The Sanlam Select Strategic Income Fund changed it's name to Amplify SCI Strategic Income Fund, effective from 01 December 2019.

Global outlook

It wasn’t more than a year ago that US Federal Reserve (Fed) Chairman Jerome Powell was praising robust employment figures, strong consumer and business investment and strengthening economic activity. Counter to this, at the turn of the year we were clear on our view of a late-cycle scenario with global growth slowing towards and even below 3%. This view remains firmly entrenched and given recent issues in Germany and China it is even possible we see a more meaningful dip sub 3% in coming quarters. Germany, on the brink of a technical recession, is particularly starting to take strain on the consumer front and seems very reluctant to move on fiscal stimulus. The Chinese – finding itself in a slightly similar situation, and importantly still under pressure from relentless US attacks – are unlikely to repeat broad-based stimulus measures that bailed out the global economy in 2012 and 2016. In the absence of stimulus from these two major economies, the catalyst for an upside surprise to global growth seems missing.

While we expected global central banks to lower interest rates in 2019 and into 2020, recent reluctance in this regard perhaps speaks to the runway for monetary support running out. Post Jackson Hole in August it has become clear that monetary authorities are putting pressure on fiscal support to kick in, with the European Central Bank in particular being firm in this regard. The September Fed dot plot made clear the split in opinion not only on the strength of the US economy, but also the outlook for the global economy. This uncertainty is also tangible in global sell-side research, with the likes of BNP calling for up to five US interest rate cuts between now and mid-2020, while other global strategists suggest the Fed is already erring by lowering interest rates. As one strategist put it:

‘Credit spreads are back in line with long-term averages. The VIX is trading in the lowest decile of its long-term range. Beyond financial valuations, and despite a flurry of negative sentiment indicators, the US unemployment rate fell to 3.6% in 2Q19 – a cyclical low. Average hourly earnings are increasing by over 3% y/y, while inflation, adjusted for food and energy, printed at 2.1% y/y in July. Consumer confidence, as measured by the University of Michigan Consumer Sentiment Index, is also near a decade high.’

Much hinge on the outcome of ongoing trade disputes between the US and other economies, but in particular China. It is instructive that the Democrats are once again trying to have President Trump impeached.

Broadly speaking we have been looking for the Dollar to trade in a $1.10-1.18 range, the US 10-year bond to only briefly dip below 2% and oil prices to average around the $55-60 mark. Clearly the $1.10 mark on the Dollar is now firmly on everyone’s radar (as is 100 on the US Dollar Index), but with regards to bond levels a major change in 2019 is the arrival of negative bond yields once again – at its peak in the third quarter this year we had almost $17 trillion of global bonds trading with a negative yield to maturity.

As we approach year-end, the above global risks (we have also since our last comment had oil field attacks in Saudi Arabia) will amplify nerves in the local economy.

For the time being the catalysts for a meaningful weakening in the US Dollar seem absent. Oil markets seem roughly balanced, with two-sided risks around $60 still. US Treasuries, together with all developed market bond yields, seem very expensive, but with equity markets still hovering around record levels, where should investors look to? Markets seem to be pre-empting the re-introduction of quantitative easing, explaining the recent sharp rally in the rates market.

Local outlook

When this comment is published, we will likely (if the year-to-date trend of promising updates but not delivering on it had changed) know whether the ANC supports the recently released National Treasury economic paper, and likely also have had sight of the much-touted Eskom white paper. (I don’t count the post-NEC comments to constitute anything firm.)

We are therefore writing this comment in the absence of information on critically important pieces of information. It is our opinion that the ongoing silence from government regarding whether it supports the Treasury’s paper explains the recent reversal of fortunes of the local market.

While the reason for shifting the date of release of the Medium-Term Budget Policy Statement (MTBPS) from 23 to 30 October 2019 is not known, the outcome of the MTBPS is already expected to be much worse than that of the previous MTBPS as well as the 2019 National Budget. Strategists seem to have consensus that the deficit will be wider than 6%, 2% worse than expected a year ago, with debt/GDP now seen well over 60%. While issuance isn’t necessarily seen increasing further –with National Treasury announcing a very big increase in August, as well as announcing a successful $5 billion offshore issue (at eye-watering levels!) – in the absence of improving revenue the issuance burden on South Africa seems on a one-way track towards meeting its maker.

