Focus

The Weekly

A Market and Economic Update 12 February 2018

Contents

Newsflash ..................................................3

Market Comment ...................................................................................................................... 3 Other Commentators ............................................................................................................... 6

Economic Update ......................................8

Rates ....................................................... 11

STANLIB Money Market Fund............................................................................................... 11 STANLIB Enhanced Yield Fund ............................................................................................ 11 STANLIB Income Fund .......................................................................................................... 11 STANLIB Extra Income Fund ................................................................................................ 11 STANLIB Flexible Income Fund ........................................................................................... 11 STANLIB Multi-Manager Absolute Income Fund ................................................................ 11

Newsflash The correction in the global developed markets has been quick and sharp.

Of course no-one knows if it is over yet, but there is a reasonable chance

that it may be.

Market Comment OFFSHORE MARKETS

The correction in the global developed markets has been quick and sharp. Of course no-

one knows if it is over yet, but there is a reasonable chance that it may be.

The huge jump in volatility in the US market appears to have stemmed partly from the

unwinding of short volatility positions on the VIX or volatility index in Chicago.

Apparently companies like Credit Suisse sold billions of dollars of a product that makes

good money for clients if the VIX remains calm. Since the US election in November 2016,

the VIX traded mostly between a high of 16 and a low of 9. It was remarkably calm for a

long time, as the US market barely corrected for all of 2017.

Suddenly in late January/early February the VIX (sometimes called the Fear Index) shot up

to around 40, causing big trouble and losses for the products sold by Credit Suisse and

adding substantially to the volatility of the market as these positions were unwound.

The VIX is now trading at 29, still elevated relative to where it was in 2017, although down

from 40.

The S&P 500 Index fell -10.2% from its high on a closing basis, until its positive close on

Friday. Elaine Garzarelli notes that while corrections in bull markets are normally limited to

4-7%, some non-recessionary stock market corrections have been higher, -10 to -15%.

Those associated with recessions were generally -30%-plus.

She says during the tech bubble super bull market, the S&P 500 Index experienced seven

declines of -10% or a bit more.

The MSCI World Index of mostly developed markets was -9.1% on Thursday and is now -

8.8% in dollars, back at 8th November levels (see chart below).

Source: I-Net Bridge

The MSCI Emerging Markets Index is now -10.2% from its recent high (also back at

November levels), although that excludes a bit of a recovery early this morning in Asian

markets. Tencent was up over +2% for example.

So it is interesting that despite its much bigger run over the past year (the MSCI Emerging

Markets Index is still up +32.6% since end 2016 in dollars, even after this correction, versus

+17% for the developed market MSCI World Index), the emerging markets have corrected

by a similar percentage to the developed markets.

That is very unusual. Riskier markets go up more and usually down more too. That is

probably a good sign that this bull market is not over, because of strong world economies,

coupled with still low interest rates and inflation, even if US rates are rising. Brazil lowered

rates for the umpteenth time last week and SA may lower rates next month, with a bit of

luck (no Moodys downgrade to junk and some hope for the Budget Speech).

If there has been some hysteria about the sudden rise in US wages to +2.9% year-on-year

that is by no means a done deal. Who knows, next month may show a lower number. Kevin

Lings says the older people in the US (60s and older) still seem to be getting a big chunk of

the new jobs and they are typically less demanding.

But the 10-year bond yield has remained above 2.8%, despite this equity correction, apart

from one or two days below. So the bond market yield uptrend (price downtrend) remains

firmly intact.

As of Friday’s close, the S&P 500 Index is down -2.9% in 2018. The worst performers are

Real Estate with -9.8%, then Utilities -8.8%, Energy -8.7%, Telecomms -8.2% and then

Consumer Staples -6.3%.

Information Technology is now -1.8% (still better than the index), Health Care -1.9% and

Financials -1.7%, while Consumer Discretionary is +1.1%, the best of the lot.

The MSCI Europe (including the UK) Index is down -9.5% in dollars from its recent high,

back at August levels in dollar terms, while the MSCI Japan Index is down -8.4%, at

November levels. The Japanese market was closed today for a holiday.

So the US market has fallen a bit more than the others, no doubt at least partly because of

those VIX derivatives.

