MARKET REVIEW… What happens in China does not stay in China…
SA EQUITIES – Weighed down by Resources
Graph sourced from RMB
The JSE’s low beta set to be challenged as earnings downgrades persist
• For the quarter Developed Equity Markets outperformed riskier Emerging Markets by almost 10%, the worst relative performance since 2008. The biggest drag on EM performance was Brazil (-36%) and China (-23%). Greece (-36%), Indonesia (-24%), Colombia (-24%) and Peru (-21%).
SA BOND MARKET … finds late support
COMMODITIES… suffer pain and more pain
CURRENCIES … Commodity and Current Account Deficit Currencies hit the hardest
• During the quarter the rand weakened 12.1% against the USD, in response to the global risk-off move that hit all high-risk high-yield and commodity linked currencies.
• Post quarter end, the Rand is currently benefitting from the expected delay in Fed hikes, commodities rebound and the general risk-on sentiment. However the medium-term view remains bearish on the weak fundamental picture and lack of room to defend the currency via rate hikes or via forex interventions (forex reserves remain low). External factors will also continue to hold the Rand ransom – potentially weak growth in China is negative for the Rand. South Africa has the largest trade exposure to China within EMEA – nearly 16% of its exports are directed to China. Further, given SA’s dependence on commodity exports, the Rand is particularly vulnerable to weak global growth and its bearish implications from commodity prices.
SA MACROECONOMICS IN Q3… Picture remains bleak
• The fundamental picture in SA remains a bleak one. GDP is growing at its slowest pace since 2009, manufacturing data remains in contractionary territory and business confidence is low. Neither the business cycle nor structural factors are likely to provide much support to growth in the coming quarters. SA is estimated to be 6 – 12 months into a down-cycle which raises concerns over a looming recession, while structural issues (electricity shortages and labour strikes) persist.
• Monetary Policy: In a unanimous and expected decision, the SARB kept rates on hold at 6% in September “for now”, (after July’s pre-emptive 25bps hike) due to domestic economy weakness and tame inflation. The Reserve Bank did however indicate that it remains on a gradual path of policy normalisation should inflation pick up (for example on rand weakness). The Governor highlighted that the Monetary Policy Committee will not have to move rates in tandem with the Fed as domestic conditions differed, although the resultant impact on the Rand would be closely monitored.
• By the time the MPC next meets, on 17-19 November, CPI data for September and October would have been published. Consensus estimates indicate that headline inflation will still print below 5% yoy in September (4.6% in August) and marginally above 5% in October.
• A few economists believe that the Reserve Bank will likely raise interest rates by 25bps on 19 November.
• GDP Growth: the SA economy contracted by an annualised 1.3% in the second quarter over the previous quarter. Manufacturing contributed the most to the contraction, declining for the second straight quarter by 6.3% due to lower production of basic iron and steel, non-ferrous metal products, metals and machinery, petroleum, chemicals and plastic products.
• GDP growth downgrades persist and forecasts range a little above the 1% mark to 1.5% for both 2015 and 2016.
• Inflation remains contained for now. CPI dropped to 4.6% year on year in August (from 5% in July), lower than market expectations and well within the SARBs 3-6% target band. The data suggest that the forex pass-through to inflation remains low, while weakness in fuel prices and consumer demand are weighing on inflation. Inflation is now expected to peak at around 6.7% in 1Q16 with the 2016 projections around 6.2%.
• The current account deficit narrowed to 3.1% of GDP to its smallest gap in nearly 3 years (from 4.7% in Q1), as a rise in the trade balance more than offset a larger gap on the net services and income account. The trade balance improved on the back of stronger exports which benefitted from the weaker rand, whilst the subdued growth in the value of imports also contributed to the improved trade balance. The improvement is expected to be short-lived particularly given SA’s reliance on short-term financing flows.
• Domestic demand remains soft with household spending growth slowing to 1.2% q/q in line with lower disposable income growth. Households continue to delever with outstanding debt easing to 77.8% of disposable income, from 78.7% in the first quarter. Fixed investment spending remained lacklustre, mainly driven by spending by government, and flat in the private sector.
• SA’s macro mix remains unfavourable from an equity market perspective – weak growth, rising inflation, challenging twin deficits, weakening currency, uncertainty over monetary policy, lower commodity prices, depressed business and consumer confidence, and structural issues all weigh on the prospects of the economy and the outlook for equities. The uncertainty around China’s growth outlook is another major impediment for the SA economy and its equity market.
• Furthermore the currency seems likely to remain under medium-term pressure due to both external factors and the challenging cyclical and structural backdrop.
• Lastly a look to valuations sadly does not provide the buffer against the macro backdrop. SA’s 12 month forward PE relative to other Emerging Markets is close to a 20% premium to the ratio’s five-year historical average. This makes SA the second most expensive market within the Emerging Market universe. Even after adjusting for the sector biases (by using a sector neutral PE), SA is trading quite richly compared with other EMs.
• In absolute terms, select SA banks, retailers and industrials are seen as slightly more defensive. Banks dividend yields are healthy and the banks over-capitalised. Loan growth, while slowing is still resilient, nor is credit quality under the kinds of pressure that macro factors might superficially suggest. Select industrial plays – particularly those offshore – are worth emphasising.
THE INVESTMENT CASE FOR EMERGING MARKETS BEING TESTED… requires clarity
• Like beach balls held underwater, risky assets should rise harder and faster under these conditions when the relief rally comes. Nevertheless, risks of powerful structural forces dragging risky assets even further underwater remain. Slower global growth would raise difficult questions about the efficacy of QE, and perhaps trigger a paradigm shift in investor expectations of monetary policy at the zero lower bound. Even if liquidity eases and sentiment improves, growth will still be the largest determinant of longer-term solvency and valuations.
LET’S NOT COMPLETELY FORGET ABOUT THE U.S. …
• With the US Q3 earnings season about to commence, a quick review of the Q2 reported results provides insight into trends and shape to what happened to global markets in the third quarter.
• Overall the basic headline reporting stats were solid in Q2 with Sales and EPS beat rates (results beating expectations) were a bit stronger than for Q1 for all of the major size indices.
• 73% of the S&P500 companies, 69% of Russell Mid Cap companies and 61% of Russell 2000 companies beat consensus EPS estimates, whilst 50% of S&P500 companies, 49% of Russell Mid Cap companies and 52% of Russell 2000 companies beat revenue estimates in Q2.
