Yearly Archives: 2020

It has been a number of months since I have produced a client letter, the last two being in March and April. Quite frankly there has been little to add to what had been said at the beginning of the Coronavirus lockdown. I believe that on balance my views have held true, namely that markets will recover and that the weakness provided a great buying opportunity. I also expressed the view that these events will exacerbate the challenges of the South African economy and further expose the reality of our dire situation. My repetitive call to engage in offshore investing as much as possible has proven to protect portfolio values in Rand terms and since the beginning of 2019 the returns have been phenomenal (in both hard currency and Rand) – this particularly because of my bias to the USA and Eastern markets, with an emphasis on China.

So far I seem to have elevated myself to savant, but in truth there are some elements I underestimated, with the most important being that I felt that the global pandemic would pass and we would return to normality. Whilst not trying to predict the timing of the recovery, I did not think that the viral wave would be with us as long as it has or that there would be a resurgence. I still think that the death rates are rather low relative to total populations, but none the less the world is still unable to put a lid on its spread. The announcement of the role out of vaccines has been of great relief, but the efficacy is yet to be proved on a global scale. Despite “Covid fatigue” (the relaxing of attitudes to the virus), the pandemic is likely to change our way of life. It is my hope that heightened awareness of simple hygiene and some measure of social distancing will remain with us, as will consideration for how our actions affect others.

From a business / investment point of view it has already caused an acceleration of changes in the way we go about our lives. Old school shoppers have been forced to consider online purchases and have discovered the convenience thereof. The same goes for online entertainment and general interaction via social media. Many businesses have discovered the economic benefit of having staff work from home. As a gregarious species, we are not about to all become reclusive, but we are likely to avail ourselves to a greater extent of simpler and smarter ways of going about our lives. Companies that are alert to the new way will be those that not only survive, but thrive.

Much has been said about the apparent disconnect between investment markets and the underlying plight of the many who have lost jobs or a large part of their income. There is no doubt that unemployment levels have increased globally and that this loss of consumers will weigh on economies. However, there are factors that are countering these negative effects. I have already spoken of the online (technology) industry that has enjoyed increased business. It is these type of companies that make up a large part of market weightings (particularly in the USA) and have been behind the market surge. Similar to 2008, central banks have been lowering interest rates, which lends itself to lower discount rates being applied to valuations. They have also, together with government, provided liquidity and financial stimulus packages, once again propping up markets. Whilst these measures can have an inflationary impact, I feel there is limited ability to pass on price increases to a consumer base under strain. As such, and similar to 2008, I expect these stimulatory measures to have a lasting effect.

Going forward I maintain my mantra – invest offshore. From both a structural and political point of view, I find no reason to expect that local returns will match that available offshore. There will be niche opportunities locally, but in general offshore will, in my view, provide superior returns. I continue to advocate the USA as an investment destination as well as the East, with specific emphasis on China. Despite recent political challenges within the USA, the underlying institutions will prevail and I expect their economic dominance to continue. China’s global influence is rising rapidly and the growth of their own consumer base will advance them to a super power with economic influence matching and even surpassing the USA. As a somewhat contrarian play, I also believe in the potential of India, due to its sheer size and youthful demographic. However, I would temper exposure until a more stable political environment emerges (a difficult ask for a country as diverse as this). Other emerging Asian economies also hold attraction for their prodigious work ethic and productivity.

What has changed, is my view on fixed property. I had always regarded exposure to this asset class as being important for its stability and defensive qualities. Rental income had been such a reliable form of income. However, performance has been subdued for some time now. The structural change in the way we shop (online) and the way we work (from home) leads me to feel that occupancy levels will fall and rental income will be under pressure. I therefore recommend exiting this asset class or at least adopting a much reduced weighting. There are however niche property portfolios that would be worth holding, but not the more general office/retail portfolios.

Something else I under-estimated is the limited or even lack of protection so-called conservative funds hold. These would be funds holding only fixed income securities or a strong bias to this asset class. The panic of the lockdown saw loss of value in longer dated interest instruments as concerns over credit risk rose (this was exacerbated in SA as Moody’s downgrade came at the same time). At the short end returns have dropped as interest rates have been cut. There will always be a place for cash holdings to meet specific needs, but to my mind conservative portfolios come at great expense in terms of opportunity costs. Of preference would be defensive equity holdings with a good dividend history (some at levels better than cash).

