Corospondent - Trouble with the curve? - Coronation
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corospondent
The Global Quarterly
Trouble with
the curve?
OCTOBER 2019
Global readers: The information contained in the publication is not approved for the public and is only intended for recipients who would be generally classified as ‘qualified’, ‘professional’, ‘accredited’ or ‘institutional’ investors. The information is not designed for use in any jurisdiction or location where the publication or availability of the information would be contrary to local law or regulation. If you have access to the information it is your responsibility to be aware of and to observe all applicable laws and regulations of any relevant jurisdiction and it is recommended any potential investor first obtain appropriate legal, tax, investment or other professional advice prior to acting upon the information. The value of investments and any income from them can go down as well as up and investors may not get back all that they have invested. Please be advised that any return estimates or indications of past performance in this publication are for information purposes and can in no way be construed as a guarantee of future performance. Coronation Fund Managers accepts no liability of any sort resulting from reliance being placed upon outdated information contained in this publication by any user or other person. Whilst every effort is made to represent accurate financial and technical information on an ongoing basis, inadvertent errors and typographical inaccuracies may occur. Information, laws, rules and regulations may also change from time to time. Information contained in the publication is therefore made available without any express or implied representation or warranty whatsoever, and Coronation Fund Managers disclaims liability for any expenses incurred, or any damage, claims or costs sustained by users arising from the reliance being placed on the use of links, services or any information or representations contained in the publication. Coronation Asset Management (Pty) Ltd (FSP 548), Coronation Investment Management International (Pty) Ltd (FSP 45646) and Coronation Alternative Investment Managers (Pty) Ltd (FSP 49893) are authorised financial services providers. Coronation International Limited is authorised and regulated by the Financial Conduct Authority. Coronation Global Fund Managers (Ireland) Limited is authorised by the Central Bank of Ireland under the European Communities (UCITS) Regulations 2011 and the Alternative Investment Fund Managers Directive 2011, with effect from 22 July 2014. Unit trusts are generally medium to long-term investments. The value of units may go up as well as down. Past performance is not necessarily an indication of the future. Unit trusts are traded at ruling prices and can engage in borrowing and scrip lending. Unit trusts may invest in assets denominated in currencies other than their base currency and fluctuations or movements in exchange rates may have an adverse effect on the value of the underlying investments. Performance is measured on NAV prices with income distribution reinvested.. US readers: Coronation Asset Management (Pty) Limited and Coronation Investment Management International (Pty) Limited are investment advisers registered with the United States Securities and Exchange Commission (“SEC”). An investment adviser’s registration with the SEC does not imply a certain level of skill or training. Additional information about Coronation Asset Management and Coronation Investment Management International (Pty) Limited is also available on the SEC’s website at www. adviserinfo.sec.gov. The information in this document has not been approved or verified by the SEC or by any state securities authority. The opinions expressed herein are those of Coronation Asset Management (Pty) Limited and/or Coronation Investment Management International (Pty) Limited at the time of publication and no representation is made that they will be valid beyond that date. Certain information herein has been obtained from third party sources which we believe to be reliable but no representation is being made as to the accuracy of the information obtained from third parties. This newsletter contains references to targeted returns which we believe to be reasonable based on current market conditions, but no guarantees are being made the targets will be achieved or that investors will not lose money. On the cover: The US 10-year Treasury bond’s yield curve inversion has attracted much attention in recent months. Baseball is the quintessential US sport, and the curve ball speaks to the uncertain outcome of the brief inversion.
our path as custodians of the savings of millions
of South Africans. But more than that, we have
used our resources and influence to be a leader
and change agent in the South African retirement
industry. To this end, assisting in the transforma-
tion of our country has been deeply important to
us. This is why we have played a significant role
in transforming the financial services sector to be
more inclusive, in uplifting communities through
our CSI initiatives and ensuring our own business
reflects the demographics of our country.
During Women’s Month in August, we highlighted
the value and achievements of women in South
Africa by hosting a number of inspiring events.
I hosted our annual Women’s Day events for
clients and Grade 11 schoolgirls in Johannesburg
and Cape Town. Renowned US space engineer
Danielle Wood gave an inspirational talk on her
life and how she uses space technology to create
solutions for communities in need here on earth
and to address the UN’s Sustainable Development
Goals.