• There was a skew to sales beats as results for large cap Financials – more domestically focused sectors – were consistently strong, while those for more cyclical and globally exposed sectors were weaker (Consumer Discretionary, Industrials and Materials).
CURRENT MARKET THOUGHTS … Institutional Client Perspectives
Comments and perspectives taken from a Credit Suisse Strategist roadshow
Two words summarize how investors are feeling about markets right now – “lost” and “bearish”. Investors are focused more on risks, which are abnormally high, rather than reward, which is also high, with the Equity Risk Premium for example at 5.8%. However it remains evident that visibility is abnormally low.
PortfolioMetrix (Pty) Ltd is an Authorised Financial Services Provider in South Africa. The information contained is given for information purposes only and is not intended to constitute financial, legal, tax, investment or other professional advice and should not be relied upon as such. Investments can go down as well as up and past performance is not a guide to the future.
• South African markets were largely guided by global drivers over this first quarter of 2015; namely: (1) Europe’s QE (Quantitative Easing) stimulus and signs of economic recovery across the euro area, (2) initiation of US rate hikes being pushed out, and (3) ongoing falls in Oil and other commodity prices. Overlain upon these market moving drivers talk of “Grexit” (Greek exit from the Eurozone) grabbed many a headline with a drawn-out negotiation process still in play.
• The JSE All Share touched a record peak at 53,374.8 on February 24th, before entering a choppier period for the remainder of the quarter. March in particular saw the Rand as well as Resources and Industrials pressured whilst Financials and Property stocks carried their winning streak.
• Looking across the asset spectrum in Rand terms: SA listed Property once again trumped returns with a 13.7% rise over the quarter, followed by Global Property returning 9.7%, Global Equity 7.7%, then Local Equity at 5.9%, both Local and Global Bonds gave you a 3% return. Sitting in cash proved unfruitful with SA Cash yielding 1.5% and Global Cash lost you 4% in Rand terms. Local headline inflation for February was 3.9%.
• The Rand began the year on slightly firmer footing at 11.57 to the USD and steadied for the first two months. However the strong dollar across the globe, saw our local currency suffer a volatile March and gave back all its earlier gains. The Rand ended the quarter 4.9% weaker against the USD at 12.13 but healthy against the Euro at 13.02 and Sterling at 17.98. Encouraging is the 7% appreciation of the Rand against the Euro over the quarter, SA’s major trading partner.
Data sourced from Bloombergs, total return calculated on Gross Dividends reinvested
• Considering the JSE All Share index rose 11.1% in the year of 2014, the first quarter’s performance appears more than satisfactory at 5.9% with a peak record high of 53 374.8 on February 24th.
• From a broad Sector basis, Financials carried the baton, leading returns for the quarter with an increase of 11.2%, Industrials rose 5.6% and Resources just 0.1%.
• Year-to-date SA equities have attracted foreign inflows of R9.6bn, with outflows of R0.5bn from SA bonds.
• SA Equities have risen by an annualised 18% over the last 10 years whilst SA Bonds have given you 8.9%. Over this period Industrials outperformed, rising 23.2% versus Financials 17.8% and Resources 9.5%. On a 2 year view, Industrials and Financials have given roughly a similar range of returns of around 25-26% with Resources losing over 4%.
• Over the first quarter the JSE All Share earnings were downgraded by 6.5% largely in response to the fall in oil and commodity prices severely impacting Resource earnings, which were cut on average by 15.6%. Financials saw small upgrades of approximately 1.7% whilst Industrials were trimmed 1.7%.
• Platinum stocks were revised lower by a massive 27.7%, followed by Industrial Metals, General Miners and Construction companies.
• Upward revisions were most notable amongst Non-life Insurers, Banks and Fixed Line Telecoms.
• On 2015 earnings estimates, the All Share forward PE re-rated to 16.4x at the end of March from 15.5x at the end of December. The forward PE on Industrials remains hefty at 19.7x (largely thanks to Naspers’s forward PE over 60x), followed by Financials at 14.6x and Resources at 14.2x.
Global Market Returns Compared:
EMERGING MARKETS ONLY MARGINALLY UNDERPERFORM DEVELOPED MARKETS…
• In US dollar terms MSCI Emerging Markets rose 2.3%, marginally underperforming MSCI Developed Markets +2.5%.
• Within Emerging Markets – Asian markets rallied, up 5.3% whilst EMEA added 2% and LatAM tumbled 9.5%.
• Top performing Emerging Markets included: Russia rebounding off 2014 lows +18.6%, Hungary +14%, Philippines +10.2%, China +8.1%, India +5.4%.
• Worst performing Emerging Markets were: Greece -29.3% on geopolitical / debt standoff concerns, Columbia -19.3%, Turkey -15.8% and Brazil -14.6%.
• MSCI South Africa fared relatively well, returning 3.3% in $-terms, outperforming EM’s +2.3% and DM +2.5%, despite rand depreciation of 4.9% against the strong dollar.
BOND MARKETS … experience a second wind as initiation of US rate hikes gets pushed out
• SA Bonds had their best monthly return in six years with a return of 6.5% in January. However during the rest of the quarter the index gave back some of those gains resulting in a return of 3% for the quarter. The SA benchmark 10 year yield was down 15bps over Q1. SA Inflation-Linked Bonds underperformed, returning just 0.27% over Q1.
• US 10 year benchmark Treasury yields fell to their lowest levels since May 2013 (1.64%) as the timing of US rate hikes was pushed out by Fed Chairwoman Janet Yellen following a bout of disappointing US economic data, in particular employment and Inflation data. Economists now expect the US to only initiate rates normalisation around September of this year.
• European bond markets rallied sharply since the ECB began its asset purchases of public-sector bonds on March 9th as part of its trillion-euro stimulus program, the German 10 year yield ending the quarter at 0.185%. In comparison the US 10 year ended Q1 at 1.93%. The German-US 30 year spread has moved to levels last seen in the 1980s.
US Fed Funds rate targets
IMPACT OF THE STRONG DOLLAR… Winners and Losers (report by Deutsche Bank)
➢ Graphs sourced from JPM
• Three months into 2015, the global economy appears on track to expand at about the same pace as in 2014 (consensus sitting at Global GDP growth of 3.4%), with advanced economies growing slightly faster and emerging economies growing somewhat slower than last year. Relative to expectations at the end of last year, however, the US is off to a slower start, while other advanced economies, especially the euro area, are doing better than anticipated. These surprises appear to have much to do with faster than expected moves in the dollar’s value against key foreign currencies.