It seems a fait accompli that unless government comes out in at least partial (but we can only hope full) support of the National Treasury paper, and if there is indeed truth to the $11 billion green funding solution for Eskom, Moody’s should move the outlook on the sovereign to negative on 1 November 2019. Although this is not the end of the road for the sovereign, it is no doubt a slippery slope towards a downgrade and exit from the World Government Bond Index.

The time has come for government to step up to the plate and not only talk about reform but put words into practice. And if you don’t want to take our word for it, then how about this.

The following excerpt is from a media release by Cas Coovadia, MD of the Banking Association of South Africa:

‘The National Treasury discussion document – Economic transformation, inclusive growth and competitiveness: Towards an Economic Strategy for South Africa – is an important contribution to the development – and urgent implementation – of a pragmatic economic recovery plan for the country.

The Banking Association South Africa (Basa) supports the proposed strategy.

We appreciate the opportunity – given to all South Africans – to contribute to the discussion document. It is a welcome departure from the normal policy-making processes of the government and the governing party.

Economic policy affects the quality of life of all South Africans and cannot be the sole preserve of the governing party and its allies, especially given the last nine years of state capture, low economic growth, corruption and maladministration.

Today South Africa has a depleted fiscus, debilitating unemployment, poverty, inequality and dangerous levels of social instability. The discussion document speaks to the realities of the economic crisis facing our country and the urgency with which it must be addressed – without narrow political or ideological considerations.

We urge the president of South Africa, Cyril Ramaphosa, to take ownership of – and responsibility for – the strategy and hold his ministers accountable for its implementation.
Without brave, committed political leadership, these proposals cannot succeed – and neither will our country.’

Ke nako!!

Global While there is, on average, 4 400 hours in every half year, the pace, intensity, and effort required to manoeuvre this most recent set of hours (I have done a few sets…) seem slightly out of sample relative to norm. It is almost impossible to imagine that global markets have experienced its best first half in a decade given the hurdles that keep hurtling its way, none more so than in the form of Donald Trump. It is therefore appropriate that we end the first half with Trump news, this time in the form of G20 feedback. Analysts describe it as an uncertain pause - no immediate escalation, but still no clear path towards a comprehensive deal. One thing we can be sure of, Twitter will be busy in the coming days/weeks once more.

US stocks are up between 15-20% year to date, European stocks similar, and most Asian markets slightly less, but also well in the black. US$11 trillion developed market bonds are trading sub 0%. US Treasury yields dipped below 2% for the first time since late 2016 (while the S&P 500 is within a whisker of the magical 3 000 level - a far cry from the mid-600s late 2008).

Clearly markets will welcome any sign of a truce, but downside risks remain - Trump has made his intentions towards India, Europe and other nations clear. And if there is one thing we know about downside risks, especially where sentiment is concerned, it is that sometimes the impact on sentiment souring can be non-linear. This is probably why central banks are trying to pre-empt a souring of corporate and consumer sentiment, with all eyes focused on the US Federal Reserve (Fed) and European Central Bank (ECB) this month (or at least markets appear to be forcing central banks to pre-empt such souring). Incoming PMI data continues to surprise to the downside, with US ISM and employment data likely to dictate whether the market's 'demand' for at least a 25-basis point (bps) rate cut ('fast money' traders baying for a 50-bps cut) comes to fruition.

From a macro data perspective, the global capex cycle has slowed down significantly. Capital goods imports have dropped hard (in July 2018 they were tracking at 18% year-on-year (y/y) on a three-month moving average basis, but plummeted to 2% y/y in January 2019 and an estimated -3% y/y in May 2019), while private fixed capital formation in the G4 and BRIC economies fell from a peak of 4.7% y/y in 1Q18 to just 2.8% y/y in 1Q19.