This was particularly meaningful given the
Kirshni on point
increased focus globally on issues of climate
change and sustainability. In South Africa, dia-
logue about these and other environmental,
social and governance (ESG) issues has certainly
We’re up for the challenge increased. The Financial Sector Conduct Authority
released its guidance note in June, requiring
pension funds to factor ESG concerns into their
investment strategy and monitoring. For us, this
By K I R S H N I T O T A R A M
means increased time spent understanding, arti-
culating a belief system, and reporting on these
matters – something that will become a standard
Kirshni is Global WELCOME to our latest Corospondent! part of the offering of managers around the world.
Head of Institutional
Business. She joined
Coronation in 2000. Not surprisingly, I again started this note with We also welcomed South African athlete and
penning thoughts about the uncertain times we Olympic gold medallist Caster Semenya to our
currently find ourselves in. And it dawned on me Cape Town office as part of our mentorship pro-
that it’s been this way for some time now. As an gramme for employees. The story of her rise to
individual and as a company, when you have the top of her discipline speaks to the resilience
navigated through years of challenging environ- required to prosper over time. Her boldness in the
ments in the local and global markets, as well as face of adversity reveals deep self-acceptance
in our industry, I think it’s important to pause and and confidence. It was hugely inspirational to
reflect from time to time. hear that to navigate successfully through tough
times takes immense grit. She taught us that it is
I find it valuable to look at who we are and what okay to be bold and acknowledge the awesome
we continue to stand for. At Coronation, we have things you do. As she said, “I believe in everything
stayed true to our culture since starting out in 1993 I do”. And so do we.
– an anchor which has served us well over the past
quarter of a century. Always remaining singularly However, the month concluded on a sombre and
focused on our purpose of building long-term dark note with cases of brutal gender-based
wealth for our clients gives us great clarity in what violence holding the headlines and our hearts,
we need to achieve. And, while we acknowledge with a subsequent rise in mass civilian protests.
that uncertain times means that we still have a We lend our voice in support of the calls to bring
lot to do, we take pride in what we have achieved about change that improves the treatment of and
over the long term. We have never wavered from respect shown to women everywhere.
TRUST IS EARNED™ 3
WHAT WE NEED IS LESS TALK, MORE ACTION preparing to take on Wales in the semi-finals of the
South Africa is in desperate need of some tangible Rugby World Cup. Go Bokke!
action. For the past 18 months, we have not been
short of commissions and white papers identify- IN THIS ISSUE
ing the real challenges we face as a country and Economist Marie Antelme outlines her laundry
an economy. But to move us forward, we need to list of concerns on page 12 . With the US 10-year
start acting. For this reason, the market welcomed Treasury bond yield briefly inverting this quarter,
Finance Minister Tito Mboweni’s surprise release of portfolio manager Seamus Vasey provides
the National Treasury’s plans to boost growth and the logic behind the widely reported and eye-
create a million jobs. brow-raising event on page 6.
Adding his weight, President Cyril Ramaphosa later Back home, portfolio manager Tumi Motlanthe
announced the appointment of a new economic outlines the investment case for Shoprite on page
advisory panel to help turn the ailing economy 26. Globally, investment analyst Chris Cheetham
around. In addition, in a move to increase both his provides insight into the value we see in leading
leadership and communication to the country, the US cable operators on page 16. Portfolio manager
President recently implemented a weekly news- Suhail Suleman weighs in on China’s influence on
letter titled “From the desk of Ramaphosa”. While the emerging market basket on page 33, while
these are all good and crucial steps, some tough investment analyst Greg Longe points out why
decisions are overdue and much needed. it’s best to be circumspect about frontier market
IPOs on page 20.
A GLOBAL GEOPOLITICAL SPECTACLE
Globally, the world seems a mess. Ongoing geo- TRUST IS EARNED
political theatrics would certainly provide enough At Coronation, we continue to seek opportuni-
material for the next decade of soap operas. The ties amid the challenges, and convert them into
Brexit deadline of 31 October is looming, while value adds for our clients. I believe we are made
across the Atlantic, Trump’s tweets have turned more resilient by the demanding environment in
into marathons as he voices his disdain for his which we manage the money entrusted to us. We
impeachment enquiry. The simmering rivalry remain steadfast in our purpose, with our clients’
between the US and China continues to play out best interests at the core of what drives us.
with the trade wars, and increased military unrest
in Syria has raised concern from humanitarian As we head into the last quarter of this decade,
groups. Looking further east, Hong Kong is facing I wish you all the best and share my gratitude for
its first recession since the Global Financial Crisis your ongoing support.
as the negative impact of anti-extradition law pro-
tests that have escalated to violent confrontations Thank you
begins to weigh.