• Since middle of 2014 the dollar has risen by about 25% against the euro, 20% against the yen, and 15% on a broad trade-weighted basis. These trends have good prospects for continuing in the same direction with the expectation of moving through parity against the euro later this year. The concomitant question becomes how will the global economies adjust to these currency swings and who will be the winners and losers thereof.
• TWI – Trade-weighted index = ave of the US$ against the currencies of its major trading partners weighted relative to reflect each trading partners importance to the US
OITP = Other important trading partners
• Dollar appreciation is a clear plus for the euro area and Japan, as currency depreciation is a key transmission channel of their recently adopted and expanded QE policies aimed at raising domestic inflation from uncomfortably low levels. So far these policies and the induced currency moves seem to be generating the desired effect of lifting inflation expectations and boosting sluggish economies via increases in net exports.
• A second set of winners is emerging market countries that are energy and commodity importers and whose currencies have not been tied closely to the dollar. The rise in the dollar has tended to be associated with declines in the price of oil and other commodities, favouring consumers over producers. India is a prime example of a winner, and is projected to take the mantle of fastest growing major emerging economy this year.
• There are four sets of losers. First, the US. The dollar appreciation has already helped push US inflation to lower than desired levels, and economists estimate that it will depress US GDP growth by ½ to ¾ percentage points per year over the next year or two. These effects were no doubt important in the Fed’s recent decision to signal a later, rather than sooner, start date for embarking on policy normalisation.
• The second set of losers are countries whose currencies are closely tied to the dollar, ie China. However, despite recent currency appreciation, loss in price competiveness has not yet shown through to China’s external performance. The third set of losers is commodity exporters, including dollar bloc countries, Brazil, Russia and oil exporters.
• The final set of potential losers is countries than have bulked up on dollar-denominated debt. But such vulnerability appears low relative to history, especially at the sovereign level. The build-up of Emerging Market external debt has been mostly an Asian phenomenon, driven primarily by China, whose external debt burden remains low relative to GDP. And while dollar-denominated debt has risen for EM corporates, they generally appear well-positioned to withstand further dollar appreciation without leading to systemic events.
EUROPE: QE and growth versus political risk…
• As expected, the ECB initiated a large-scale, broad-based asset purchase programme encompassing government bonds. Despite being particularly controversial in the euro area, the ECB still managed to design a QE programme that exceeded market expectations.
• The ECB intends purchasing EUR60bn of assets per month for 18 months from March 2015 to September 2016. The pace of purchases was above market expectations, the total implies a balance sheet expansion in excess of EUR 1 trillion and possibly more so. The ability to find EUR60bn of assets every month for 18 months will depend in part on the strength of the economic recovery.
• The euro area in general remains behind the curve on structural reforms, but the lower oil price and euro depreciation together have pushed 2015 and 2016 GDP growth expectations up to 1.4% and 1.6% respectively with upside risks, particularly if other QE channels work.
• Politics remain the main risk. Populism is on the rise and the risks have materialised in Greece. Best case is a balanced compromise to be agreed and Greece to remain a euro area member, but the risk of a political accident is high. Even in Spain government instability is a significant concern. Elsewhere in the periphery policy continuity is expected despite anti-austerity rhetoric.
• Grexit is a downside tail-risk. On 20 February Greece agreed to extend the current loan programme despite having earlier said that it would not. Most economists believe that an exit is in no one’s interest, least of all Greece. Although there has been little progress since 20 Feb.
• There is EUR7.2bn of aid available in the current loan programme, but Greece will have to demonstrate its commitment to fiscal adjustment and reform before the EU will release funds. Time is running out. The risk of Greece failing to compromise is high. As the government’s limited cash resources get used up, depositor nervousness is rising again. If the ECB imposes a hard cap on Emergency Liquidity Assistance, it could force Greece into capital controls, and propel Greece into making concessions. Alternatively it could be the staging post for the exit from the euro.
• Political fragmentation could also be the theme in the UK election on 7 May 2015. The result is the most uncertain in a generation. There are few market-friendly outcomes. The Conservatives would offer a referendum on the EU. Labour’s loose fiscal stance could speed up the pace of monetary tightening. Consensus sees the BoE on hold until May 2016.
• Prospects across EEMEA (Emerging Europe Middle East and Africa) are subdued. This is largely due to Russia and masks modest upward revisions elsewhere in the region on the back of a decent end to 2014 and an improved backdrop in Western Europe, itself due to lower oil.
• The outlook for Russia has become more challenging. Although economic activity held up relatively well last year with GDP growth at 0.6%, the combination of ongoing sanctions and sharply lower oil prices is starting to weigh heavily and the Russian economy could contract as much as 5.2% this year.
PROSPECTS FOR SOUTH AFRICA …
• USD strength is pertinent for South Africa where the economy has historically benefitted from a weaker exchange rate, but the gain in price competitiveness has usually been eroded by domestic inflation pressure. In contrast, this cycle has been distinctly different from the past, thanks to subdued FX pass through to local inflation due to the lower oil price. In real trade weighted terms, the rand has depreciated by more than 20% over the last five years, notwithstanding recent strength, with the effects beginning to show up in some improvement in exports, especially manufactured goods.
• With growth prospects improving in Europe – SA’s major trading partner and a key destination for manufactured goods – the outlook for the export market is slightly more positive. Whether exchange rate pass-through remains subdued at current exchange rate levels remains to be seen.
• In terms of the monetary policy outlook, SA will be one of the few EM economies where rates may rise shortly after the Fed’s normalisation has started. Improving real rate differentials may actually stand the rand in good stead, especially if the Current Account deficit improves as is expected. Dollar strength will in all likelihood promote further rebalancing of the Current Account deficit, especially at levels above R12/$ which is close to the fundamental equilibrium exchange rate estimate needed to stabilize the Current Account deficit over time.
• Despite the view of a decline in general EM risk, there are a number of reasons to expect an increase in SA specific risk. Two critical factors come into play: (1) the cost of a downgrade on SA debt and (2) Electricity supply shocks and the result thereof. Both of these factors will most certainly shape and possibly unnerve markets in the coming months.
• And lastly, SA Equity Valuations are unequivocally stretched based on trend. One can argue that based on consensus numbers Resource counters may appear cheap, however one would have to caution that earnings on these counters still need some downgrades and that the current PEs are not a true reflection of value.
