Financial markets were subdued in July. The equally weighted portfolio of JSE-listed ETFs shed 0.8% while the Intellidex portfolio gained a pedestrian 0.46% (+10.38% year-to-date, YTD). Local assets came under pressure as sentiment towards SA deteriorated further amid concerns of a worsening fiscus outlook, heightened political risk underpinned by factional battles within the ANC and no implementation of reforms.

Moody’s, the only major ratings agency that still grades South African debt higher than junk, warned that National Treasury’s plan to double financial support for Eskom was “credit negative”. Similar sentiment was echoed by Fitch Ratings which downgraded its outlook for SA. These and other negative events somewhat overshadowed the sentiment-positive repo rate cut by the South Africa Reserve Bank.

Local equities suffered the most. The all share index regressed 2.37% with the under-performance noticeably pervasive across all sectors and somewhat pronounced among SA-facing sectors such as financials. Bonds softened marginally. Commodities, particularly the platinum group of metals, performed relatively well.

The Macroeconomic view

We are seeing the following key themes playing out in the markets: slow economic growth; low inflation; and lower interest rates. For SA, sentiment remains on the ropes because of the following factors:

• Extremely low economic growth with limited hope for positive per capita GDP growth, compounded by global growth issues and risk narratives;
• The sharp weakening of the rand;
• A sense that no reform is occurring, and politics and political egos are trumping rational and necessary policy making;
• A view that the government is not doing anything in response to the crises of low growth and rising unemployment;
• The view that prescribed assets (using pensions to fund public debt), national health insurance and land reform etc all skew risks to the downside
• Increasing despair at the lack of action over Eskom; and 
• A Moody's downgrade of SA's credit rating looking more and more

Given this backdrop, local assets are likely to be under pressure in the coming months. 

ETFs featured

Local:

SA’s outlook remains weak and the political economy is in too much discord to inspire investor confidence. As such, sticking with the tried and tested stocks is important. The Satrix SA Quality ETF selects constituent companies using a set of quality metrics, including return on equity, liquidity and leverage. Such stocks tend to be resilient to economic shocks and volatility. The ETF rose 5.22% during July.

There are extensions to this core local equity exposure that can be added in a tactical sense as a satellite fund. The NewFunds Equity Momentum fund is worth considering. It has performed ahead of other equity funds under both market extremes in the past three months. However, the sample period is too short to draw strong conclusions.

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Commodities:

Adding a commodity ETF to your portfolio improves diversification because commodities march to the beat of their own drum when compared with broad markets, which makes them an excellent portfolio diversifier.

Traditionally, gold is the preferred addition to an investor’s portfolio because over longer periods it has shown to be the least correlated with other assets. However, our preference based on our medium-term outlook is between rhodium and palladium.

The new vehicle emission laws in Europe and China are driving demand for both commodities and this is expected to continue in the foreseeable future. We are slightly more inclined towards rhodium because it is scarcer, with lower extraction rates from PGM ore. The primary production of rhodium is somewhat inelastic and is expected to decline moderately over the medium term.

Important note: This ETF does not qualify for a tax-free savings account.

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There's plenty more from where that came from. The team at Intellidex have more insights for the month of August. To see more in-depth analysis and market insights (global and local), check out the full note here.

Background: Exchange-traded funds (ETFs)