of May. This was mainly due to the strengthening US dollar and a reduction in safe-haven buying from investors which limited demand for resources shares. The Gold and Platinum Indices are still the best performers, year-to-date, on the JSE with gains of 80.75% and 79.22% respectively. The Banking Index fell 3.98%. This can partly be attributed Moody s decision to revise its ratings outlook on the South African banking system to negative from stable. Moody s expect SA banks creditworthiness to come under pressure in the next 12 to 18 months. The exchange rate of the Rand during May Pressure from an emerging market sell-off, local political instability and indications that the US Federal Reserve is prepared to raise interest rates as early as June led to a weakening of the Rand during May. The rand depreciated by 10.04% against the US dollar, 6.35% against the euro and 8.73% against the pound during the month. On a year-to-date basis the rand has lost 1.51% against the US dollar, 4.12% against the euro and 0.90% against the pound. Global market commentary: Sell in May and go away? A note on seasonal patterns in share returns and the outlook for global share markets for the remainder of 2016 We all know the saying sell in May and go away and the fact that there is a seasonal pattern in share returns, with relatively low returns from May-September. However, this year might be different: global share market returns were very low during the first four months of 2016, the traditionally strong months for shares. On the other hand, returns on most global markets and the JSE were positive during May. 1

2 A possible reason for the weak first 4 months of 2016: oil was the major theme on the financial markets During the first 3 months of 2016, equity markets were all fixated on oil prices. The oil price had a dominant effect on the US equity market. The correlation between the intraday movements of equity markets and oil price movements was remarkable: every price movement of USD 1 per barrel more or less resulted in a 1% movement in the S&P 500. The price of a barrel of oil fell by almost USD 15 in the first two months of the year, it is clear just what an impact this move had on the financial markets. If one then assumes that the oil price would continue to have a big impact on share markets, the logical question to ask is what will happen to the oil price? In this regard, Lukas Daalder from Robeco asset management warns that it is extremely difficult to accurately predict changes in the oil price. It is difficult to estimate changes in both oil demand (how quickly is the global economy growing and how quickly the shift to alternative energy sources is occurring?). Supply side predictions are equally difficult. The cost of extracting shale oil fell much more quickly that people had expected (which lead to more supply at every price level), but we were also dealing with a change in Saudi Arabia s stance (no longer the swing producer to which we were accustomed) and the prospect of Iran returning to the global market as an oil producer. There are also other short-term aspects to take into consideration, such as generating sufficient cash to pay off debt (for example for those US companies active in the high yield market), to win or keep market share (Saudi Arabia) or finance wars (ISIS). Speculation, rumors and production shocks make short-term oil-price predictions even more difficult. Despite this difficulty in predicting oil prices, most analysts expect the oil price to continue to strengthen for the remainder of Some factors that support a higher oil price: Increased demand from India. India is expected to have the fastest growing demand for crude between now and 2040, according to the International Energy Agency (IEA). Oil demand from India represented 30% of total global oil consumption growth in Q This makes it the world s star performer growth market, a role occupied until recently by China. Contributing to this increase in demand are policy changes that make India s economy resemble China s in the late 1990s, soon before its industrial boom. Compared to other major economies, India s per capita consumption of oil is relatively low, as ownership of cars and motorcycle is still developing, with penetration at merely 144 per 1,000 people. In terms of passenger cars alone, the rate is closer to 17 per 1,000 people. (In the U.S., the figure is 850 per 1,000 people. The number of vehicles driving on Indian roads doubled between 2007 and The country is now on track to become the third largest auto market by 2020, behind China and the U.S., and obviously this has huge implications for oil consumption. Global oil markets are rebalancing faster than expected. U.S. producers, reacting to low prices, continue to trim exploration and production spending, leading to fewer active rigs and, consequently, less output over the past year. Oil demand remains strong. The IEA expects global demand to outpace supply in mid to late 2

3 2017. Analysts with Bank of America Merrill Lynch believe that oil demand will peak sometime after 2050, as long as we remain in a relatively low oil price environment of $55-75 per barrel in real terms. Standard Chartered s chief economist, now see oil climbing above $60 by the end of the summer. Goldman Sachs noted that global storage levels are heading into a deficit much earlier than we expected. The busy summer travel season is also expected to boost oil demand. For example, the industry trade group Airlines for America expects record high air passenger numbers for the summer seasons in the USA. Production shocks. Supply disruptions as a result of wars, strikes, sabotage and even forest fires (Canada) can also have a large impact on the oil price. The following graph provides an indication of such disruptions There is an increasing level of supply disruption in Nigeria. This is partly the reason why Goldman argues that the oil price really has already hit its lowest point. This is a shift in opinion given their earlier warning that oil prices could fall below the USD 20 per barrel mark Apart from uncertainty about the oil price and the risk of seasonal weakness in the months ahead, there are several other risks in the short term. Event risks during June, including the June Fed meeting for consideration of another interest rate hike and the Brexit vote on June 23 with a leave vote likely to be negative for the UK economy and posing the more significant risk that it might trigger renewed debate about a break-up of the Eurozone. 3