It appears that the fall in global equity markets is creating a buying opportunity for those

who have been underweight. The bull market has had a setback, in line with all bull

markets, but at this stage remains intact, even though it will turn nine years of age in a

month’s time.

Company earnings are growing nicely and longer-term interest rates remain comfortably

above short-term rates, i.e. we’re a long way from an inverted yield curve, where short rates

rise above longer-term rates. Also in most regions, short-term rates are still very low.

The biggest concern amongst market participants is what the effect on markets will be as

central banks withdraw liquidity, because this has never really been seen before.

So once the European Central Bank stops its quantitative easing program in September

(buying bonds every month, pumping newly created money into the economy) and the US

Fed continues to tighten a bit.

Of course, the ending of the Fed’s quantitative easing program a while back did not appear

to have any effect on the US stock market. After all, we don’t believe that central banks in

the US or Europe have been or were buying shares at all.

Also, although the European Central Bank may cease buying bonds in September, it is

unlikely to start raising interest rates in 2018, by the looks of things.

Global listed property has continued to struggle, falling with global equities in the latest

correction, -7.5% in dollars in the past week or two, and now near the lows of the past 20

months.

LOCAL MARKETS

The JSE ALSI was -9.4% from its recent record high as of Friday’s close (see chart below),

once again heavily influenced by the big fall in Naspers, which was down -27.4% from its

high as of Friday’s close, trading at a discount to its net asset value of around 38%, per

RMB Morgan Stanley.

Source: I-Net Bridge

They calculate that Naspers is worth R4900, based on Tencent’s latest price, versus its

price this Monday morning of just under R3000 per share. Naspers is around 18% of the

JSE All Share Index.

Some of the other big rand hedges on the JSE have also taken a big knock, such as one of

the favourites in most portfolios, British American Tobacco, down almost -22% from its

November high and at its lowest rand price in almost 2.5 years.

On the longer-term charts it has a “toppy” look to it, implying further possible downside risk.

Obviously the rand plays a big role. Some expect 11.50 to the dollar once President Zuma

moves off the Presidential stage.

Likewise Reinet is down -29.3% from its 2016 high and is back at levels of 3 years ago.

Anheuser Busch Inbev, which bought SAB, is trading almost -30% below where it listed in

October 2016 and is down -10% so far in 2018.

Anglogold has tumbled -61% from its 2016 high. The rand gold price is down almost -17%

from its 2016 high, although it has broadly traded sideways in the past year.

It was surprising to see that Christo Wiese reduced his stake in Steinhoff International from

21% to 6% recently. What does he know that the market doesn’t know….until the

investigations are concluded? The PIC is now the biggest shareholder.

Why would Wiese convert his paper loss into an actual loss at this stage? Steinhoff

International owns almost 78% of Steinhoff Retail Africa, which owns Pep Stores,

Ackermans and Tekkie Town.

Meanwhile, the JSE Mining Index has corrected by -12% from its recent high, while Sasol is

down over -14% since 25 January. Oil shares have been weak in the US too.

The SA Listed Property Index has been on a wild ride of late, despite the very stable 10-

year bond yield around the 8.4-8.5% level. It emerged on Friday that Asset Manager and

short-seller 360ne Asset Management had compiled a negative report on the Resilient

group, including NepiRockcastle, Greenbay and Fortress B.

Resilient has responded this morning, but is compiling a fuller response to the report, which

it will place on its website later today. Resilient and NepiRockcastle are both down over -

8% so far this morning, back close to their lows of last week.

NepiRockcastle hit a record high of 217 rand in December and is 126 rand today, down -

42% from its high. Resilient is down almost -35% from its high of 151 rand in December,

back at August 2015 levels, on an historic dividend yield of 6.1%, similar to

NepiRockcastle’s yield.

Fortress B’s dividend yield has leapt from 4.2% a month ago to the current 7.8% yield.

The JSE Listed Property Index historic (last 12 months) dividend yield is currently at 6.7%,

after trading between 5.8% and 6.3% over the past 15 months. It does look good value at

these levels, although clearly there is quite a bit of selling going on, especially of the

Resilient stable shares.

Looking at the dividend yields of the main JSE indices, the ALSI 40 Index is currently on a

yield of 2.84%, its highest in 11 months, the JSE Mid-Cap Index is on a yield of 3.65%,

close to a 6-year high, while the JSE Small-Cap Index is on a yield of 4.3%, also relatively

attractive.