As I have already said, offshore equity returns have been quite phenomenal since the beginning of 2019. Whilst I do not think this pace will be maintained for the year ahead, I am confident of the continuation of an upward trajectory. This is predicated on the efficacy of Coronavirus vaccines and a somewhat more congenial world order under a Biden presidency. It is difficult for me to recommend chasing after US stocks that have already run so hard, but I do not foresee any surprises on the downside and therefore advocate a hold. The defensive equities I spoke of above that will benefit not only from a recovering consumer base, but also a growing one (especially in the East), is something currently worth considering for a portfolio. China (and perhaps the East as a whole) is also worth including, for both its ascendancy in the world order and the benefits that I think will flow from improved trade under Biden. The USA’s relationship with China will not be a comfortable one, but I do think it will be less confrontational.

Please note that whilst our offices will be closed from 18th December to the 11th January, we are still available telephonically and on email.

After what has been a crazy year, the Harvest Team thanks you for your continued support. We wish you peace over Christmas and prosperity in 2021. Most of all, we wish you good health.

China’s economy plows on as world’s only major growth engine

Bloomberg News

China’s recovery from the coronavirus pandemic continued in the third quarter and showed signs of broadening in September as consumer spending accelerated, keeping the economy on track to be the world’s only major one to grow this year.

Gross domestic product expanded 4.9% in the third quarter from a year ago, missing economists’ forecast for a 5.5% expansion. Both retail sales and industrial production gained momentum in September, reassuring markets that the recovery is on track.

The numbers show China’s early and aggressive containment of the coronavirus has set the economy up for a faster rebound than any of its peers. That’s a rare positive for a world economy still clawing its way out of its worst slump since the Great Depression – a revival further complicated by the resurgent virus in Europe and the US.

“It’s an encouraging and hopeful message for the rest of the world,” said Rob Subbaraman, global head of macro research at Nomura Holdings Inc. in Singapore. “If you successfully handle the health crisis, your economy can recover.”

Retail sales expanded 3.3% in September from a year earlier, industrial production grew 6.9% and investment growth accelerated to 0.8% in the nine months to the end of the quarter. Strong import growth in the third quarter may have dented the GDP number, even though it’s broadly seen as a bullish sign for demand.

Output expanded 0.7% in the year to date, meaning that the world’s second-largest economy has now regained all the ground it lost in the early months of the year.

Markets were mixed on the news. The CSI 300 Index of stocks, which last week was within 1% of a five-year high, slipped 0.3% as of the mid-day break in Shanghai. The yuan was little changed near 6.7 per dollar, after briefly trading at its strongest in 18 months.

Underpinning the recovery has been the containment of the virus that has allowed factories to quickly reopen and capitalise on a global rush for medical equipment and work-from-home technology. That export strength was offset by a recent increase in imports, depressing the contribution of net trade to output growth.

“That should not be viewed negatively,” said Liu Peiqian, China economist at Natwest Markets Plc in Singapore, because the strong import growth suggests the recovery in underlying economic growth is accelerating.

The improving picture has come with relatively restrained government borrowing and central bank easing compared to China’s peers. Instead, the government has focused on targeted support for business and the central bank on keeping liquidity flowing; today’s readings suggest there’s no need to change tack.

‘Basically under control’ 

Central bank Governor Yi Gang said Sunday that China has “pro-active fiscal policy” and “an accommodative monetary policy to support the economy.”

“Right now, China has basically got Covid-19 under control,” Yi said in a webinar organised by the Group of 30. “In general, the Chinese economy remains resilient with great potential. Continued recovery is anticipated which will benefit the global economy.”

Yet the recovery isn’t without its holes.

Even with the virus under control, shoppers have spent about 7% less in the first nine months of the year compared to the same period last year. Services sectors including tourism, education and travel are continuing to lag.

“The economy is not entirely back in its strongest shape,” Helen Qiao, chief Greater China economist at Bank of America, told Bloomberg Television. “The services sector is not doing that well.”