Corporate sentiment has also declined to multi-year lows. Global PMIs for May fell in broad-based fashion (June data even softer, with about two-thirds of countries tracked reporting a PMI below the 50-expansion threshold). Crucially, consumer sentiment is also starting to sour, with the Conference Board's Consumer Confidence Index for June falling to the lowest point since September 2017. Interestingly, the Citi Economic Surprise Index for most major economies, as well as the composites for DM and EM, is trading close to multi-year lows. So, none of the above should be a major surprise.

Any sign of tightening financial conditions will concern central bankers. Given higher corporate leverage, particularly for companies with weaker balance sheets, defaults could accelerate, bringing corporate credit risks to the fore. These in turn lead to impaired lending and exacerbate the negative feedback loop to even weaker confidence, which lowers growth.

From a global perspective the only certainty in the short term is probably further trade policy uncertainty, which is expected to continue to weigh on economic prospects. It will be interesting to see if markets can continue to trade at elevated levels in anticipation of monetary and in some instances even fiscal support. Evidence indicates that risk markets are trading well ahead of what flow indicators will imply (some reports indicating some markets are at three-year highs based on this indicator).

Local Pretty volatile conditions were experienced in June, with markets allowed no time to settle post a draining National Election campaign, nervously awaiting Cabinet reshuffling, parliamentary committee announcements, news around Eskom support, detail from the second State of the Nation Address (SONA) of 2019 and finally G20 headlines - all in a month's work.

30-year bonds sold off (and rallied) 20-30 bps twice this past month (the R2048 sold off 35 bps between 4 and 7 June, rallied to 9.68% by 20 June, sold off back to 10% on 25 June, only to end the month below 9.70% again), impacting liquidity markedly. A further compression of global risk-free rates also brings into question views around fair value and what is currently priced in with regards to sovereign risk. (The five-year credit default swap, in anticipation of at least a rating outlook change to negative to end-2018, traded to a peak of 260, rallying to a low of 170 into the second round of Ramaphoria in early February, only to sell off once more to an intra-day worst level of 220 post a weaker than expected National Budget and ahead of the March Moody's review, but have subsequently at the time of writing rallied almost 60 points from these levels to trade at 162.)

If we were to score June on a scale of 0 to 10 from a local political perspective, we would be hard pressed to go beyond a 5. SONA was uninspiring, long, repetitive and for once I agree with the EFF in that we are not paying people to dream (our 3Q19 Scenarios even borrow from the SONA speech for its three scenario titles - our muddle-through title 'It's time to make choices' (who hasn't heard that one before from politicians, right?!); our bull case 'I choose to dream'; and our bear case 'Confronted by severe challenges').

Importantly, key committee appointments have gone to opponents of Ramaphosa's proposed reforms, with more than a few highly tainted individuals back in the mix.

Disappointingly we still await details on the front-loaded state support for Eskom - it seems lost on politicians that markets see a material difference between 'imminent' and 'about three months' with the likes of Pravin Gordhan and even the President guilty of interchanging between these timelines way too often. While we received further confirmation that the South African Reserve Bank's independence is nonnegotiable, noises around this issue just refuse to die down, with the latest comments from Gwede Mantashe raising concerns about the motives of some individuals.

Despite recent negative developments in domestic politics, the global backdrop continues to be the main driver of risk appetite and South African assets continue to benefit from global tailwinds (I know, an ironic word choice given macro data and political headwinds - but the irony is meant to be just that). From a local perspective, the government's ability to execute on the reform agenda remains key to any turnaround expectations, which remains questionable in the near-term.

Regarding the global backdrop - as well as global investor views on EM, and South Africa in general - the consensus view among many real money investors appears to be that duration is great to own, given the dovish Fed and slower global growth. But emerging market FX could be the shock absorber should trade tensions escalate. Therefore investors seem to tend to be overweight duration and underweight emerging market FX exposure in their GBI-EM portfolios.