SA MACROECONOMIC RELEASES OVER Q1
• The SA GDP growth rate in 4Q14 was an improvement on the previous three quarters with an increase of 4.1%, although capping the year to just 1.5%. This was particularly disappointing when compared to the already muted growth of 2.2% in 2013.
• On the positive side, SA inflation decelerated to 3.9% in February, the lowest level since March 2011.
• Despite the lower levels of inflation, the MPC kept rates on hold at 5.75%, with a statement that was more hawkish overall than expected, arguing that the scope for pausing monetary policy normalisation had diminished. The current very drawn out period of policy tightening began with a 50 bps hike in 1Q14 followed by a further 25bps hike in July 2014. But the SARB has paused since then. Many economists propose that although not imminent a hike later in the year is likely.
• The SARB marked up its inflation projections materially to 4.8% in 2015 and 5.9% in 2016.
• At the same time, it left this year’s GDP growth outlook unaltered at 2.2% y/y, while marginally lowering next year’s forecast to 2.3% (from 2.4%).
• The sharp narrowing in the 4Q14 trade deficit to 0.9% of GDP, from 2% was unsustainable and reflected temporarily strong Chinese imports ahead of the Lunar New Year. The January record R24.2bn deficit showed these exports to China had collapsed by the amount of the late 2014 gain. February’s trade deficit of R8.5bn improved from January’s record as sales of vehicle and transport equipment jumped 74% as well as precious metals surging 30%. In contrast export of mineral products shrank 10.6%. The expectation for 1Q15 as a whole is approximately a 1.2% deficit of GDP.
• SA Purchasers Managers Index rose marginally to 47.9 in March from 47.6 in Feb. The slight improvement brought the average for Q1 to 49.9 points, just below the neutral 50-point mark. Sadly electricity load-shedding and general weak demand seems to have nipped the late 2014 recovery in the bud and looks likely to weigh on the economy this year.
GLOBAL MARKETS AND CHARTS SHAPING THE FUTURE … waiting for the Fed
• Over the last 12 months, equity and bond flows have been closely tied to market expectations of Fed rates. Falling expectations of Fed rates have seen outflows from equities and a strengthening of bond inflows; rising rate expectations the opposite.
• If US rates move up in 2015 as anticipated, expect reallocations of flows from bonds to equities to resume.
• Recent European equity outperformance is being driven by record inflows, both foreign and domestic which are following strong positive data surprises in Europe as US data has disappointed. European data surprises are running close to the top of their historical band while US data surprises are at the bottom of their historical band.
• These inflows into Europe has seen European equity relative valuations 10% above average, pricing in strong earnings growth in Europe of 15%, outpacing the US by 11 percentage points with a large relative currency benefit partially offset by slower underlying growth.
• Besides the macro and geo-political issues that played out over the course of the year, several themes shaped a volatile fourth quarter global market performance, that being: (1) the strong US dollar (2) the “surprise” rally in Treasuries (3), the late recovery in Chinese equities and lastly (4) the dramatic sell-off in Oil markets. This saw Global Equities returning 4.7% (in $- terms) in 2014, its twentieth year of positive returns in its 27 year history of data.
• Against this backdrop South Africa weathered the global volatility rather well, the JSE ended the year with a sobering 10.9% total return, somewhat sombre when compared to 2013’s = 21.4% and 2012’s = 26.7%; but in context of weak commodity prices, a weak Rand, and a very uncertain and tepid macro outlook.
• The MSCI South Africa index rose 5.7% in $ terms relative to the MSCI Emerging Markets index loss of 1.8%.
• Although almost 10% weaker, the Rand certainly wasn’t the most significant driver in 2014 like it had been in 2013 where it lost 19% of its value.
• Looking across the asset spectrum in 2014: SA listed Property trumped returns with a 26.6% gain, followed by Inflation-Linked Bonds with 11.2%, then the JSE All Share’s 10.9%, closely followed by the SA All Bond Index 10.2% and Cash returned almost 6% against average headline inflation of 6.2% for the year (cash currently offering negative real returns).
• Investing in Global Equity (MSCI AC World) in Rand terms gave you 15.1% (compared with 52% last year), Global Bonds (JPM GBI) returned 11.0% (relative to 18.2% in 2013) whilst Global Cash lost 1.3% (23.5% in 2013).
• Overall 2014 was no stellar year for investors on the JSE. The All Share index rose a mere 7.6% before dividends which is less than 2% above inflation. The total return with dividends reinvested is a slightly more comforting 10.9%.
• But in context, other Emerging Markets did not fare as well as South Africa, particularly in December. The MSCI Emerging Market index ended down 1.8% in 2014 (in $ terms) versus MSCI SA’s 5.7% gain, and underperforming Developed Markets by over 7% and the US by some 15%. The other commodity producing Emerging Markets performed shockingly – Russia lost 45.9% in value whilst Brazil fell 13.8%, but were plagued by numerous other macro and geo-political factors. China ended up 8.3%, India was a strong performer up 23.9% and Turkey rose 19%.
• Taking a longer term view SA Equities have given investors a whopping 18% compound annual average return over the last 10 years whilst SA Bonds have returned 8.5% over the 10 years.
• SA sector winners in 2014 tended to be more defensive groups with exposure to low interest rates, falling bond yields and/or a weaker rand. The Materials and Energy stocks bore the brunt of selling as commodity prices continued to collapse for a fourth straight year.
• The spread in returns from financials, industrials and resources was significant. Financials far outstripped the rest of the market, delivering a total return of 27.8%, whilst Industrials gave you a respectable 17.2%, however Resources lost you 15%.
• Financials outperformed, with banks reporting relatively stable earnings, although African Bank obviously blots this sector’s record in the third quarter. Non-life insurers were one of the sectors showing significant earnings upgrades particularly in this last quarter. Along with other yield plays, real estate stocks were a surprise star performer in 2014 with forecasts at the beginning of the year of approximately 5-6% returns, significantly below the 26.6% total return achieved. The Property sector also attracted the bulk of new listings on the JSE with 8 of the 23 new listings.
• Industrial counters were restrained by lacklustre earnings, particularly in the retail industrials. The SA consumer was noticeably under pressure earlier in the year, although the late fall in the oil price buoyed the sector sentiment in the fourth quarter. Construction and Material stocks remained out in the cold in 2014.