It’s also unclear how durable the recovery will prove to be given domestic pressures from unemployment and rising corporate and household debt. China Evergrande Group, the world’s most indebted developer, has rattled investors amid fears for its financial health.

Much will also depend on how relations with the U.S. evolve after November’s presidential election. Any worsening of trade frictions could throw a spanner in the export revival.

Analysis of International Monetary Fund data shows the proportion of worldwide growth coming from China is expected to increase from 26.8% in 2021 to 27.7% in 2025, according to Bloomberg calculations. The IMF says Chinese growth is virtually the only reason it expects global output to be 0.6% higher by the end of 2021 compared to the end of 2019.

Getting the economy quickly back on its feet is crucial to China’s global ambitions. They were hammered home last week by President Xi Jinping during a tour of tech-hub Shenzhen, where he doubled down on calls to take the global lead in technology and other strategic industries.

Urging an “unswerving” commitment to technological innovation in a period of “changes unseen in a century,” Xi again promoted a need to become more self reliant, a policy that is expected to be a central part of a new 5-year economic plan that will be discussed at a Communist Party gathering expected later this month.

Nearer term, the return in consumer confidence has set the economy up for a strong finish to the year, said Natwest’s Liu. “GDP is on track to grow further into the fourth quarter.”

Solar is now cheaper than coal for energy

Renewables are set to overtake coal this decade as the world’s favourite fuel to generate electricity, the International Energy Agency says.

Solar photovoltaics are now cheaper than plants fired by coal and natural gas in most nations, the Paris-based researchers concludes in its annual report on global energy trends. Those cheaper costs along with government efforts to slash climate-damaging emissions will increasingly push coal off the grid and give renewables 80% of the market for new power generation by 2030, the IEA says.

The findings mark a profound shift away from fossil fuels in the world’s energy supply at a time when governments everywhere are looking for ways to rein in the greenhouse gases blamed for global warming. While hydroelectric plants will continue to be the biggest source of renewable power, solar is catching up quickly because the cost of manufacturing and installing panels has come down so much.

While hydroelectric plants will continue to be the biggest source of renewable power, solar is catching up quickly

“I see solar becoming the new king of the world’s electricity markets,” Fatih Birol, executive director of the IEA, says in a statement with the report on Tuesday. “Based on today’s policy settings, it’s on track to set new records for deployment every year after 2022.”

The IEA’s projections are based on what it calls the Stated Policies Scenario, which assumes Covid-19 is gradually brought under control next year and the global economy returns to levels seen before the outbreak. The scenario includes currently announced policy intentions and targets that the IEA considers to be backed up by detailed measures for the plans to be enacted.

Coal demand shrinks

It also anticipates natural gas demand slowly easing in developed nations, especially Europe, and coal dropping everywhere. About 275GW of coal-fired capacity worldwide, 13% of the 2019 total, will be shut off by 2025, mostly in the US and European Union. That will more than offset increases in coal demand in developing economies in Asia.

Coal’s share of the global power supply is set to fall to 28% in 2030 from 37% in 2019. By 2040, the fuel that once was a staple of utilities will fall below 20% for the first time since the industrial revolution, the IEA concludes. That decline could be even sharper if governments pick up the pace on decarbonisation.

The assumptions require a massive investment in power grids, which need upgrades to absorb supply from more diverse sources that only work when the sun shines or the wind blows.

Investment to modernise, expand and digitise the grid will need to reach US$460-billion in 2030, two thirds more than the cost last year. That spending will help roll out two million kilometers of new transmission lines and 14 million kilometers of distribution networks, 80% more than was added in the last 10 years, according to the IEA.  — Reported by William Mathis and Jeremy Hodges, (c) 2020 Bloomberg LP

Client Letter – April 2020

A luta continua

We are almost two weeks into the lockdown in South Africa and face a rather insulated Easter Weekend. Whilst life might have become somewhat boring, it has also become more introspective and calmer, even spiritual. Those long delayed chores have been seen to and pleasure perhaps found in some of the simpler things of life. A friend shared with me that we have realized how little we need, how much we have and what the true value of human connection is. There are of course those that are not as fortunate, being at the frontline or not having the means to get by. Perhaps social distancing will lead to greater awareness of social responsibility?