And of course, before we get into this issue of
Corospondent, here’s a strong shout-out to our boys
in green and gold. At the time of writing, they are
IN THIS ISSUE
03 16 30
Kirshni on point Next-generation South African bonds
entertainment attractive in
low-yield world
05
Trust is earned 20
Buyer beware 33
China
06
24
Yield curves
National imperatives 36
2019 third quarter
12 26 in review
Economic comment
Shoprite
4 COROSPONDENT
TRUST IS EARNED
When Coronation opened its doors back in 1993 and commit- We are a homegrown South African business and have become
ted wholeheartedly to the future of South Africa, the country one of the leading investment managers in our country. We are
was moving through uncertain times. As we head into the next privileged to manage the savings of millions of South Africans,
decade, that sense of uncertainty is again palpable, both at a responsibility that we take very seriously. Our unique culture
home and globally. But navigating through challenging times and values, instilled from inception, drive how we show up every
takes courage, confidence and a strong sense of clarity of single day to earn our clients’ trust. Here are ways in which we
purpose. honour our long-term commitments to clients and stakeholders:
Long-term performance matters
Building 97.5%
our clients’
12x
PERFORMANCE
of client assets1 have
7x outperformed their
wealth over benchmarks since inception
the long term
1
As at 30 September 2019; funds with a
10-year+ history
YEARS
We have generated Coronation Houseview Equity
JSE Capped Shareholder Weighted Index
12x purchasing
long-term outperformance
for our investors.
Source: Coronation, as at 30 September 2019 power after
Based on R100m invested in Coronation Houseview Equity Strategy on
1 Oct 1993, compounding at a real rate of 9.9% gross of fees
Note: This portfolio is only available to South African investors. It is
26 years
included for illustrative purposes only.
Transforming Level 2 B-BBEE contributor*
Successfully recruited, trained and retained exceptional black and female talent
our business across our business since 1993.
from within 56% 49% 78%
>R210bn2
of total AUM managed
We are a proud South by black investment
African business. black female of our board professionals
employees employees members are black 2
As at 31 August 2019
Established 3 Since 2006, we have Over the past decade, we
Advancing independent black
businesses
allocated have funded and trained
transformation >R300
African Harvest million 120
in our industry Fund Managers
in brokerage to black
black IFA practices through
Pre-dating BEE legislation in South stockbrokers through
Kagiso Asset the ASISA IFA Development
Africa, we pioneered corporate the Coronation Programme
Management
initiatives that have contributed to Business Support
meaningful transformation and the programme
development of skills in the financial Intembeko
Investment
27
services industry.
Administrators
analysts through the Vunani
Securities Training Academy
*as measured by the revised Financial Sector Code
All figures are as at 30 September 2019, unless otherwise stated. TRUST IS EARNED™ 5
INSIGHTS
Yield curves
Inverted yield curves, negative
bond yields, liquidity everywhere
and not a drop to drink
By S E A M U S VA S E Y
The post-GFC Times are
An inverted US It’s not insane to invest
THE central bank unprecedented;
10-year Treasury in negative-yielding
monetary arsenal more than 25% of
QUICK bond yield curve
may well prove the global bond
bonds; in current
TAKE can not only be a conditions it would be a
ineffective in market now trades
predictor, but a cause pity if SA missed the bus
current conditions at a negative yield
SMALL FORESTS HAVE been razed to the ground THE ORACLE
and squids worldwide have been sucked dry to But it’s not just the success of this indicator that’s
help support the volumes that have been written attractive to market watchers; it’s the extent of
about bond yield curve inversions in recent the forewarning the signal provides. While many
times. This reached a peak at the beginning of other harbingers of a slump in economic activity
September when the US 10-year Treasury bond tend to be practically contemporaneous with the
Seamus is a fixed yield briefly fell below that of its short-dated coun- slowdown itself, the yield curve is seemingly able
income portfolio terpart, the two-year bond, for the first time since to look over the horizon and provide several quar-
manager and analyst
with 15 years of 2006. The ensuing frenzy of handwringing and ters’ advance warning.
investment experience. woeful prognostications from market commen-
tators has certainly been eyebrow raising. Yet are Just as important as the reliability and predictive
they wrong? strength of this indicator are its simplicity and
plausibility. These latter benefits are related. The
There are respectable justifications for taking difference between a long-term interest rate (typi-
heed when long-term interest rates in the US fall cally the 10-year bond) and a short-term interest
below the level of short-term rates. This is a rare rate (alternatively the policy rate, a T-bill rate or
occurrence and has been – without contest – the yield on the two-year bond) is the entire metric.
most reliable early warning signal of an impen-
ding recession. Out of the 10 instances that the Hence, even as macroeconomic, external and
curve has inverted since World War II, only once regulatory conditions varied considerably at
(in the mid-1960s) did the slope of the curve turn the times when the yield curve became down-
negative without an ensuing recession; conversely, ward sloping over the past seven decades, all
there haven’t been any modern US recessions that these influences were arguably already incor-
weren’t preceded by an inverted yield curve (see porated into interest rates. The uncondition-
Figure 1 on page 7). ality of this metric shouldn’t be too surprising.