All-in-all, it does look like the correction has created a buying opportunity in shares on the

JSE.

Other Commentators

US Market Analyst, Elaine Garzarelli Garza’s quants model reading is at a bullish 71.5%, down 3 points from 74.5% a week ago,

due to the downgrade of the Bloomberg financial conditions index, which measures the

health of the financial industry, to neutral from bullish.

Shares are adjusting to the possibility of more rate hikes than expected. The Fed is

forecasting three rate hikes in 2018.

Garza assesses the current market decline as a correction, rather than the beginning of a

major bear market. Inflation is up, but still modest at 2.1% (core inflation is 1.8%) and the

core PCE (personal consumption expenditure) inflation is at just 1.5%. The oil price is down

-$5 over the past 2 weeks.

Earnings are coming in above expectations and global economies are healthy.

So Garza recommends using the current decline as a buying opportunity. As long as her

quants model remains bullish, she does not look for a long-lasting correction or bear

market.

Standard & Poors revenues in the 4th quarter are expected to rise +8% year-on-year, the

biggest rise in six years. Earnings estimates have risen by +11% over the last 2 months.

Currently Garza calculates a fair value for the S&P 500 Index of 2,736, meaning the index

is now 4.5% undervalued at Friday’s close of 2,619.

The number of bullish US investment advisors fell to 54.4% last week (from 66%), which is

the lowest reading (least bullish on the market) since September last year; but the reading

would need to fall below 53% to be upgraded from bearish in Garza’s model.

Global growth is a powerful force that should be a support for US equities. Economic

reports from around the world continue to be strong.

Also there are a large amount of deals around, as liquidity and economic growth remain

healthy.

Consumer spending should remain an engine of growth buoyed by rising employment,

disposable income and household wealth.

The government reached a two-year budget and spending deal that will raise US spending

by almost $300bn over two years, which is positive for a number of industries, including

defense.

BCA Research

The sharp correction in the US stock market was aggravated by technical factors, as the

spike in volatility (the VIX Index) caused or aggravated the stock market fall, rather than the

other way round.

The relatively muted reaction of other “risk gauges” such as high yield bonds, emerging

market shares and the gold price over the past week is consistent with this thesis.

Strong economic growth and positive earnings surprises should keep the equity bull market

intact.

But investors need to be aware that volatility will pick up.

Inflation is likely to move above the Fed’s target early next year, setting the stage for the

next recession late in 2019.

None of BCAs recession-timing indices is flashing red. Global Leading Indicators are rising

at a healthy +5.5% year-on-year pace. Breaking below zero has been a reliable recession

indicator.

Likewise, the ten year US Treasury bond yield is comfortably higher than the two year yield.

Once the reverse happens, one can start to worry, although it can take another year or so

before a recession starts.

The two year is currently 2.14% and the ten year is at 2.85%.

BCA thinks central banks will only gradually wind down their extraordinary stimulus of the

past few years, so it is unlikely to upset markets too much.

Global bond yields remain low by historic standards and this should continue to support

equities. They are still close to half of what they were in 2011.

BCA expects global bond yields to grind higher, but more gradually than has occurred over

the past six weeks.

A sustained move above 3% for the US 10-year yield will require a more durable increase

in inflation.

Shares tend to peak about six months before the start of a recession. So if the next

recession starts in late 2019, the equity bull market could last a while longer.

A modest overweight on global risk assets is warranted for now.

Investors could consider reducing exposure to risk assets like equities later in 2018.

Paul Hansen Director: Retail Investing

Economic Update 1. SA manufacturing had a strong end to 2017, after struggling in the first half of the year.

The improvement in output has been supported by buoyant global economic conditions, which appear sustainable.

2. The Western Cape water crisis remains a major concern, and could limit SA’s expected economic recovery in 2018.

3. Nigeria’s PMI continues to signal that the positive growth momentum has continued. 1. In December 2017, SA manufacturing production rose by a surprise 1.1%m/m, after

increasing by 1.1%m/m in November and 1.0%m/m in October (monthly data is seasonally adjusted). The market was expecting production to rise by only a further 0.5%m/m in December. Over the past year, manufacturing has risen by a modest but improved 2.0%y/y, and while the overall level of production remains far below the level of activity that prevailed prior to the onset of the global financial market crisis in 2008, the sector experienced a noticeable acceleration in output during the final quarter of 2017. This, together with the stronger than retail sales data will help to buoy the Q4 2017 GDP data.