Whilst health is of paramount importance, our life savings and investments are particularly valued and needed to help us get through times like these. I have always held that offshore investing (from a South African point of view) reduces one’s risk and this has certainly held true under what is an unprecedented situation in modern times. Markets all came off their highs by about 35% to 40% as countries one by one locked down their citizens. When the world goes through difficulties the Rand always reacts negatively and has lost over 30% of its value, largely offsetting market losses. Therefore from a local perspective those of you who have followed an offshore strategy will find your total investment value has been left largely intact. The weak Rand could well result in higher inflation, meaning that the real value will not hold. However, with the oil price off by so much and a consumer base now under more pressure than ever, I think it will be difficult to pass on any price increases of significance.

There are those that are invested locally for various reasons, one of them being that compulsory money (retirement funds) are compelled to have a large percentage in South Africa. Whilst many of our local counters have Rand hedge qualities, they have not fared well at all. The percentage drop has been similar to foreign markets, but when one adds the currency depreciation it has been significantly worse. It is interesting to note that even fixed interest securities experienced some downturn. The flight to safer currencies, Moody’s downgrade and fear of local default saw yields kick up, thereby dragging bond values down.

China seems to have got through the pandemic (although reporting might be questionable) and their market was far less affected. Europe is still in a bad way, but signs of the virus peaking are there or in the case of the UK expected in the next week or two. The US (mostly in the north) is also being hit hard, but also expected to peak before month end. The expectation of the beginning of the end of the crisis has led to a general rally in markets, recovering almost 40% of losses (as of 7^th April). First world countries have the means to throw massive amounts of funds at their economies, which together with pent up demand will in my opinion lead to a rapid return to relative normality. As such I advocate buying into these markets, although to do so with the Rand at over R19 to the US Dollar becomes questionable. I feel the Rand did over do things and has already come back to almost R18 to the USD. I think at below R18 (and with foreign markets still off their highs) it is viable to buy in.

Assuming correct or complete reporting, South Africa’s infection rate is remarkably low. Whether this is related to a successful lockdown, rigorous infant vaccination program or even a warmer climate, it is good news. However, it does not allow us to escape the fact that the country will now be even more financially broke and the recovery take a long time. There might be positives if the dire situation allows the powers to dispense with political expedience in favour of pragmatic decision making – however I suspect they will find it difficult to elevate themselves above party and personal patronage. I continue to advocate the accumulation of your wealth offshore.

As always, please do not hesitate to get in contact with me should you wish to discuss your personal financial circumstances. Whilst our office is closed, the full team is hard at work from home and available to assist.

I wish you well over Easter – which might be different from the usual recreation, but perhaps one in which contemplation of the greater good will be at the fore.

 

17 March 2020 – Coronavirus – Some Market perspective

Past Epidemics and the MSCI Index – 1970-2020

17 March 2020

With the effect the Coronavirus has had on markets around the world, it’s good to step back and see the situation for what it actually represents. I have 6 points to make –

Firstly, as Goldman Sachs recently remarked, this is a health and confidence crisis, not a financial crisis. Unlike in 2008, the Banks now are in very good shape, with healthy balance sheets and are lending widely to consumers, so credit is flowing.

Secondly, there is no systemic risk to the system. Government Financial Bodies across the world, like the US Federal Reserve, have acted aggressively and decisively to ensure that the fundamentals of their economies remain sound. For example reducing Fed rates and injecting cash into the system. Where businesses are being affected, large Government subsidies are being put together – for example in the US and France and shortly the UK.

Thirdly, China & South Korea have shown that the Pandemic (like all Pandemics before it) has a timeframe – whose length depends on actions taken. The Peak has now passed in those countries and western countries will also eventually meet and move beyond their own peaks.

Fourthly, we are already seeing firms in China, like Foxconn, start to tentatively head back online and get supply chains back in order. It won’t happen overnight, but it’s the system starting to fix itself again and head back to normality in due course. See article here – https://www.techradar.com/news/resumption-of-work-at-foxconns-chinese-factories-beats-expectations

Fifthly, both Morgan Stanley & Goldman Sachs can see an upcoming eventual rebound in the markets, now that we are seeing the end of the emotional sell off, triggered by health concerns over the Coronavirus. Please see the attached graph showing the way the MSCI reacted to past Pandemics and the positive movements in the markets after Pandemics had occurred.