6 COROSPONDENT
After all, bond yields are really just aggregated Figure 1
market expectations of all the macroeconomic HISTORIC YIELD CURVE INVERSIONS
factors that influence growth, inflation and % daily, not seasonally adjusted
policy, and savings and investment decisions. 3
And if that weren’t enough to solidify confidence 2
in the importance of this measure, there is a cau-
sality argument. Most analysts view an inverted 1
yield curve as being anticipatory of an approach-
0
ing economic slump. However, there is some vali-
dity to the notion that an inverted yield curve
-1
itself can help promote a negative feedback loop
within the broader real economy. -2
So, it’s not just the collective foresight of the US -3
bond market that – for all intents and purposes 1976 1982 1988 1994 2000 2006 2012 2018
– predicts recessions each and every time, but it US yield curve slope (10-year maturity minus 2-year maturity)
is the very occurrence of long-term interest rates US recessions
being less than short-term rates that helps bring
Source: Federal Reserve Bank of St. Louis
about the slump. This negative effect would most
clearly permeate through the banking system,
which relies on an upward-sloping yield curve to
be profitable.
in applying additional scepticism to the signals
Weakness in the ability of the economy to gen- being sent by the US yield curve. So, to return
erate credit almost inevitably harms economic to the original question: is the intense concern
growth, so it’s quite conceivable that yield curve generated by yield curve inversion in the US
inversion may actually help bring about reces- justified or not? For most people, the concise
sions – which would certainly bolster the metric’s answer would still be ‘yes’, despite the counter-
predictive ability! arguments. But for long-term investors, the origi-
nal question itself is largely irrelevant.
IS THIS TIME DIFFERENT?
But what are the counterarguments to the impli- A US RECESSION: WHEN, NOT IF
cations of the ‘true’ US yield curve inversion that Long-term investors are always interested in
recently arose, or equivalently, to invoke the most what’s beyond the next phase of the business
dangerous question in economics: is this time cycle. It isn’t controversial to suggest that the US is IS THE INTENSE
different? facing a slowdown. Exactly when it will occur and CONCERN
how deep the slump will be are important cycli- GENERATED BY
There are two key differences for the US bond cal questions, but there are far more significant, YIELD CURVE
market between the current era and prior secular uncertainties to contemplate. INVERSION IN THE
decades. The first is financial repression – the US JUSTIFIED OR
extent to which policymakers have actively influ- Indeed, these structural questions are already NOT?
enced bond yields through direct, unconventional being posed in many economies and bond
means. The second is the substantially globalised markets around the world. The US will very likely
nature of G10 sovereign debt markets and how face these same challenges in time, but they are
distorted these markets have become through immediate for most other developed markets.
their own central bank involvement.
Underlying these concerns are two interrelated
The former simply means that one can’t nec- questions: what is the effectiveness of monetary
essarily trust the signals being provided by a policy from this point and how (un)sustainable are
market that has been deliberately distorted negative interest rates?
by the Federal Reserve Board (the Fed), princi-
pally through its quantitative easing (QE) pro- THE FUTURE OF MONETARY POLICY
gramme. The latter implies that, even when the The key is to recognise that the current, syn-
Fed isn’t directly influencing US Treasury yields, chronised global slowdown is substantially dif-
the substitutability among G10 sovereign bonds ferent to the downturn that materialised in the
means that central bank interference anywhere wake of the 2008/2009 Global Financial Crisis
will filter through to other markets, including (GFC). Central bank optimists will highlight
the US. These differences certainly lend weight that this is a positive starting point: the vastly
TRUST IS EARNED™ 7
expanded toolboxes of the European Central NEGATIVE-YIELDING BONDS ARE OBVIOUSLY
Bank (ECB), the Bank of Japan, the Bank of IRRATIONAL … OR ARE THEY?