Portfolio actions

Given volatility over the month tactical trading was required, with the fund the beneficiary of sound risk management processes across the balance of our business, while further gains were also derived from our long-held views on the progression of the monetary policy environment. Listed property continues to disappoint

While we continue to look for a slow, bumpy economic recovery, early-year drawbacks (loadshedding and broader SOE support) have somewhat taken the shine off the shortterm outlook. South Africa's current economic profile stands out by ranking with countries at war and in political turmoil (think Venezuela and Argentina). Following six years of stagnant GDP per capita, electrical shortages, weak confidence and risks to the global outlook, further downside pressures persist. We will not be surprised to see a negative GDP growth print in 1Q19, and with the second quarter unlikely to see a sharp recovery, the burden on post-election 2H19 to drag GDP over the 1% mark now becomes quite onerous. From our initial expectation of 1.0-1.3% growth, growth will probably print below this forecast.

Clearly South Africa is currently ill-equipped to deal with a recession.

This highlights the importance of post-election reform to raise trend growth and break the negative cycle.

The fiscus remains under pressure. Unjustified ongoing socialist ideological support to SOEs that are caught in a death spiral, regressive tax policies pushing us past the peak in the Laffer Curve, and a collapse in business and consumer confidence, paint a bleak picture. It is very disappointing that funds extended to SOEs aren't done so contingent on them meeting strict publicly available pre-determined targets.

Funding needs of health schemes, free education, crumbling infrastructure, a bloated ? and highly overpaid ? public sector workforce all pose risks to fiscal consolidation and debt stabilisation. South Africa is now also deviating from its own expenditure ceiling.

The continued reliance on short-term financing flows to fund the current account deficit remains a source of macro vulnerability.

The outlook for monetary policy is balanced. A late-cycle global slowdown (Federal Reserve (Fed) pricing has taken a dramatic about-turn since late 2018) allays pressure on the Monetary Policy Committee (MPC). However, while inflation anchoring seems to be embedded in longer-term expectations, the weak fiscus presents a challenge to monetary authorities. Subdued core inflation and a clear absence of demand-pull or FXpassthrough all point to signals for lower interest rates. Real interest rates (r-star) are also arguably moving into restrictive territory. The make-up of the MPC could undergo significant change over the remainder of the year. These changes present volatility for the outlook.
GLOBAL

The end of 2018 saw two narratives with very different consequences for global growth. On the one hand, significant equity market turbulence, tightening financial conditions, plunging PMIs, an escalating trade war, and increasing recession probabilities contributed to a negative spiral of news. On the other hand, unemployment continues to fall, labour force participation continues to improve, wages are on the upswing, and emerging markets overall are weathering the currency, financial, and trade storms with a good degree of resilience.

With the S&P 500 Index now up 13% year to date, 1Q19 marked the best first quarter since 1998 and the best quarterly gain since 2009 in the US, while 10-year Treasury yields fell to their lowest level since December 2017.
Despite this move, analysts are rapidly changing their outlook for the US economy, with some now removing any further hikes in the cycle and shifting to forecast at least two cuts in 2020 (with the risk of a cut in 2019 rising). Recession fears are still a major part of market action.

It has become more likely that both the European Central Bank and Bank of Japan will struggle to hike rates, further supporting the view that we have seen the peak in bond yields.

The outlook for 2H19 will be important for the above view, as there can be no debate that several temporary shocks at the start of the year likely resulted in a meaningful slowdown in 1Q19 (government shutdown, slower pace of tax refunds, adverse weather conditions). Labour income growth has been steady throughout the current expansion, and the labour market is expected to remain tight during the current industrial production slump. A relatively high savings rate and healthy balance sheets offer additional resilience, even if income growth slows. However, while labour markets in most economies continue to support demand, the capacity of domestic strength to outweigh trade tensions is waning, as policy uncertainty is weighing on real and financial investment decisions.