• Resource counters once again took a pounding in response to a confluence of reasons – fears over Chinese demand, a global oversupply with various new mines coming on line, while the surging US dollar further pressured commodity prices and oil’s fourth quarter demise was the last nail in the sector’s coffin. All the big diversified miners were out of favour, all losing more than a quarter of their value.
• From a valuation perspective, SA began the year on 1 year forward PE of 13.9x earnings which steadily crept up to around 15x by year end. Most of the increase in PE rating has come from the Industrial sectors – Media, Personal Goods, and Food & Drug Retailers. The biggest forward PE declines were seen in Platinum, Mobile Telecoms (MTN responding to the slump in the Naira) and General Mining.
• At year end the JSE All Share’s Market Capitalisation of all constituents was R9.85 trillion with Industrials making up 58.6%, Financials 22% and Resources the remaining 19.4%.
• In 2014, foreigners ended the year Net Buyers of SA equities for the first time in 3 years. Foreigners bought a healthy R18.1bn worth of equities, reversing the trend of sales of approximately R160m in 2013, R3.4bn in 2012 and R17.2bn in 2011. This inflow is in sharp contrast to Emerging Market equity flows, which saw a massive $25bn outflow in 2014. In December alone, Emerging Market funds suffered severe outflows to the tune of $17bn in the month alone as the collapse in the Rouble and sharp sell-off in EM Forex and debt ultimately weighed on EM equities.
• However SA Bonds were sold by the foreigners, Bond outflows of R5.7bn were recorded in 2014.
• Emerging Market equity ended almost 2% lower in 2014 underperforming Developed Equity by over 7% and the US by 15%. Dispersion in market and sector performance was high. Egypt, Indonesia, Philippines and India were the best performers, all gaining in excess of 20% in $ terms. The bottom three markets were Russia, down a massive 46%, Greece off 40% and Hungary -27%.
• Interestingly analysts revised down EM 2014 and 2015 Earnings by 17% in the past 12 months, whilst Economists have revised down 2014 and 2015 GDP growth forecasts for all countries except Hungary, Malaysia and India. Russia had the biggest negative GDP revision from 2.65% to 0.05%.
• Oil markets slumped after the OPEC meeting on 27 November 2014 where Saudi Arabia surprised the globe by saying it would not cut back on production to support oil prices. As a reminder, the average price of Brent oil in 2014 was approximately $99/barrel, compare this to the current price of $50/bl. How did we get here?
• The November OPEC meeting was a significant event in Global Oil markets with Saudi Arabia opting to defend market share at the expense of price for the first time since the 1980s. This change in Saudi’s behaviour is a short term game-changer and far outweighs the demand weakness which is seen as more transitory. This new era of volatility is expected to result in spending and investment cuts, which should see OPEC’s intended slowdown from key non-OPEC producers: US Shale and Russia.
• The next OPEC meeting is scheduled for 5 June 2015, but an emergency meeting before this is a possibility. At $50/bl Brent oil is already well below the marginal supply cost for the industry. At this price, spending will be reduced, projects delayed and investment will fall. The marginal supply over the last three years has come from US shale, where the companies have begun announcing significant spending cuts for 2015 by on an average 25%-30%. (Investec estimates the marginal cost for US share to be around $75/bl).
• Russia also plays a role in Oil’s outlook with the effect of sanctions and underinvestment pulling Russia’s 2015 production materially lower, approximately 0.5 million bl/day. Other supply side risk events in 2015 include Saudi Arabian succession, Venezuelan debt default and Nigerian elections.
• Oil price forecasts for 2015 are wide ranging from $60-$77/bl, averaging around $65-$70 for the year.
Emerging Market currencies weakened on the back of a strong US dollar and weaker commodity prices, weighing most notably on oil producer, Russia (as well as geo-political factors).
Relative to the other current account deficit candidates, i.e. “the Fragile Five”, the rand is the worst performer over the last two years. Only Brazil fared worse than SA in 2014.
• The Christmas break has seemingly done very little to calm investor nervousness about the global and local economy, and especially concerns surrounding the Eurozone. The volatility seen in recent weeks suggests investors remain unsure how to position against the heightened concerns of deflation in light of the dramatic fall in oil, vacillating and unsynchronised global growth and the will-they-won’t-they debate about the future European Central Bank (ECB) Quantitative Easing (QE) policy. The head of the ECB, Mario Draghi, has committed to the purchasing on assets (bonds) to the value of 60 Billion Euro’s per month in order to stimulate inflation and Economic Drive within the European Union. Furthermore a looming Greek parliamentary election (Jan 25th) also has the potential to unsettle markets that could possibly see an austerity/euro party to power.
• From a Macroeconomic point of view, South Africa was in a state of stagflation in 2014 (accelerating inflation and declining GDP growth), which typically favours a higher allocation to Bonds (both local and foreign) according to BNP Paribas. However, in the face of the declining oil price and a possible concomitant pickup in consumer activity transitioning SA into a possible recovery in 2015, this phase favours Equity (both local and foreign), but it also allows for a higher Cash weighting, due to a typically lower inflation-based hurdle (for mandates that have inflation-based targets).
• History has shown the Resource sector is the most positively geared to the economic cycle, whilst Financials the least and therefore fared the best during periods of declining GDP growth, like that seen in 2014. If the consensus is for a pickup in GDP growth into 2015 and 2016 then history suggests that the Resource sector should outperform. Consensus forecasts also show the Resource sector with the largest number of Buy recommendations whilst Financials show the largest number of negative recommendations. BUT herein lies the dilemma that has many fund managers grappling with answers – is it time to switch into Resources (“The Great Rotation Debate”)? Views are widely divided with some analysts basing their investment cases around valuation. However over the past decade earnings growth has been the key driver of the Resource sector performance. Earnings growth is largely driven by commodity prices, which in turn are influenced by global demand, supply, speculative positions and currency dynamics. Thus in view of current events, namely oil, plus a slowing Chinese economy, the strong US dollar and poor European outlook the likelihood of a significant pickup in commodity prices is poor, according to Analysts.
• On the upside, Analysts expect SA GDP growth to rebound to 2.3% in 2015 after a significantly labour-impacted 2014, but will remain muted with possible downside risks in the wake of electricity constraints, public sector wage negotiations in Q1, inter-union rivalry and the ANC’s National General Council in June to add to political risk events.
