By Francis Marais, 18 January 2017
I believe that, regarding this statement, there are quite a number of analogies that can be drawn between this and 2016. One is certainly that 2016 has been all about the journey - quite a tumultuous one at that. We lost cultural icons including David Bowie, Prince, Muhammad Ali, Mandoza, Leonard Cohen and George Michael. We lived through mass shootings, terrorist attacks and we still have the situation in Syria. We saw natural disasters - such as the earthquakes in both Italy and Indonesia, as well as Hurricane Matthew in the US.
Politics played a major role in our experience of 2016, both locally and globally and both in developed and emerging markets. Events such as Brexit and Trump immediately spring to mind. Locally we will remember the Constitutional Court finding on the Public Protector’s report into the President’s private homestead in Nkandla, the local government elections, #FeesMustFall, #ZuptaMustFall and the report into State Capture in our country.
The world of sport did not disappoint either, from Leicester winning the Premier League, to Ireland beating the All Blacks… and of course Italy beating the Springboks (although that last event might not necessarily qualify as a low probability event anymore).
To be sure, 2016 was definitely a year in which the frequency of low probability events was indeed very high.
With the benefit of hindsight, it is fair to say that many of us experienced 2016 as a bit more intense than usual. But is this necessarily the case? Various media houses were quick to declare 2016 as the worst year ever. It dethroned the previous worst year, 2015, which in turn dethroned 2014. It does not bode well to extrapolate this into 2017, but it does point to a trend, especially regarding how we experience things. As humans, we suffer from a number of cognitive biases and we tend to remember recent and bad events the most vividly. It therefore becomes difficult to maintain perspective.
From a South African investor’s perspective, 2016 will be remembered as another difficult year for risky assets, defined as equity and property. The JSE All Share returned 2.63%, with the SWIX managing to deliver 4.13% YTD. Property fared somewhat better, returning 10.20% for the year. Comparing these returns to headline inflation (6.34%), only property managed to deliver positive real returns. If you invested offshore you would not have been better off. In rand terms the S&P 500 delivered -1.19%, the FTSE 100 was down 11.90%, and the Japanese Topix returned -11.08% for the year. Overall the MSCI World and MSCI ACWI were also down -5.12% and -4.81% respectively (in rand terms).
Rand appreciation played a major role in investment performance during 2016. The rand reached some of its lowest levels in January 2016, only to recover strongly and appreciate around 11%, 26% and 14% against the US dollar, British pound and the euro respectively. This detracted from the performances of offshore assets, but also had a meaningful impact on rand-hedge stocks as well as listed property counters, specifically those with material UK exposure. Therefore, funds that were exposed to these counters as well as making full use of their 25% direct offshore exposure would have had a particularly difficult 2016. These funds tended to have held very negative views on the South African economic and political environment, and while the events of 2016 have certainly confirmed their views in many ways, these events did not materialise in investment performance.
The rand strength during 2016 was once again a confirmation of the continued impact of major central banks around the world, as well as investors’ search for yield. In February, Janet Yellen, the Federal Reserve Chair told the US Congress that increased volatility in world financial markets could threaten the recovery in US growth, a point she repeated in her rather dovish statement at the March Federal Open Market Committee meeting. Expectations of further rate hikes were tempered and investors turned to higher yielding emerging markets, bringing with them capital flows and consequent emerging market currency appreciation.
In SA, however, foreigners were persistent net sellers of both our SA equities and bonds, but we are a commodity-reliant economy and therefore our currency is closely related to commodity prices. Commodities made a strong recovery during 2016 as concerns over Chinese growth subsided and we consequently saw our currency strengthen along with other major commodity exporters.
The graph above shows the relationship of the rand-dollar exchange rate (red line) to a basket of commodities (green line) that we export. It is also a very useful reminder that while we become fixated on political events, larger more fundamental forces are at play regarding our currency.
Locally, an asset class that did do well during 2016, was bonds and more specifically longer duration bonds. The Beassa 12 Year Index returned 17.43% followed by the 7-12 Year Index at 15.37% and the 3-7 Year Index that returned 13.41% for the year. These bonds were sold off heavily during December 2015, with the firing of then Finance Minister Nhlanhla Nene - testament to negative events and sentiment creating huge opportunities for those investors who were able to keep their wits about them. Cash returned 7.37%, a positive real return, and when one considers the additional option value of this asset class, it would have been quite an attractive asset class to hold during 2016.
2016 was a particularly difficult year for larger capitalisation shares, delivering -1.60%, however, small and mid-cap stocks delivered strong returns, returning 21% and 27% respectively. In particular, the basic resources category was a significant contributor to returns with regards to mid-cap stocks.
From a style perspective - value outperformed in 2016, followed by quality, growth and momentum stocks, returning 17.15%, 3.72%, -3.63% and -13.31% respectively.
In summary, funds with high exposure to fixed income instruments, resources, mid and small-caps and that were also long on the SA rand with little offshore exposure have therefore tended to outperform their peers during 2016.
Personally, I disagree that 2016 was the worst year ever. We had no world wars or major financial crises. Yes, a lot of terrible things did happen in 2016, and I wonder how much of our sense of anxiety has to do with the realisation that we are living in an increasingly complex world that we struggle to accurately predict and make sense of. The second law of thermodynamics states that with the passage of time, entropy (the degree of disorder or randomness of a system) increases.
What are the implications in terms of the future of your investments? Having a long-term plan and sticking to this plan will help you avoid much of the noise and pitfalls out there. Avoiding excessive tactical calls in terms of asset classes, sectors or styles if you are not a professional investor with a vast amount of relevant information, is another useful habit. This, together with building a well-diversified portfolio together with your financial adviser should go a long way in successfully navigating 2017 and the years beyond.