Global growth has been subpar with mild deceleration, but the US recession risk does not presently seem a 2019 event (US growth revised downwards from close to 3% in 2018 to the 2% region - still above trend). Meanwhile, core inflation is expected to trend sideways around 2%. Central banks, the Fed in particular, also seem much better prepared for a recession relative to 2008. Risks to the US outlook are therefore roughly balanced: stillabove-trend growth, wage inflation still evident, firm business investment vs. threats to international trade, weaker than expected residential investment, potential disorderly asset price corrections.

While another opportunistic hike is possible, we expect the current level of the federal funds rate as at or near the terminal level of this hiking cycle. If faced with a sharper economic weakening than currently forecast, and heightened threats of a recession, the Fed could cut, and even aggressively so. This scenario would probably involve deterioration of jobless claims, trend payroll growth, the unemployment rate, manufacturing and non-manufacturing PMIs, and industrial production. But the Fed could also cut in the face of an adverse market event or disappointing inflation data. In the last two cases, the goal would be to extend the recovery.

For the Eurozone, growth is forecast to slow to a below-consensus 1.0-1.5% in 2019 from close to 2% in 2018. This view reflects the tightening in financial conditions in Italy as well as weaker global growth.
In the UK, most investors expect a long Article 50 extension for Brexit, with no specified UK political process, followed by a second referendum, exit on terms specified by the current withdrawal agreement or general election, with only a small minority expecting no deal and reversion to World Trade Organisation norms to govern trade.

In China, 2019 growth should slow to the middle of a 5.5-6.5% range ? reflecting uncertainties caused by trade tensions with the US, domestic pressure to deleverage, and an economic policy with partially conflicting targets (growth and unemployment versus financial stability). We do expect signs of stabilisation to set in after the late-2018 slowdown, as the fiscal easing impact kicks in.

A moderate rebound in CPI to 2-3% is possible on rising energy and food prices, while the Peoples Bank of China is widely expected to cut reserve requirements further rather than cut rates. Any further depreciation of the Yuan against the Dollar is likely to be moderate unless trade negotiations between the US and China fail and tensions escalate. But we flag this as a key risk in our outlook ? and have done so for many quarters ? as the threat of a global trade war remains the key geopolitical risk in 2019. Based on the above developed market view, some breathing room may exist for emerging markets (EM). EM seems to be in a 'sweet spot' for four reasons. Benign inflation expectations, a dovish Fed and reasonable optimism about both Chinese stimulus and a US?China trade deal set the scene for the coming quarter. However, the latter two factors mean that the former two might not be very durable. China's downturn is at the heart of global disinflationary pressures, and the market's optimism about Chinese stimulus is thus at odds with the idea that this can persist. In addition, China's downturn has helped to justify the Fed's dovishness. A stabilisation in China could therefore revive expectations of Fed hikes. That's not a bad scenario for EM, but arguably not as good as the one EM has enjoyed the first two months of the year.

With central banks on the sideline, the Euro/US Dollar exchange rate broadly seen in the $1.20/$1.10 range, and Chinese stimulus putting a floor under commodity prices, a window for a local rally ? and, importantly, a recovery for cyclical SA Inc assets - might be open.

September proved to be a very tricky month – at least for those present for the full 30 days. For those that only witnessed the latter half of the month, where the MPC left rates unchanged, the Rand rallied 3.3% and bond yields moved more than 60bps lower, all seemed well with the world. It’s the early-month price action that left some scars across the risk universe that mattered. Equities probably tell the story best, dropping 4.2% on the month to once again take the year-to-date (YTD) return back into negative territory (-3.8%). Ongoing pressure in the first week of October saw the rand giving back the bulk of its gains - after testing R15.50 against the dollar more than once over August and early September - with the ALBI (Sept YTD 4.8%) down 1.7% after the first week in October. The latest South African finance minister scandal clearly took its toll.