• Also the consumer price inflation is expected to moderate from pushing against the 6% upper limit of the target range to about 4.5% in mid-2015 easing the pressure on the South African Reserve Bank’s Monetary Policy committee to raise the key interest rate to quell inflation. This is largely as a result of the lower oil price, this however is expected within the hear ahead to trade between the $60 and $70 per barrel range, so do not get comfortable with your home bond repayments not rising, I would recommend that you willingly request your bank to marginally increase your payments in expectations of the rising REPO rate. This will result in you not being “caught off guard” when the interest rates do rise.
• The current account deficit should also shift from a worrying 6% of GDP, to a more palatable 4% of GDP, which should lift some of the pressure off the rand. In addition, on a purchasing power parity basis, the rand remains fundamentally cheap and attractive. But for this to translate into economic reality, SA needs more robust growth and a stable economic environment. Without a rise in productivity and a more disciplined fiscal setting, the rand is set to remain weak.
• The attractiveness of bonds will only likely improve on the expectations of an easing interest rate environment. We are not there yet. And whilst the budget deficit remains wide (4.1% of GDP) and tax revenue remains under pressure and demands on the fiscus continue to grow, the bond market is not expected to rally any time soon.
• The property market will benefit from an improved economic growth outlook, the lower oil price, moderate price inflation and a stable interest rate environment. But, the caveat here is the proliferation of property listings on the JSE over the last year. Investors need to be mindful of the nature and quality of the property assets in which they invest – not all the assets are of equal attractiveness.
• According to consensus, the JSE All Share Index appears relatively fully priced and not a hugely compelling investment. Using just about any valuation metric – SA ranks towards the bottom of the table relative to global markets. However, it is critical to keep in mind that the index is exactly that – an index. There are pockets of value to be found, which are masked by the All Share Index composition.
• Some 50% of the index is made up of the large industrial companies which are on very expensive multiples and continued to rise through 2014. Momentum works very successfully – until it stops working. Rather than rely on sector momentum, investors will have to look beyond the big names and identify some hidden smaller to mid-cap counters for intrinsic value.
• All-in-all, South Africa goes into 2015 in a better state than in 2014, with some positives on the horizon. But once again, investors need to exercise caution in making investment decisions and focus more on the robustness of each particular business than any blue sky potential that may (or may not) exist. Yield will remain an important factor of total return and should not be ignored. On the equity side, consensus forecasts 5-6% earnings growth for the All Share with a 3% yield bringing the total expected return to between 8% and 9%, but caveat that risks are to the downside.
• Below is a range of both global and SA Analyst forecast Asset returns for 2015, (note the disparity in SA Bond forecast).
• From a Global perspective 2014 brought many surprises for financial markets with the biggest probably being the rally in bonds and the decline in energy sectors. These two were related to the extent that global demand weakness induced investors to reassess the outlook for both interest rates and oil prices. In fact the two were self-reinforcing with lower oil prices exacerbating market’s assessment about deflation risks and thus lowering expectations about the future path of policy rates.
• Global growth is expected to languish in the mid-3% range in 2015. The dichotomy between those central banks that are now beginning to normalise their policy rates (US and UK) and those that are expanding their balance sheets (Europe and Japan) suggests a volatile year (evident by the first couple weeks trading). China is slowing and may be weaker than it looks. USD strength and weaker-than-expected Chinese demand threaten commodity exporters like SA.
• The expectation that Fed policy rates will rise around mid-2015, coupled with the end of US QE, should continue to drive the US dollar higher and US yield curve flatter. As is in 1990s, when Japan and Europe were flailing and Emerging Markets were in financial crisis, the US dollar and US Treasuries were the safe haven assets. In this environment, US equities outperformed on a strong US economy, while inflation fell and bond yields remained low. There are a number of similarities today with the US emerging as a growth leader in a world of softer growth and low inflation – Europe and Japan are struggling with weak growth and risks of deflation, and emerging economies are being constrained by weak commodities, tight monetary policy and deteriorating growth.
• In light of this, capital flows into the more risky assets or vulnerable emerging market economies, like South Africa, will no doubt come under some pressure when US tightening finally kicks offs, though the balance sheet expansion in Europe and Japan could limit the sell-off.
o The MPC kept rates on hold at 5.75% in November although the tone turned decidedly dovish. Furthermore the SARB lowered its GDP and CPI forecasts and the Governor also made reference to possible delays in the US Fed’s decision to raise interest rates, due to a more benign outlook for global inflation. The next MPC meeting is scheduled for 27-29 January 2015.
o Stats SA this week confirmed that the consumer price inflation dropped to 5.3% in December 2014 from 5.8% in November. Inflation is expected to moderate in 2015 to average approximately 5.2% (from 6.1% in 2014)
o South Africa’s current account deficit narrowed somewhat to 6.0% of GDP in 3Q14, from a revised 6.3% of GDP (6.2% before revisions) in 2Q14.
o For the fifth consecutive quarter, export volumes grew faster than imports, but better terms-of-trade made the real difference. Despite July’s strike in the metals and engineering sector and a platinum sector that is still ramping up production (after a six-month stoppage in 1H14), export volumes still performed marginally better(+3.3%) than imports (+3.2%), in part benefitting from a pickup in vehicle exports (as a new model comes into production), but mainly reflecting weakness in domestic demand. However, the key driver of trade improvement was the price of Brent, which represents around a quarter of South Africa’s imports.
o The credible fiscal consolidation message in the MTBPS saved South Africa from a downgrade this time around. Fitch said that the government’s MTBPS commitment to reduce the deficit rather than delay consolidation supports creditworthiness. However, execution will be challenging. In 2015, the challenging growth outlook and difficult wage bill growth targets, will likely weigh on fiscal performance, further delaying fiscal consolidation, which, may imply a downgrade of Fitch’s rating to BBB-, in line with S&P’s.
The JSE All Share recorded its worst quarter in three years and shed 2.58% in the month of September alone.
For the Third Quarter, SA Listed Property was the star performer, returning 7.1%, the All Bond Index rose 2.2%, Cash gave you 1.5% whilst SA Equities lost 2.1%.
SA Listed Property surprisingly leads the year to date returns at 13.9%, whilst the All Share has given you 9.5%, All Bond Index 5.7% and Cash at 4.3% against CPI inflation of 6.4%.
External reasons for this weakness include: uncertain prospects out of China, worrisome economic reports from Europe prompting fears of the Eurozone dipping back into recession, and lastly commodity prices in particular being aggravated by the very sharp rally in the US dollar.