4 Uncertainty around how much the Fed will ultimately hike will likely cause ongoing angst in terms of its impact on the US economy and globally if a rising US dollar puts renewed pressure on commodity prices, emerging countries and the Chinese Renminbi. The US Presidential election in November and the rise of Donald Trump The global growth environment remains fragile and China remains a source of uncertainty. The US share market might be in for a correction- it is trading at relatively high valuation levels and had the smallest fall from its high last year to its low in February (-14% compared to 20% plus falls in other major share markets). According to BCA, equity mutual fund inflows have dried up, with little prospect for a recovery given negative sentiment. A plunge in share buyback announcements, on the heels of corporate credit quality strains and shrinking free cash flow, could further lower the demand for shares. SA: uncertainty surrounding local elections in August The lead-up to South Africa s local elections in August has turned increasingly violent as poor communities use the campaign as leverage to demand better living standards.communities staged 70 protests against a lack of decent housing, education and other services in the first four months of the year, up from 44 in the same period last year, according to Municipal IQ, which monitors the municipalities. Perceptions that the authorities only respond to grievances when demonstrations turn violent is fueling the unrest, according to Kevin Allan, the research company s managing director. However, against this there are reasons for optimism particularly beyond near term risks. First, some of the above mentioned risks may not be as threatening as they look: The Fed would be very careful when deciding on interest rate increases. Chair Janet Yellen and other key decision makers have repeatedly stressed that it takes account of global risks and that it is likely to be gradual in raising rates. The above mentioned risks are arguably well known and should be allowed for at least to some degree. After all most share markets are down on year ago levels. Remember the old saying shares climb a wall of worry. Valuations for most share markets are not onerous. Price to earnings multiples for some markets are above long term averages, valuation measures that allow for low interest rates and bond yields show shares to be cheap. 4

5 Source: Thomson Reuters, AMP Capital The Shiller or cyclically adjusted PE is actually cheap for most markets globally including Eurozone, Chinese and Australian shares (see the next chart). It must be noted that the Shiller PE for US markets is high in historical terms. 5

6 Source: Global Financial Data, AMP Capital Global monetary conditions are very easy and likely to remain so, with further easing in Europe, Japan and probably China likely to ensure that liquidity conditions for shares and growth assets remain favourable. Although global economic growth is slow in historical terms, there are no signs of a US or global recession. This is very important. Stockbroker Credit Suisse, distinguish between Gummy bears (bear market during economic expansion) and Grizzly bears (during economic recessions. Grizzly bear markets tend to be much deeper and longer than Gummy bear markets. If recession is avoided as appears likely, the profit outlook should start to improve. There are some pointers to this: US earnings are likely to have bottomed as the negative impact of the fall in oil prices and the rise in the $US has abated; earnings momentum will improve in many JSE listed companies as the impact of last year s plunge in commodity prices which drove resource profits down 60% falls out. A note on a possible Brexit Why this is important: it causes uncertainty, which in turn could lead to global stock market volatility, indirectly impacting on JSE returns in the short term. Brexit would be seen as a negative for the UK given the threat it would pose to its access to EU markets, its financial sector and labour mobility. The size of this impact would depend on what sort of exit is negotiated with the EU but has been estimated at somewhere around -2% of UK GDP. This would adversely affect UK assets including the pound. This will impact on earnings from companies earning the majority of their earnings in the UK, for example BAT. Here are some key points on the June 23 Brexit vote: Even if Britains vote to leave the EU, it could be two years or so before the terms of the exit are agreed. The real issue would be perceptions of the impact on the Eurozone. It could lead to renewed concerns about the durability of the Euro to the extent that it may be seen as encouraging moves within Eurozone countries to exit the EU and Eurozone, which in turn could reignite concerns about the credit worthiness of debt issued by peripheral countries such as Greece. This can lead to a flight to safety out of the Euro into the US$ which could in turn put renewed pressure on emerging market currencies, the Renminbi and commodity prices. All of which could trigger a bout of nervousness in global financial markets. However, Shane Oliver from AMPCapital is of the opinion that a majority of British voters will chose to stick with the status quo, much like the Scots did last year attach a 70% probability in favour of Remain. JUST HOW LOCAL IS THE JSE By Charles Collocott of Sharenet Close to 65% of the JSE s Top 40 earnings comes from foreign currencies and as the below table below shows, just over 50% is from the top 10 largest companies alone. The extract relevant data from each company s latest financial statements. According to his research, the JSE Top 40 has just over 64% exposure to foreign currencies. 6

