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07 Jun 2019

The Unfolding Environment

Our analysis suggests that the world economy is in the late stages of a prolonged, but relatively shallow expansion cycle. There are signs that US growth is slowing while ex-US growth has been anaemic, besides stimulus driven buoyancy in China.


Trump’s geopolitically motivated trade policies introduce uncertainty for global business leaders. While market valuations are not extreme, negative earnings surprises could lead to increased volatility. The Foord global funds are invested in businesses with long-term earnings drivers that are mostly shielded from current geopolitical tensions. But they are not immune to short-term bouts of volatility as experienced in May.


The SA economy faces severe structural risks and is nearing a sovereign debt trap. The new political leadership augers some hope of a better future, but successfully implementing a turnaround requires tough decisions, which thus far seem improbable. Failure to improve growth will be negative for SA’s investment grade rating from Moody’s. The prospect of financial bankruptcy aside, we are as alarmed by the slide towards moral bankruptcy – the scandal unfolding at Tongaat being the latest waypoint.


For the last three years, we have repeatedly stressed our defensive positioning. This strategy has turned out to be broadly correct: low “SA Inc.” equity, low property, high medium-term bonds and cash and maximum foreign assets.


South Africa’s cash and bond markets offer attractive, high-yielding investment opportunities. The R186 medium-term government bond has a high probability of achieving at least 4% per annum above inflation over the next three to five years and we own substantial quantities of this investment.


Share return prospects for companies that sell services and goods domestically remain poor, despite a significant fall in the share prices of SA consumer and industrial companies. We still favour investment in JSE-listed global companies with a lower risk of loss compared to SA Inc. counters. But these too are not immune to short-term volatility.


Despite the correct macro strategy, a small number of domestic stocks have unfortunately dragged down short-term performance over the last few years. This understandably creates cognitive dissonance with our “defensive” portfolio positioning message. However, we expect many of these core holdings to recover significantly. Many already have over the last few months.


The speed with which performance can turn was demonstrated after Tuesday’s shock Q1 GDP contraction print. Many of the funds’ core holdings were up over 5% on the day as other more bullish market players took fright and rotated into the defensive counters that we already own. At the time of writing, this rotation continues and we expect these stocks to contribute to significant outperformance through the full cycle.


Lastly, we are reminded that meaningful inflation-beating returns do not come in tidy increments over every discrete period. Returns are lumpy and cyclical. Staying invested through the long-term cycles is the key to achieving long-term investment outcomes.


We are confident that the portfolios are well positioned for the unfolding environment. As always, we are available at any time for deeper discussion of these issues.


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