Highlights

  • Covid-19; a stimulant or depressant on the Global economy?
  • Global inflationary pressures are mounting,
  • Current Portfolio Positioning,
  • Risk asset valuations are rich, but alternatives are lacking

Covid-19; a depressant or stimulant for Global growth?

Almost to the day, a year ago, the world was for the first time confronting the Covid-19 Pandemic. The immediate response was to follow the strategies first deployed by China and to lock economies down and hope it would be enough to suppress the spread of the deadly disease. For a few countries, this approach was successful, but for most, all it did was cause the greatest and sharpest contraction in economies, in living memory and failed to stem the growth of the virus. What followed was aggressive and synchronised monetary and fiscal stimulus on an unprecedented level. As infections and deaths spiked through the ensuing months, so too did quantitative easing, rate cuts, fiscal support and global liquidity soared to levels rarely seen before.

The great irony therefore is that the impacts of Covid on the global economy have quickly shifted from being a deep depressant to a significant stimulant!
Today, twelve months after the start of the Global Pandemic, we are witnessing one of the strongest periods of synchronised global growth we have seen in years.

US retail sales as a reflection of the buoyancy of the world’s largest consumer are growing at an annualised level of four times the run rate since the end of the global financial crisis. This is extraordinary when you consider that this has occurred during a Pandemic where over five hundred thousand US lives were lost over the period.

The excessive consumption currently being witnessed in the US questions the need for the aggressive “Helicopter Money” that has been handed out to the majority of Americans as an aggressive form of Fiscal support through the Pandemic?

Covid “Helicopter Money” spikes US Retail sales

Source: INet, Obsidian Capital, March 2021

The current global growth is supporting financial assets in ways typical of periods of synchronised global growth, however coupled with massive global liquidity and supply chain disruptions due to Covid-19, are providing a further impetus in driving assets to unprecedented levels. Agricultural commodities, to copper prices, to tech stocks, to global steel prices to crypto-currencies, are all soaring to record levels.

Global Steel prices reaching multi-decade highs 

Whilst vaccination programs are being rolled out in earnest in many developed economies, the limitations to rapid immunisation of a world population of over 7 billion people is being quickly realised by authorities and this is arguably the reason why we are seeing extensions to excessive monetary and fiscal policies as caution remains despite a dramatically improving global economy.

Global inflationary pressures are mounting

For the moment we remain in a sweet spot for risk assets while global demand is synchronised, and inflationary pressures while rising are still evenly balanced between rising inputs costs (food and energy) and benign core inflation.  The rapid rollout of vaccinations in the US and the above-trend growth that the economy is currently enjoying is rapidly absorbing the excess unemployment created during the Covid shock of 2020.

US economy rapidly reabsorbing Covid-19 Unemployment

Source: INet, Obsidian Capital, March 2021

Rapidly falling US unemployment, a weaker than expected US Dollar and continued buoyancy in commodities could tip the balance to a higher-than-expected inflationary environment and force the Fed to hike rates earlier than expected. This scenario could be problematic for many assets that are currently highly rated. As the year progresses, this scenario could become more acute, and as such we will be closely monitoring inflationary pressures going forward.

Current Positioning

We enter Q2 2021 with positioning broadly consistent with the previous quarter;

  1.  Rand to appreciate in real terms against the US dollar
  2.  Global equity to outperform cash and bonds
  3.  Emerging market assets to outperform developed markets
  4.  SA domestic and resource shares to outperform
The rand has strengthened significantly since April 2020. On a purchasing power parity basis, the Rand is now fair value against the British Pound, the Euro and the Yen.

Rand recovered to Fair value against the Crosses

Source: INet, Obsidian Capital, March 2021

Despite its impressive moves since April, it remains undervalued against the US dollar. This speaks more to the fact that the US Dollar remains relatively expensive against most global currencies. South Africa is enjoying one of the most buoyant commodity cycles in decades, reflected clearly in a record trade surplus. The continuation of buoyant commodity prices should provide an underpin for further appreciation of the rand against the US dollar.

We believe that a weaker US dollar and relatively undervalued emerging market assets and fixed income, coupled with continued synchronised growth, should support the relative outperformance of emerging market equity over their developed market counterparts.

Through Q1 2021, we maintained our bias towards resources and domestic-facing equity counters. Rising commodity prices, significant Free Cash flow generation and generous ratings continue to support our resource holdings. Domestic shares should benefit from further expectations of a stronger Rand, coupled with the depressed base in earnings due to the Covid-19 disruptions through 2020. Furthermore, aggressive interest rate cuts through 2020 should, on the margin, support consumer expenditure in the year ahead.

Significant portfolio transactions during the final quarter of 2020 included the following:

  • a switch from ABSA to Investec,
  • switching of Banorte to Citigroup,
  • an increase in our holding in Alibaba,
  • an increase in Lewis,
  • introduction of Nedbank, Capco, Sasol and iShares Global Energy,
  • the JSE, Liberty Holdings and Metropolitan were all sold during the quarter.
Historically, this stage of the economic cycle is supportive of commodity prices, a weaker US dollar and rising developed market bond yields; we maintain a significant underweight in offshore DM bonds. We have increased duration in our domestic bonds as we believe the risk premium priced into our longer duration bonds is attractive relative to the shorter duration bonds that outperformed during the aggressive interest rate cuts of last year. We do not anticipate further cuts in SA and as such we believe lengthening duration is appropriate going forward.

Risk asset valuations are rich, but alternatives are lacking

We do acknowledge that, due to the significant liquidity that has been injected into the world economy during the pandemic, many risk assets and specific equity sectors have had valuations pushed to very elevated levels. Whilst we do not anticipate an imminent reversal in the excess global liquidity, we are wary of exposing the portfolio to excessively valued sectors.

US equity ratings reflect buoyant and synchronised global growth 

Source: INet, Obsidian Capital, March 2021

The alternatives to equity remain elusive as interest rates around the world remain at levels that are reflective of Covid uncertainties rather than the buoyant global growth we have witnessed since the Covid lockdowns ended. As interest rates normalise, we anticipate reducing equity in favour of Fixed Income assets.

Whilst the ingredients for synchronised growth remain in place, it would be remiss to overlook the ongoing risks associated with the spread of the Covid-19 virus. Even with a successful vaccine rollout, it is likely that the world will see significantly more deaths from Covid-19 in 2021 than through 2020. It therefore remains critical that the world overcomes the challenges of vaccination programs to mitigate further significant lockdowns in the important economic hubs of the world.

In summary, the behaviour of financial markets during the second quarter of 2021 should largely reflect what we have witnessed since mid-2020. Thereafter, a slower Chinese economy and a higher global industrial production base will provide opportunities to reallocate our current positioning.