The Q4 2017 surprise increase in manufacturing activity (+1.5%q/q) was largely due to very strong growth in petroleum output (fuel), basic iron and steel, and chemicals. Over the past twelve months South African manufacturing has averaged an annual average growth of -0.6% (see chart attached), which is obviously extremely disappointing, but hurt by the weakness in the first half of 2017 .

Domestically, the manufacturing sector is comprised of ten major sub-sectors. The largest being food and beverages (25% of overall manufacturing), followed by the chemical sector (24%), and iron and steel (19%). At the other end of scale, the clothing and textile sector comprises a mere 3% of total manufacturing, while the manufacture of electrical machinery is only 1.6%. Each of these ten major manufacturing sectors are comprised of a number of additional sub-sectors, which means that in total South Africa’s manufacturing sector is divided into more than 40 distinct industries, each with its own performance characteristics. Remarkably, while the manufacturing sector (in total) has exhibited only 2.0% growth over the past year, there is a very wide dispersion in performance at a sub-industry level. This dispersion is highlighted by the massive growth gap between the production and basic iron and steel (+12.3%y/y), motor vehicles (+10.6%y/y), and refined fuel (+6.4%y/y) vs. publishing (-18.9%y/y), clothing (-4.4%y/y), and rubber products (-10.8%y/y).

During 2010, SA manufacturing activity grew by 4.7%y/y, which was obviously a vast improvement on the 13.5%y/y decline recorded during the global financial market crisis in 2009. In 2011, production averaged a more modest rise of 2.8%, with the sector experiencing significant disruptions due to strike activity. For 2012, manufacturing growth averaged a mere 2.3%, which is somewhat understandable given some weakening of the global economy and the extensive mining strikes. In 2013, activity rose by an average of only 1.4%y/y, which is really more stagnation than expansion, with the motor industry heavily disrupted by labour unrest. In 2014, South Africa’s manufacturing production increased by a very disappointing 0.2%y/y. This was despite the Rand/Dollar weakening by 30% over the preceding three years. The sector was plagued by periodic electricity outages. In 2015 as a whole, South Africa’s manufacturing sector averaged growth of -0.01%, which was the worst annual performance since the 2009 recession, and signalled that the sector experienced stagnation or a low intensity recession. This trend continued in 2016 with growth of 0.8% and under-performed further in 2017 as a whole with a decline of -0.6%, although as highlighted above, there was a noticeable improvement in the final quarter of the year.

At this stage we expect the recent improvement is SA manufacturing to continue at a modest pace in 2018, help by relatively strong global growth in many of the major developed and emerging economies, a systematic uplift in business confidence due to a more stable domestic political environment, relatively consistent electricity production, on-going labour market stability when compared with prior years and some revival in Sub-Saharan Africa growth.

2. The Western Cape water crisis has arisen mainly as a result of an unusual three year

of well below-average rainfall (2015, 2016 and 2017). Consequently, dam levels have fallen dramatically despite a massive decline in consumption. The cut back in water usage has been substantial, with Cape Town reducing its daily consumption from a peak 1 200 million litre to below 600 million litres. Unfortunately, consumption levels need to drop further to around 450 million litres per day in order to avoid water rationing (day-zero). At this stage Cape Town will have to introduce water rationing on 11 May 2018.

The impact of the drought has seen wheat production fall 46% in Western Cape, and is expected down 22% at a National level in 2017/2018 (1.473 million tons vs 1.910 million tons last year). At current prices this means R1.5bn less wheat exports. The SA trade balance could weaken by around R20 billion in 2018 as a result of the negative impact on edible fruits, nuts, wine and manufactured food. The Western Cape exported around R120b worth of goods in 2016: R30bn edible fruits and nuts; R11.5bn wine; and R8.2bn in manufactured food. South Africa’s workforce in Agriculture is around 5.0%, with 25% of this employment in the Western Cape (210 000 formal jobs). There were 25 000 jobs losses in agriculture in Q3 2017 having a negative impact on retail and financial services. The unemployment rate in the Western Cape is 21.9%, well below the national average of 27.7%. Water rationing could slow GDP growth in Western Cape from an expected 1.7%y/y in 2018 to a recession in 2018/2019. This would reduce SA GDP growth in 2018 by around 0.3 percentage points. A loss of business and consumer confidence could negatively impact tourism, food processing plants, restaurant businesses, conferences and sporting events. In addition, house price growth and housing investment could dampen bringing with it a loss of revenue for Cape Town, but also a loss of tax receipts for the National Government.