Finally, this is a better investing opportunity than 2009, because not only are market fundamentals more sound, but investors cannot get yield from elsewhere, for example Bonds, so we will see a large bounce back in equity valuations. With equity valuations at current levels, give or take a little bit more volatility, there are some great opportunities for buyers who are willing to look at the bigger long term picture.

 

Credit: Castlestone Management Inc.

Client Letter – What’s going on!

What’s going on!

People are dying! Markets are crashing!

Indeed, what is going on?

Well, what’s happening is that people are being people and markets are being markets.

This sounds like a rather flippant remark on the serious subjects of life and life savings. However, in truth we have been here before – a number of times. There is invariably an event (or series of events) that send the world into a panic, leading to selling of shares and buying of baked beans, toilet paper and now hand sanitizers. And like before, we will one day look back and wonder what all the fuss was about.

I must immediately qualify my dismissive remarks and express deep sadness for those who have lost loved ones due to the contraction of Covid-19. For them the devastation is real. However, the majority who are infected will recover and many more than that will remain untouched. As authorities move to stem its spread, lives will be disrupted and economies negatively affected. It is therefore right that we should be circumspect of markets and accept that companies’ results (particularly in certain sectors) will take a knock. However, eventually the virus will be contained and markets will stabilize and then recover.

In 1987 (gold collapse) the US market dropped over 30% in a very short space of time. In the early 2000’s (tech bubble) it came off over 40%; in 2008 (housing bubble) over 50%; in 2018 (trade wars) almost 20%; and now about 20%. Despite these shocks, the US market is up over 2,500% in the past 40 years – an annual compound rate of 8.5%. For South Africans you can add a further 8% per annum for currency depreciation.

It is worth mentioning that quite a bit of the recent market loss is due to a new trade war – one between Russia and Saudi Arabia. The latter wanted OPEC members to cut oil production in the face of prices coming off due to lower usage (virus related). Russia rejected this, so Saudi Arabia retaliated by ramping up production and dropping prices further. This is bad news for oil producing countries like Nigeria and for many big listed companies aligned to the oil industry. However, for the consumer and countries like South Africa (producing little of its own oil) it is good news.

I am often asked if the market is going to crash, particularly after a good year such as 2019. My answer is always yes, but stating that I just don’t know when. I can also confidently say that this will not be the last crash, but with the same confidence I say that the markets will recover and over time it is growth assets such as equities that will provide the best returns. For those who have cash funds available, these market drops provide great buying opportunities, even if it means doing so with a weakened Rand as markets have come off more than what the Rand has. For those who are already in the market, sit tight – it will get better. That is not to say it won’t first get worse, but short term movements are anyone’s guess.

All of this highlights the importance of good investment planning and considered asset allocation. Equities remain the place to be for longer term investors (5 years plus, although in some cases even 3 years will do). For South African residents, the cushion provided by a weakened Rand during such times shows the benefit of offshore investing – something I have always advocated. For shorter term needs and for those who require regular drawdowns and cannot wait for the markets to recover, fixed income / cash is for you. There are nuances to this, as each individual has their own set of unique circumstances to consider. I welcome the opportunity to continue to guide you on your financial journey and to provide council for those who feel financial anguish in times such as these. In general I encourage you to keep to your long term strategy and not be swayed by short term events. Those who try to time upturns and downturns by moving in and out of markets tend to lose more from predicting crashes than from the crashes themselves.

More important than money, stay healthy and keep the virus at bay as seasons change and we head towards winter.

 

 

 

 

 

 

 

This decade belonged to China. So will the next one.

Martin Jacques

The west is still finding it extraordinarily difficult to come to terms with China’s remarkable ascent

‘China has proven itself to have a formidably innovative economy.’ Xi Jinping proposes a toast at the welcome banquet for the Belt and Road Forum in Beijing, 26 April 2019. Photograph: Reuters

By 2010, China was beginning to have an impact on the global consciousness in a new way. Prior to the western financial crisis, it had been seen as the new but very junior kid on the block. The financial crash changed all that. Before 2008 the conventional western wisdom had been that sooner or later China would suffer a big economic meltdown. It never did. Instead, the crisis happened in the west, with huge consequences for the latter’s stability and self-confidence.