England and the Swiss National Bank, among It seems absurd that literally thousands of
others, can be more quickly and assertively billions of dollars’ worth of bonds are trading
deployed. Previously, short-term policy rates with negative yields; has the global bond market
were really the only primary tool to ease mon- collectively lost its mind, quaffed generously
etary conditions, but, through dire necessity, a from a “Drink Me” potion and willingly plunged
much broader set of interventions came to frui- down the infamous rabbit hole (as suggested by
tion, along with a greater willingness to embrace the long- and very long-term yields in figures 3
HAS THE GLOBAL unorthodox methods. The problem is whether the and 4 on page 9)?
BOND MARKET
limits of even these unconventional interventions
COLLECTIVELY
LOST ITS MIND ... might already have been reached. The answer is: maybe not. There is a variety
AND WILLINGLY of rationalisations for holding negative-
PLUNGED DOWN The most blatant sign that monetary policy yielding bonds. The first fallacy to displace is
THE INFAMOUS in many parts of the world may be pushing up the overwhelmingly widespread notion that
RABBIT HOLE? against an effective limit can be seen in the buying a negative-yielding bond guarantees
extent of negative interest rates. a loss-making investment. This is patently not
true for holding periods of less than maturity
The landscape is unprecedented. Over a quarter where capital gains outpace the losses from
of the global bond market (c. $15 trillion of the negative yields. It is also not necessarily true
Bloomberg Barclays Global Aggregate Bond for bonds bought with a negative yield and
Index) now trades with a negative yield (see held till maturity. Provided a bond has an initial
Figure 2). And with the US being the second-to- non-negative coupon (as all bonds currently do)
last major bond market with an all-positive yield and reinvestment rates aren’t always negative,
curve (the UK is the other), this means that nearly the total return over the life of the bond may still
90% of the positive yield being generated from be positive.
the global investment-grade bond market comes
from America. As such, if bondholders were momentum-driven
investors with short-term horizons or long-term
Furthermore, unlike previous episodes of nega- holders not overly concerned by market-to-
tive-yielding debt, not only are large proportions market losses in the intervening period, a strange
of sovereign and investment-grade corporate equilibrium could be sustained whereby views for
bond markets trading at below-zero interest rate a return to positive rates and even more deeply
levels, but this has even infected some parts of negative rates could co-exist and negative yields
‘high-yield’ bond markets (subinvestment grade could be maintained.
or junk), making a mockery of price-based risk dis-
crimination within certain jurisdictions. A less far-fetched rationalisation for the
sustainability of negative-yielding bonds for an
extended period lies with a more entrenched
fear of deflation. In the face of a potentially
Figure 2 protracted period of negative inflation, nominal
A PROXY FOR NEGATIVE-YIELDING DEBT IN THE GLOBAL BOND MARKET bonds are typically the superior asset class to
% hold. With declining price levels, any asset that
35 can provide a sustained nominal cash payout
becomes very valuable.
30
25 Another way to see this is to focus on the real
yields provided by nominal, fixed-coupon bonds;
20
these can very well be positive in a deflationary
15 environment. And aside from the fixed cash-flow
profile that nominal bonds provide, they become
10 even more valuable relative to other asset
5
classes, which tend to struggle in the macro-
economic climate that accompanies an
0 extended period of deflation. This is the
Dec 09 Dec 10 Dec 11 Dec 12 Dec 13 Dec 14 Dec 15 Dec 16 Dec 17 Dec 18
‘Japanification’ scenario whereby a similar fate
Proportion of Bloomberg Barclays Global Aggregate Bond Index that has a that befell Japan over its lost decade strikes
negative yield
elsewhere, with Western Europe being highest
Source: Bloomberg ranking on the candidate list.
8 COROSPONDENT
Figure 3 capital preservation and negative correlation to
10-YEAR GOVERNMENT BOND YIELDS – HISTORICALLY COORDINATED growth assets) within a multi-asset class context.
AND DEPRESSED And it is these latter characteristics that are
% highly sought after within any holistic invest-
20 ment portfolio. Indeed, they are scarce enough
that investors may even be prepared to pay up
15
for these features; a cost potentially represented
by negative yields.
10
But perhaps the most feasible validation for
seeing sustained negative global bond yields
5 lies with market expectations. In the context
that the short-end policy rates of major central
0
banks were increasingly seen as being set
around or below zero for an extended period, it
would be rational to anticipate equally subdued
-5
2000 2008 2016
long-term rates. Indeed, provided the equilib-
1960 1968 1976 1984 1992
rium real rate of interest (or ‘R-star’ in econo-
Australia Canada Switzerland Germany Spain UK
mists’ jargon) was believed to have reset to a
Japan Norway New Zealand Sweden US
very low level, the danger posed by bond yields
Source: Federal Reserve Bank of St. Louis ‘normalising’ to some pre-GFC long-term neutral
level is effectively neutered. Hence it is the
notion – increasingly more plausible to inves-
Figure 4 tors – that structural factors are responsible for
HISTORY OF LONG-TERM UK BOND YIELDS a lower equilibrium real rate (essentially where
%
inflation and unemployment are in balance in
16 an economy).
