The markets since May and during the first part of June have been marked by grim deterioration driven almost entirely by local political factors, particularly the proposed changes to the Mining Charter. Therefore, during June, we cut the net exposure of all our funds down to 60%. During July, for our Robert Falcon Scott fund, we moved away from leveraged products (CFDs) and into equities. Along with less risk, the reduced gearing also translated into lower costs.
The country is in a state of extreme flux and in this environment, we do not see good prospects for growth by companies dependent on the South African economy. Evidence of state capture, which unfortunately includes international companies such as McKinsey and SAP, means that we can only conclude that the rot goes far deeper than we thought. Still to come are the Zuma no-confidence debate and the ANC leadership conference, and more evidence of losses and corruption at state-owned enterprises like SAA and Eskom.
In this environment, it would be foolhardy to second-guess a favourable outcome. However, it pays to look back at June and consider which shares and sectors were most resilient, and which ones are most likely to stand fast in the coming political storm.
While the general market was very oversold in June, the JSE Top 40 Index has shown remarkable strength for the year. This was due almost entirely to the major components of the index, which make most of their revenue offshore. Naspers, Richemont and British American Tobacco held firm during the year, indicating that there has been a significant flight to safety while SA Inc stocks in the commodities and retail sectors sold off.
Technically, although there was an overall 3.4% rise in the Top 40 since the beginning of the year (on the back of the big three global industrial stocks), mid-caps were down 9.2% and we saw market sentiment deteriorate rapidly. In simple terms, this means that in June only 35% of the market was on an upward trend. Compare this to more confident times, as recently as 2015, when 80% of the market was rising, and that positive mood tended to lift the rest.
At this stage, many investors will be nervous about the prospects for a crash, followed by a full-blown recession and bear market, which might cause even “safety net” stocks like Naspers to collapse. At this stage, we do not see cause to panic, given that stock valuations are not vastly inflated, but we remain extremely cautious because market sentiment at the moment is not good and the potential for a parliamentary crisis remains in play.
Given the political climate in the near future, our positioning is understandably cautious. Often the best thing to do is to expect the worst. While there is no immediate sign of a significant market downturn, investors will likely tread water until there is more clarity on the political front.
Beyond the macro political-economic picture, we are keeping a close eye on the charts. Technical analysis tells us the Top 40 needs to break above its upside resistance levels of 48000 and 49000 before we can more confidently expect rising prices across the board.
In the past few weeks we have seen a move to the upside (see chart above), but how far will it go? Value hunters have been picking up on the likes of Bidvest, Capitec and a few of the global miners like Billiton and Glencore, but for the rest, people remain wary. It feels like a relief rally rather than a sustainable upswing. Given the regulatory uncertainty, the Resources sector, especially platinum and gold, seem right now to be a no-go. Realistically, we know the JSE has gone sideways for at least three years. That pattern, without positive news, is likely to continue.
Our quantitative indicators echo our current view of the market with the market strength indicator (MSX-monthly) at 44, reflecting that only 44% of the market is on an upwards trend. Our short-term market strength indicator (MSX-W), which assists in determining short-term buying opportunities is at 60. In our last market review, the value for MSX-W was 25 and correctly predicted a bounce from extremely oversold positions which occurred during the last 2 to 3 weeks. However, since we are focusing mainly on our long-term indicators (sentiment and market valuation) we remain cautious of adding exposure during these uncertain conditions (the current political scenario and low economic growth). We expect the market to remain range bound between 42 000 and 48 000 for at least the remainder of the year, or until evidence of improved economic growth and/or resolution of the current political instability emerge.
Looking ahead for the next six months, our position remains defensive -- to stabilise portfolios, reduce downside potential and play the waiting game. If the political environment swings to the positive, we have ample ammunition in store to take advantage of such development.
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