Add to this a weakening local outlook given a record August trade deficit of R16.3bn and signals from the Monetary Policy Committee of a tightening bias for local rates despite a weakening economic growth outlook. Our currency remains the key upside risk to inflation which continues to appear vulnerable given SAs deteriorating current account deficit, falling commodity prices and tenuous foreign portfolio flows funding the shortfall.
On a sector view, weakness has been broad-based with all the major indices ending lower. Although marginally lower, Financials have outperformed, with insurers benefiting from a low claim season due to favourable weather, wealth managers reaping the benefits from positive returns, compounding effects and banks have reported relatively stable earnings. African Bank obviously blots the sector’s record, the demise of the micro-lender impacting many of SAs Money Market funds in particular.
Industrial counters have been pressured by lacklustre earnings, particularly in the retail industrials. The SA consumer is noticeably under pressure which is weighing on the SA retailers.
Resource counters have once again taken a pounding in response to a confluence of reasons – fears over Chinese demand while the surging US dollar further pressured commodity prices and the effects of the prolonged strike action filtering into the earnings reporting season.
Top sector performances came from Fixed Line Telecoms, Healthcare and Real Estate.
Bottom sector performances were from Platinum, Personal Goods, Golds, Auto and Industrial Transport.
The rand has depreciated 6.1% against a surging US dollar over the quarter, although held ground against a weak Euro, gaining 2.1%.
South Africa recorded a mixed quarter from foreign portfolio flows – a R10.7bn equity inflow was offset by R12.4bn of outflows from bonds.
The sharp rally in the dollar also translated into weak commodity prices, notably gold, platinum, iron ore and other metal prices, especially with more speculative investors dumping their exchange traded funds in the metals. This selling has more than offset any increase in demand from the global car industry which was just beginning to show signs of improvement.
The platinum price has slumped 12.4% in dollar terms in the last 3 months to a 5-year low and remains in this down-trend spiral that started in 2011 at $1915 compared to the current price around $1200, prices last seen in 2006/7.
The outlook for iron ore also appears jaded with BHP Billiton forecasting the increase in iron ore supply to continue to outstrip demand from the steel industry over the next 2 years, meaning the iron ore price could remain pressured, even after tumbling 41% in the year to date.
The oil price fell close on 16%, its biggest quarterly decline since 2012. Strong supply was the main culprit as North American and OPEC production surged and Libyan ports and oil fields were reopened.
SA has not been in isolation – the MSCI Emerging Markets Index fell 7.4% in September and places Developed equities back in the lead for 2014 on a return of 4.4% against the ytd MSCI Emerging Market return of 2.6%.
In US dollar terms, the worst quarter returns amongst the emerging markets came from Russia -15.1%, Turkey -11.8%, Brazil -8.4% and the South Africa -6.6%. Both India and China recorded small positive dollar returns in Q3.
Amongst developed markets, the S&P500 hit new closing highs in each month of the quarter and breached the 2000 mark in September before succumbing to profit taking late in September. The US performance certainly stands strong against the weak UK and European markets.
Commodity Prices and Emerging Market Currencies take a beating:
In developed markets we are beginning to see significant decoupling of business cycles and monetary policy prospects, with the US in particular approaching peak inflection point, the UK hot on its heels, while the Eurozone and Japan lag significantly behind.
Most fund managers continue to believe that the US offers the greatest opportunities with US earnings forecast to rise approximately 10% in 2014 and close to 15% in 2015. Earnings strength helps buffer shares against the worries about Fed tightening and possible geo-political issues that may arise. Another positive read from the US is that US corporates have bought back $338billion so far of their own shares in 2014, the most in 7 years.
From a top-down perspective, again the US appears to be the global beacon of hope with respect to global growth although credit creation in the US is still well below average. Consumers continue to pay down their debt, even though mortgage yields have fallen to record lows.
Unleveraged growth means the developed world is unlikely to spring into boom times and we’re likely to make slow yet irregular progress.
The world economies are still feeling the effects of excessive debt and commentators believe that the deleveraging will take longer and possibly see negative real rates (inflation higher than official interest rates).
The breather seen across global equities in the last couple weeks has been welcomed whilst the long term bull market trend, albeit temporarily hindered, remains intact. We caution however that market commentators believe there may be more pain to follow across equities but the consensus call is to stick with equities over bonds.
The consensus outlook in US Treasuries is fairly neutral with the risk of a significant sell-off relatively low given the world of overabundant savings. When faced with an over-savings scenario, bond yields traditionally fall to stimulate spending. Excess savings in Europe remain large and growing. Meanwhile the strong US dollar will dampen the pricing power of the US economy, drive down inflation expectations and compress bond yields even lower.
The outlook for China remains worrisome and described as “two steps forward, one step back” as authorities try to juggle both reform and growth at the same time. In Japan, the spurt of nominal growth has stalled and another dose of stimulus is needed to sustain reflationary momentum. Furthermore, Japan’s demographics remain poor with the labour force contracting at 0.5% per year.
Europe is the other big worry and seems headed for stagnation as credit growth continues to contract. Banks are reluctant to lend and businesses and consumers are loathe to borrow.
Economists are also warning that an ongoing strong US dollar will possibly reverse the strong capital flows into Emerging Markets – another cause for concern across local equities.
For South Africa there is significant cause for concern and most fund managers are expecting some Fourth Quarter weakness. Valuations amongst the Top40 heavyweights, in particular amongst the consumer industrials, are stretched and we are beginning to see a noticeable search for value amongst the smaller and mid-caps. This trend is likely to continue into Q4.
On the PE basis, the JSE All Share is trading just below 17x earnings down from its peak of over 19x in June. The current level is the lowest since July 2013 but still above the long term average of 14.7x. Again the disparity is evident amongst the industrial conglomerates with the likes of SAB trading on a PE of 29x and Naspers a massive 85x.
JSE PE Ratings – Industrials appear stretched
The MPC kept rates on hold although continued to signal a tightening bias.
The SARB marked down the growth outlook to 1.5% (from 1.7%) for 2014 and 2.8% (from 2.9%) in 2015 with risks skewed to the downside. The inflation outlook was lowered to 6.2% and 6.3% for the next 2 years on a more benign food inflation trajectory. However, the MPC did single out the currency as a key upside risk to inflation although also highlighted concerns around a wage-price spiral and elevated wage demands.
Governor Gill Marcus announced that she is stepping down as her term expires ahead of the October MPC meeting. The deputy governor, Lesetja Kganyago was announced as her successor.