In contrast, the drought will have a positive impact on water related investment/spending. In addition, people in the Western Cape have started working co-operatively and innovatively, to alleviate the crisis. Overall, though while the “solution” articulated by the City of Cape Town could provide some support in the short-term, the region will continue to struggle with water supply unless there is a very meaningful increase in rainfall as well as a longer-term water supply solution. Cape Town could be entering a sustained phase of lower average growth, after having out-performed most of the other provinces for many years.

3. The Nigerian PMI registered its second highest PMI in its history at 57.3 for January

from 56.8 in December. A figure above 50 denotes expansions whilst a figure below 50 indicates contraction in manufacturing activity. This is encouraging as it shows that private sector activity has picked up. New orders as well as output drove the PMI figure higher. Employment also increased, which should help decrease the unemployment rate (latest figure is third quarter 2017 at 18.8%). Demand for locally produced inputs stimulated demand in the economy as well as growing non-oil exports to other regions.

The latest PMI figure is suggesting that the Nigerian economy is likely to have a strong start to the year. Oil production has reached 1.8 million barrels per day (mbpd) as at end of January 2018, which is higher than the 1.4 million mbpd recorded in August 2016. In addition, the liquidity shortage in the currency market has partially been resolved. Growth is expected to improve this year in Nigeria from last year’s estimated 0.8% and the -1.5% in 2016.

Please follow our regular economic updates on twitter @lingskevin

Kevin Lings, Laura Jones & Kganya Kgare (STANLIB Economics Team)

Rates These rates are expressed in nominal and effective terms and should be used for indication purposes ONLY.

STANLIB Money Market Fund

Nominal: 6.77%

Effective: 6.99%

STANLIB is required to quote an effective rate which is based upon a seven-day rolling average yield for Money Market Portfolios. The above quoted yield is calculated using an annualised seven-day rolling average as at 09 February 2018. This seven- day rolling average yield may marginally differ from the actual daily distribution and should not be used for interest calculation purposes. We however, are most happy to supply you with the daily distribution rate on request, one day in arrears. The price of each participatory interest (unit) is aimed at a constant value. The total return to the investor is primarily made up of interest received but, may also include any gain or loss made on any particular instrument. In most cases this will merely have the effect of increasing or decreasing the daily yield, but in an extreme case it can have the effect of reducing the capital value of the portfolio.

STANLIB Enhanced Yield Fund

Effective Yield: 7.78%

STANLIB is required to quote a current yield for Income Portfolios. This is an effective yield. The above quoted yield will vary from day to day and is a current yield as at 09 February 2018. The net (after fees) yield on the portfolio will be published daily in the major newspapers together with the “all-in” NAV price (includes the accrual for dividends and interest). This yield is a snapshot yield that reflects the weighted average running yield of all the underlying holdings of the portfolio. Monthly distributions will consist of dividends and interest. Interest will also be exempt from tax to the extent that investors are able to make use of the applicable interest exemption as currently allowed by the Income Tax Act. The portfolio’s underlying investments will determine the split between dividends and interest.

STANLIB Income Fund

Effective Yield: 8.52%

STANLIB Extra Income Fund

Effective Yield: 8.00%

STANLIB Flexible Income Fund

Effective Yield: 7.12%

STANLIB Multi-Manager Absolute Income Fund

Effective Yield: 5.65%

Collective Investment Schemes in Securities (CIS) are generally medium to long term investments. The value of participatory interests may go down as well as up and past performance is not necessarily a guide to the future. A schedule of fees and charges and maximum commissions is available on request from the company/scheme. CIS can engage in borrowing and scrip lending. Commission and incentives may be paid and if so, would be included in the overall costs.” The above quoted yield will vary from day to day and is a current yield as at 09 February 2018. For the STANLIB Extra Income Fund, Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down.

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