The STeFI 3-month Index returned 51bps in September, while the 3-month JIBAR ended the month at 7.00%, declining by 0.8bps compared to the previous month. South Africa’s August CPI printed at 4.9% y/y, which was lower than consensus expectations of 5.2% y/y. The downside surprises were primarily in categories that tend to be sensitive to exchange rate pass-through, namely in food, alcoholic and non-alcoholic beverages, clothing and footwear as well as household contents – proving the lack of demand pull in the economy. However, it is expected that risks to the inflation outlook are now firmly to the topside. The SA Reserve Bank’s Monetary Policy Committee (MPC) kept the repo rate unchanged at the September MPC meeting, although with a surprising 4-3 vote split in favour of a hold. The statement was hawkish and was it not for the weak second quarter of 2018 GDP print, an interest rate hike would likely have been a foregone conclusion. With the departure of Brian Kahn the November meeting seems ‘live’.

Retail sales volumes grew 1.3% year/year (y/y) in July, below the June upwardly revised number of 1.8% y/y (from 0.7% y/y previously) and Bloomberg consensus forecast of 1.6% y/y. Seasonally adjusted sales increased by 1.3% month/month (m/m), compared to June’s contraction of 1.1% m/m. The significant upward revision for June was due to two large retailers not submitting their data on time for June’s retail sales publication, according to Statistics South Africa (Stats SA). The weakness in retail sales is consistent with the view of a weak SA consumer faced with high and generally inelastic petrol prices and VAT increases reducing spending power. The low consumer confidence environment has seen a slow take up of debt even as banks are more willing to lend.

September was again a busy month in terms of issuance, with Aspen, Hyprop, Landbank, Woolworths, and new entrant in the capital markets AECI issuing primary bonds. Credit demand remains strong and average credit spreads are still slightly above average historical levels. Perhaps this speaks to the fact that demand is contained to specific names as evident in the inconsistency in bid-tocover ratios for credit auctions. In line with our view, the market has become more selective on names.

On the global front September was dominated by a decisive break higher in developed market yields. The common theme of this break higher relates to the unwind/expected unwind of stimulus policy dating back to the global financial crisis. to 2.25%. The Fed is forecasting hike rates to a peak of around 3.25%. Market expectations for the peak using Fed Fund futures are around 3.00%. In Europe, Mario Draghi commented that domestic inflation pressures were strengthening and that uncertainty over inflation was receding.

The trade war theme continued through September with the following noteworthy events taking place:
·September 7: Trump threatens new tariffs on about $250bn’s more worth of goods ·September 12: The US invites China to trade talks
·September 17: The US finalises tariffs on $200bn’s worth of Chinese goods
·September 18: China retaliates and announces tariffs on $60bn’s worth of goods ·September 22: China cancels planned trade talks with the US

September provided some reprieve for emerging market (EM) currencies with some of the Turkey/Argentina driven August weakness reversing. The broader trend for EM currencies since the start of the year is still decisively toward weakness.

Toward the end of September, the market focussed once again on the Italian debt theme. This was triggered by the Italian government’s plan to loosen the budget deficit to 2.4%, which put the government on a collision course with the European Commission. Italian yields sold off about 30bps dragging some of periphery European (Portugal, Greece, Spain) yields with it.

Still there is no respite in the price of oil with September seeing a roughly 7% increase in the price of Brent. This is on continued expectations of constrained supply as a result of US sanctions to be imposed in November. It is important to note though that there have been some attempts by China, Russia and Europe to try and find a mechanism to bypass these sanctions – setting up for some more conflict with the US.

The Brexit saga continued to add volatility to the British pound. Negotiations between Prime Minister May and Brussels have been slow. In addition to this, there seems to be internal squabbling within May’s Conservative Party on the terms in which Brexit should be applied. The volatility of the pound is likely to remain elevated as the Brexit deadline approaches.
Equities in the US continued its upward trend with the S&P500 postings its sixth consecutive monthly gain. Important to note is that this upward trend in equities has been confined to the US with broader equity indices outside the US performing quite tepidly during 2018.

Portfolio overview
The investment environment remains challenging. Risks remain from more aggressive US Fed monetary policy tightening and quantitative tightening in Europe, while locally we face policy uncertainty around land and mining reform, political risk, a constrained fiscus and subsequent impact on the rand. The risk premia that SA government bonds trade at is unlikely to unwind in the near term and under certain conditions could extend even further. Risk management seems prudent in the current context.