7 The article contains interesting information about the earnings of the different Top 40 companies, including the percentage of earnings earned in foreign currency. The table below provides a summary of this information. Top 40 companies with 100% of earnings in foreign currency Capital and Counties properties, Intu properties, Anglogold Ashanti, Angloplat, BHPBiliton, Sasol Top 40 companies with 70%-92%of earnings in foreign currency Richemenot 91.60%, SABmiller 80%, BAT 75.8%, MTN 72.77%, Aspen 78%, Mondi 90%, Mediclinic 73% Top 40 companies with 40%-70% earnings in foreign currency Steinhoff 67.75%, Woollies 45%, Bidvest 48.5%, Netcare 48% Naspers 47.95% Top 40 companies with less than 20%earnings in foreign currency FirstRand 6.55% Shoprite 14.78% Growthpoint 15.5% Vodacom 8.14% Redefine 17% MrPrice 8.36% Nedbank 6.38% Reinet 19.7% Capitec, Fortress Income (A and B fund), RMB: all 0% The correlation between the JSE Top 40 returns and the Rand/ US $ and Rand/ Euro exchange rates is shown in the following graph. The rows labelled USDZAR-6 is the correlation between the USDZAR and JSE Top 40 returns 6 months later. The rows labelled USDZAR-12 is the correlation between the USDZAR and JSE Top 40 returns 12 months later. The same applies to the EURZAR. 7

8 Over all the different periods the correlation was never lower than 0.87 signalling a significant relationship between the two exchange rates and JSE returns. And the highest correlation occurs when one uses JSE returns 6 months later. One might assume that this is because the changes in the exchange rate have had time to reflect in the company s next reporting period and the market has rewarded or punished the share for it. The graph also show that the correlation between the exchange rate and Top 40 returns changes over time: sometimes a weaker Rand coincides with high Top 40 returns, while a weaker Rand sometimes coincide with lower share returns. Thus, factors other than the Rand exchange rate also impact share returns. The exchange rate is thus just one factor investors should take into account. A summary of individual company news and results during May 2016 AngloGold Ashanti (ANG) Market update for the quarter ended 31 March 2016 AngloGold announced that adjusted earnings before interest, tax, depreciation and amortization decreased to $378 million in the three months to 31 March 31, compared with $402 million in the previous year. Production dropped 11% to 861,000 ounces while all-in sustaining costs slipped 6.5% to $860 an ounce. Brait (BAT) Trading statement for the year ended 31 March 2016 Brait expects NAV per share to increase in rand by 74% to 80% to between R and R (2015: R77.12) and in euros by 35% to 40% to between 8.00 and 8.27 (2015: 5.92). Bidvest (BVT) Corporate action Bidvest s food services division, Bid Corp (BID), spun off from its parent company and listed on the JSE Top 40 Index. Compagnie Financière Richemont Final results for the year ended 31 March 2016 Richemont reported HEPS of 2.882, which is an increase of 34% (FY15: 2.143). A cash dividend of CHF1.70 was declared. Investec (INL/INP) Final results for the year ended 31 March 2016 Investec reported 38.5 pence, which is an increase of 7.5% (FY15: 35.8 pence). A final dividend of 11.5 pence was declared taking total dividends to 21 pence, which reflects a 5% increase (FY15: 20 pence). Mondi Group (MND/MNP) First quarter trading update First-quarter underlying profits rose 14% to 269 million ($307 million) from 236 million in the previous year. Mr Price (MRP) Final results for the 53 Weeks Ended 2 April 2016 Mr Price reported HEPS of 1,057.8cps, which reflects a 15% increase (FY15: 919.7cps). A final gross cash dividend of 419cps was declared, taking total dividends to 667cps which reflects a 15% increase (FY15: 580cps). MTN Group (MTN) Quarterly update for the period ended 31 March

9 MTN announced that Group subscribers decreased by 1,4% q/q. MTN South Africa subscribers decreased by 1,7% q/q. MTN Nigeria subscribers decreased by 6,9% q/q. Constant currency (organic) data revenue increased by 20,1% y/y. Corporate action The Nigerian government suspended talks on the $3.9 billion fine imposed on MTN and the group announced that it will appoint a new CEO by the end of June at the latest. Netcare (NTC) Interim results for the 6 months to 31 March 2016 Netcare reported HEPS of 86.7cps, which is an increase of 1.8% (FY15: 85.2cps). An interim dividend of 38cps was declared, which is unchanged from the prior year. A perspective on longer term global share market returns The following graph show cumulative returns from selected global stock markets since The French market was the worst performer over this period- the CAC40 index is still considerably lower than levels reached in On the other hand, the Indian stock market is up over 400% over the same period. This once again points to the danger of historical share return comparisons- for instance in this case; the positive impact of the commodity boom on emerging market share returns should be taken into account, as should be the negative impact of the 2000 stock market crash on developed market returns. Choosing a different sample period can have a dramatic impact on the results. Nevertheless, it is a reminder of the sometimes dramatic difference between share returns from different regions. It must also be kept in mind that the graph compares index levels- it is thus an indication of returns in the local currency. Currency movements can have a big impact on returns in, for example, US $. 9