Headline inflation unexpectedly ticked higher in August as food inflation picked up and core inflation also rose. The August report disappointed as food inflation climbed to 9.5% driven mainly by a 1% rise in meat prices (meat inflation at 10.1%) and a 1.5% gain in dairy products (dairy annual inflation at 12.7%).
Core inflation rose to 5.8% partly due to base effects, but also a rise in vehicle and personal care costs.
SA’s current account deficit widened to 6.2% in 2Q14 from 4.5% in the first quarter, and attributed to the impact of the platinum strikes. Weak domestic demand will continue to limit growth while the removal of supply side constraints should favour export growth and hopefully see a slight improvement in the current account deficit in the third and fourth quarters.
The trade deficit widened to 2.8% of GDP, from 2.1% previously, due to the impact of the platinum strikes filtering through the system as well as weak external demand.
The Purchasers Managers Index recovered to 50.7 in September from 49 in August, rising above 50 for the first time in the past five months, indicating a slight improvement in manufacturing activity.
A slowdown in Consumer Spending was reflected in the SARB’s 2Q Bulletin, as well as a concerning drop in fixed investment. Household spending softened further as real disposable income growth fell to just 1.3% partly due to wages lost during the strikes as well as more modest real wage gains in most sectors.
It was announced that Medupi is likely to cost the state R35bn more than original estimates placing the final figure now over R105bn, according the Public Enterprises Minister Lynne Brown. The first unit of Medupi is expected to be synchronised to the grid by December and come into full operation in 1H15.
In corporate news, the SARB put African Bank into curatorship and begins restructuring the ailing business. It undertook R17bn of the bank’s bad loans at a cost of 41% of face value. This left R26bn of good loans (after provisioning) which is to be recapitalised by way of a R10bn rights issue underwritten by
7 major financial institutions – Firstrand, Std Bank, Nedbank, Absa, Investec, Capitec and the PIC. African Bank JSE listed instruments, debt and equity were suspended on August 11th, and the good bank holding company will list in due course.
The US Fed reduced its asset purchases by $10bn in each month over the quarter with “QE” set to conclude in October.
The focus of this quarter turned to the timing of a Fed rate hike, though FOMC commentary continued to look for a “considerable period” between the end of QE and the first hike.
2Q14 GDP expanded at an annual rate of 4.6% quarter on quarter, the highest rate since 2006 as growth bounced back from a 1Q contraction of -2.1% caused by poor weather conditions.
Nonfarm payrolls underwhelmed and the unemployment rate was unchanged at 6.1%, whilst the participation rate held steady at 62.8%.
Consumer confidence firmed over the quarter with the Univ of Michigan survey rising to a 14 month high of 84.6 in September, up from 82.5 in June.
Purchasers Managers Indices also rose sharply, the Manufacturing PMI rose to 59.0 in September from 55.3 in June, whilst the non-Manufacturing Index rose to 59.6 from 56.0.
China’s Central Bank announced in September that it would provide RMB500bn of liquidity to five major banks for a period of three months.
Housing conditions continued to deteriorate over the quarter with house price declines reported across most Chinese cities.
GDP growth in 2Q14 was 7.5%, up slightly from 7.4% in 1Q14.
CPI inflation eased to 2.0% year on year in August compared to 2.3% in June. PPI deflation continued, running at -1.2% year on year in August from -1.1% in June.
The Manufacturing PMI fell over the quarter to 50.2 in September from June’s read of 50.7.
Credit data was soft over the quarter with new bank loans totalling 703bn yuan in August compared to 1079bn yuan in June.
The UK economy remains in expansion mode, growing by 0.8% in 2Q14. A more balanced growth profile looks set to be underpinned by a solid housing market, strengthening corporate confidence and investment and a slowly improving export performance, as indicated by the quarter’s business surveys.
However official wage figures remain alarming and the BoE is cautious on the economy’s ability to withstand rate increases. Comments by the UK governor of the BoE, Mark Carney, caused investors to push back their anticipated timing of interest rate hikes.
Economic reports across Europe were weak over this past quarter. Both Italian and German GDP shrank in 2Q14, with Italy returning to recession. France’s economy also failed to return to growth over the period. Germany however, surprised with record employment figures and rising wages.
Consider this: An economic region where GDP growth is stagnating, retail sales are weak, unemployment is floundering at 11.5% and industrial output is sluggish. Worst of all, the region’s inflation rate has declined throughout the first half of 2014 to a mere 0.3% in August, its lowest level since 2009 and well below the target rate of 2%.
The response from Eurozone bond investors becomes more positive the worse the news gets – short term government bonds have drifted into negative yield territory, the 10year German Bund yield moving firmly below the 1% mark. As Europe stagnates and the risk of deflation increases investors are becoming more and more confident that the ECB will be forced to intervene and undertake further quantitative easing action to counter the weak inflation and aid the region’s recovery.
Following the subdued inflation prints and stubbornly high unemployment, the ECB President, Mario Draghi, finally announced a much anticipated 10bp reduction in the interest rate corridor and confirmed that purchases of asset-backed securities will begin in October.
Japan’s economy is also under threat, and recorded a contraction of 1.7% in 2Q14. The Japanese current account fell into deficit for the first time in five months in June.
Capital Gains Tax (CGT) is triggered when an asset is sold at a higher value than that of its base cost. When an investor rebalances their portfolio back to a strategic weight, in order to ensure consistency of risk in their portfolio, CGT may be triggered resulting in lower returns. If one were to compare the effects of realising capital gains on an annual basis as opposed to ‘once off’ at the end of the investment term, it is found that the difference is dependent on client circumstances, time horizon, size of investment and expected capital return.
In Conclusion Capital gains and the tax associated with it is inevitable for taxable portfolios. In our opinion, the risk control and higher risk adjusted returns associated with regular rebalancing compensate the client for the tax paid over time. Triggering capital gains associated with rebalancing in order to meet long term objectives at a higher probability and lower risk is good investment practice. This also adjusts your base cost going forward which lowers the Rand value of CGT payable in the future. However, we would prefer to be able to make fund switches within structures that will not trigger CGT where possible. If an existing investment already has substantial capital gains, this should not deter the investor from making the correct investment decisions (i.e. switching into a more efficient portfolio). CGT will ultimately have to be paid somewhere along the line and it is important to remember that a portion of your investment will always be owned by the government. Realising CGT on an ongoing basis is often favourable particularly if the exclusion is available.