14
In particular, globalisation; technological
12 changes, through digitisation; demographics,
10
through the ageing developed world; and even
the wage-bargaining process, through the shift
8
in the relative balance of power between capital
6 and labour, have lowered inflation and altered
the relationship between inflation and other
4
economic variables. And regardless of where
2 the balance lies in these explanations, provided
0 belief in lower inflation is increasingly attributed
1703 1738 1773 1808 1843 1878 1913 1948 1983 2018 to structural rather than cyclical causes, then the
Long-term UK bond yield
more justified the notion of entrenched low inter-
est rates becomes.
Source: Federal Reserve Bank of St. Louis
NOT A REVIVAL OF THE POST-GFC CENTRAL
BANK PLAYBOOK
It appears that central banks and markets have
An even more reasonable class of justifications been rapidly adjusting in preparation for a rerun
for the viability of negative-yielding bonds lies of the post-GFC interval that saw exceptional
with investment portfolio dynamics. What many monetary easing over a protracted period. After
bondholders will have found reassuring in recent all, policy rates have been cut widely, lending
months is that the ‘safe-haven’ characteristics of operations have been revived, asset purchase
bonds trading with negative yields have been programmes reinvigorated and forward guid-
sustained. This means that these are still reliable ance is open-ended once again. However, there
defensive assets. is a crucial difference this time around.
So, from a portfolio construction basis, while There is significantly more widespread recogni-
these bonds may well be vulnerable due to excep- tion that monetary policy has reached some – if
tionally high valuations, they also continue to not all – of its effective limits. Perhaps the greater
provide a nominal income stream and offer their area of dispute now is around whether excep-
traditional diversification benefits (including tional monetary easing, especially negative rates,
TRUST IS EARNED™ 9
is actually counterproductive to its own aims or Figure 5
whether these ill effects are long term enough in HAVE THE LIMITS OF MONETARY POLICY BEEN REACHED?
nature (or manageable) that aggressively loose % %
monetary policy is still better than nothing – even 45 120
if it’ll do little to solve deeper productivity issues 40
facing most economies. 100
35
Extent of extraordinary monetary
policy since the GFC
This complexity was highlighted at the ECB’s 30 80
September policy meeting. Much of the atten- 25
60
tion was focused on the Bank’s monetary policy 20
adjustments, especially the de facto open-
15 40
ended revival of bond purchases to the tune of
10
€20 billion per month. However, the underly- 20
ing messaging was very clear: monetary policy 5
cannot be the only heavy lifter. 0 0
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
Without fiscal expansion, European growth
will remain anaemic and a form of secular Federal Reserve Board (US) Bank of England (UK)
stagnation will likely take hold. The depart- European Central Bank (Euro area) Bank of Japan (Japan, RHS)
ing ECB President, Mario Draghi, even while Sources: Bloomberg, US Federal Reserve Board, Bank of England, Bank of Japan, European Central Bank
reviving easing mechanisms for the Euro-area
(and adding a few monetary innovations too),
unequivocally emphasised that fiscal policy
needs to become the main instrument to stimu-
late demand. THROUGH THE LOOKING GLASS – THE SOUTH
AFRICAN CONTEXT
This clear and forceful endorsement from such South Africa doesn’t face quite the same mone-
an eminent policymaker should – in an ideal tary policy restraints as those seen in developed
world – have significant traction in finance min- markets. Real rates are still very much positive
istries across the Continent. Yet this is not a given. across the curve, inflation is low but set to remain
Resistance to perceived sovereign profligacy has in the upper end of the target band over the fore-
been legendary in Northern Europe. After all, it seeable future, and fiscal expansion certainly
isn’t coincidental that the German word for ‘debt’ hasn’t been kept unduly restrained – in fact, quite
(Schuld) is the same for ‘guilt’. the opposite. But it would be absolutely accurate
to emphasise that South Africa’s growth issues
The most that can be said is that the debate has go well beyond what monetary policy can suffi-
already begun to shift. But while this has been a ciently address – just like in much of the rest of
global phenomenon, it has unfortunately been the world.