Every year for the past decade, China, not the US, has been the main source of global economic growth. In 2014, according to the World Bank’s international comparison program, the Chinese economy overtook that of the US to become the world’s largest, measured by purchasing power parity. Although China’s growth rate over the past decade has declined to its present 6.2%, it is still one of the world’s fastest-growing economies. Today its economy is more than twice as big as it was in 2010.

This is the story, as pertaining to the past decade, of the most remarkable economic transformation in human history. Unsurprisingly the west is finding the phenomenon difficult to come to terms with, displaying a kaleidoscope of emotions from denial, dismissal and condemnation to respect, appreciation and admiration; though there is presently much more of the former than the latter. The rise of China has provoked an existential crisis in the US and Europe that will last for the rest of this century. The west is in the process of being displaced and, beyond a point, it can do nothing about it. China’s rise is one of those world-transforming changes that occur very rarely in history. And only during this past decade has the west begun to realise that China’s rise will, indeed, change the world.

The story keeps moving. Five years, let alone a decade, ago, China was synonymous with cheap manufacturing. The west believed that China would for long remain essentially defined by imitation, unable to match the west’s capacity for innovation. But China has proven itself to have a formidably innovative economy. Shenzhen has come to rival Silicon Valley – while Huawei, Tencent and Alibaba can be counted in the same league as Microsoft, Google, Facebook and Amazon. Far from this being a product of copying, the Chinese are increasingly engaging in groundbreaking innovation: China accounted for almost half of all patent filings in the world last year. But why should we be surprised? People living in a country growing at 10% per annum for 35 years and between 6% and 8% for the past decade are used to rapid change and constant innovation. And don’t forget that China is an extraordinarily rich and intellectually endowed civilization that has always been hugely committed to learning and education.

Perhaps the starkest demonstration of China’s growing influence has been the belt and road initiative – a global network of Chinese-financed highways, railways, ports and energy infrastructure, launched in 2013. The ambition is no less than the transformation of the Eurasian landmass, home to more than 60% of the world’s population. More than 140 countries, overwhelmingly from the developing world, have now signed up; and the great majority were represented by their leaders at the belt and road summit held in early 2019, a level of representation no other country could match, the US included.

With the present international system entering its twilight, the belt and road initiative can be seen as the embryo of a new order, not in the literal sense, but symbolically. First, with the predominance of the developing world, representing 85% of the world’s population; and second, in the overriding priority given to development, hugely important to the developing world but which barely features on the west’s agenda.

For more than four decades the relationship between China and the US was relatively benign. Donald Trump’s election in 2016 marked a turning point. His hostility towards China, however, is far from unique. It is bipartisan. And not unpredictable. At root the new US attitude is based on a fear that China represents a threat to its global hegemony, something that many Americans regard to be part of the country’s DNA. This fear has in part been stimulated by China’s increasingly proactive role on the global stage, most notably with the belt and road initiative, along with the formation of the Asian Infrastructure Investment Bank, to which Britain was the first non-Asian signatory.

The US’s increasing unwillingness to support the international system that it largely created – as seen in Trump’s attitude towards the World Trade Organization and Nato – marks a retreat. It is already clear that Trump’s trade war against China has not achieved its objectives. Nor will its tech war against China: Huawei’s 5G will prevail in much of the world, probably including most of Europe. As US-China relations continue to deteriorate, and begin to look like a new cold war, it will be no replica of the last cold war. Then, the US was on the rise, the USSR in decline: this time the US is patently in decline and China very much on the rise. Whereas a singular characteristic of the last cold war was military competition, China has historically never competed as a military power and its rise – compared with the aggressive expansionism of the US, UK, France and Germany in their equivalent stages of development – has been remarkably restrained.

The next decade will see a continuing fragmentation of the western-centric international system, together with the growing influence of Chinese-oriented institutions. The process will be uneven, unpredictable and, at times, fraught – but ultimately irresistible.

PDF Document: This decade belonged to China