slowest to evolve in Europe – the developed world
geography that most urgently needs a different However, with the globalised nature of fixed
policy configuration. income markets, the direct influence of G3 (the
US, Japan and the EU) risk-free rates on domestic
And so, the market’s answers to the imperative bond yields always needs careful consideration.
questions facing bond investors reflect deep As such, it is instructive to consider the counter-
scepticism about the effectiveness of monetary factual: what would South African bond yields
policy tools, both interest rates and unconven- have looked like if there hadn’t been the most
tional interventions, from this point (see Figure 5). widespread and prolific reduction in developed
As such, the potential for an extended period of market bond yields over the past three quarters
exceptionally low interest rates is seen as quite or so?
high, as the political courage to forego extra-
ordinarily easy monetary conditions is seen as Even with other countervailing forces, it is highly
absent. improbable that South African bonds that have
fared particularly well in a world that was pursu-
Rates may be negative or slightly positive, but ing a continued de-escalation away from extra-
what isn’t doubted by the market is that they’ll ordinarily easy monetary conditions.
remain so for a protracted extent. This itself
reflects cynicism about policymakers’ willingness A higher level of global risk-free rates would have
and ability to rebalance policy interventions to necessitated a commensurate adjustment to South
favourably boost growth and raise inflation. African bond yields, while a reversal of capital
10 COROSPONDENTflows from emerging markets back to a US dollar these difficulties in a more coherent and defini-
base would likely have exacerbated this process. tive manner than has been seen to date.
So, it’s fair to characterise this episode of global If the market’s prognostication for ineffective
interest rate and spread compression as both a monetary policy and an extended period of
blessing and curse for South Africa. Without the very low developed-market interest rates pans
offsetting gravitational pull of lower developed out, South Africa has a window of opportu-
market yields, South African bonds would have nity to structurally turn around its current fiscal
almost certainly struggled to overcome the inten- predicament and avoid a far more rapid and
sification of domestic fiscal difficulties. jarring correction to an unsustainable debt tra-
jectory. It would be deeply regrettable if this
The curse is that the market signal that this would passing moment of grace were to be squan-
have provided may have prompted a quicker and dered and a crisis were necessary to correct the
more compelling political response to address imbalance. +
TRUST IS EARNED™ 11ECONOMIC COMMENT
My laundry
list of concerns
Restoring confidence is key to growth recovery
By M A R I E A N T E L M E
THE We’re experiencing Policy inertia The government The world at large is
QUICK a perfect storm of continues to debt-to-expenditure in a state of upheaval;
economic headwinds dog growth and ratio is of grave quantitative easing
TAKE to global growth confidence concern is back
TO SAY THAT we are living in uncertain times decisively or think creatively when the economy
seems more than ever a gross understatement. needs it most.
South Africa’s political landscape is in transition
from a decade of maladministration towards When Cyril Ramaphosa won the ANC presi-
painful stabilisation. Economic growth has dency at the ANC’s 2017 National Conference at
suffered and the path to recovery is still unclear. NASREC, the country was euphoric, expecting (or
Marie is an hoping against hope?) one man to transform a
economist with EXODUS corrupt state and a growthless economy into an
18 years of
experience in People are leaving and at times the political accountable state and a growing economy. To
financial markets. narrative is toxic. Globally, populist politics and date, progress has been slow at best, and expec-
protectionism are weakening traditional alle- tations have been disappointed. Several reasons
giances; while against a backdrop of slowing for this sluggishness have emerged in the inter-
economic growth, traditional policy instruments vening 19 months:
seem stretched beyond effectiveness. This turbu-
lent combination finds us in choppy, unchartered 1. The degree and depth of corruption in both
waters. In this note, I try to distil the issues that the public and private sectors were much
concern me most. worse than suspected. The Zondo Commission,
among others, has revealed this, and recent
OVER THE RAINBOW public statements by the President have con-
My most immediate concern is the outlook for firmed it.
domestic politics. Importantly, whether this
administration will deliver sustainable policies 2. The President has had to opt for a strategic,
that are necessary to improve domestic growth. reformist approach, which takes time to imple-
This extends beyond the President, through an ment. His narrow NASREC victory, coupled
administration which has thus far failed to act with ongoing opposition from his detractors,
12 COROSPONDENTboth within and from outside the ANC, means Figure 1
he has had to use commissions and review REAL GDP GROWTH COMPARISON
committees, the mechanism of the courts, and %
the slow attrition of opponents to reach deci- 10
sions and make appointments. This has taken
time. 8
6
3. Unfortunately for the President, his ability
to build an economic dialogue with enough 4
momentum has been thwarted by a number of
2
other distractions. These constraints seem to
be easing, as he recently confirmed the immi- 0
nent announcement of new policies; however,
-2
we still await key decisions.
-4
4. There have been some notable successes,
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
including the appointment of a credible
commissioner of the South African Revenue World Developed markets Emerging markets South Africa
Service, a renewed and credible head of the Source: IMF
National Prosecuting Authority, and the reha-
bilitation of various institutional investigative
units. These are all important, positive steps to
restoring institutional resilience.
pre-crisis rates; only it didn’t. The result is that
A STATE OF INERTIA revenue has fallen much faster than expenditure
A decade of poor policy setting and weak imple- has been able to adjust, and the shortfall has
mentation, exacerbated by state rent seeking, been met by an accelerated accumulation of
has led to a considerable depletion of domestic debt. And, in spite of all the best efforts of the
resources. Offshoring by local companies, and an National Treasury, this continues to be the case. It
acceleration in emigration have hollowed out the means that the two fastest-growing expenditure
financial and skills bases. It is unclear whether the lines in the budget are the public sector wage bill
economy will be able to make a full recovery, but and the price of servicing government debt.
the result has been a protracted period of very
low growth. DROWNING IN DEBT
This brings me to my next biggest concern,
Low nominal growth is the next concern. Achieving because the two are linked – rising government
better, stronger growth really is the most import- debt combined with the financial and operational
ant economic challenge for South Africa at this condition of state-owned enterprises (SOEs). In the
critical stage. It is the means by which econo- case of the former, because growth has been so
mies generate opportunities and government the much weaker than expected, revenues have con-
resources by which to provide for people where sistently underperformed budgeted amounts and
economic allocations fail. It doesn’t fix inequal- the allocation to expenditure, and government
ity, but it allows the state to make provision for has funded the shortfall by raising debt.
the most vulnerable. Without growth we have no
options. The South African economy has under- Government debt is expected to hit 60% of GDP
performed global growth, across developed and in the current fiscal year, excluding the debt owed
emerging markets, since the 2008/2009 Global by the SOEs. Alone this is not alarming, but the
Financial Crisis (GFC). This became (and has trajectory is: government debt bottomed at
stayed) more pronounced in 2012 (see Figure 1). 24.6% of GDP in the third quarter of 2008; since
then, it has increased to 56.7%, a compound
This at least partly reflects the effects of post- annual rate of 7.9%. As we stand, government
GCF policy choices: at the time, government debt will not stabilise, but will continue to build
spending accelerated as revenue collapsed. This over the medium term (refer to figures 2 and 3 on
was the right thing to do in a crisis. However, the page 14).
way in which government spent, hiring many
people and expanding their incomes at a rate Why does it matter? The bigger the debt burden
well ahead of inflation, had a permanently neg- becomes, the greater the cost it exacts on the
ative effect on government expenditure. At the economy. Not only are financial resources directed
time, government expected growth to return to away from productivity-promoting investment to
TRUST IS EARNED™ 13finance the debt; but it must ultimately be repaid. Outside of a cumbersome wage bill, the costs to
We can already see that increased debt is weigh- the fiscus of troubled SOEs have increased enor-
ing on the economy’s ability to grow. Rising issu- mously. Eskom remains the biggest challenge.
ance puts pressure on long-term interest rates, This is the next big concern – the financial and op-
which affect borrowing costs across the economy erational viability of Eskom and the risk this poses
by raising the cost of debt and debt service. to both sustainable growth and government
finances.
Taken together, the increased cost of debt, coupled
with a rising risk that the situation will become DARK MATTER
increasingly unsustainable, undermines any appe- In February, the National Treasury allocated an
tite for investment. Less investment now means additional R23 billion per annum of taxpayers’
less growth later, which means high levels of debt money over the next decade to keep Eskom afloat.
have a lasting impact on both realised and poten- By March (the very next month) it became clear
tial growth. As this happens, living standards fall. that this wasn’t enough, and government front-
loaded R13 billion of this year’s annual allocation
to the entity. At the end of July, Finance Minister
Tito Mboweni tabled a Special Appropriation
Figure 2
Bill, allocating an additional R26 billion transfer
GOVERNMENT DEBT, PERCENTAGE OF GDP
to Eskom in the current fiscal year, and a further
%
R33 billion in 2020/2021. Despite promises that
70
these transfers would be made on condition that
60 certain reforms be met, further details have not
been forthcoming.
50
40
Eskom’s financial and operational fragility really
emerged at the start of Ramaphosa’s presidency
30 in mid-2018. While the causes pre-date this, the
situation has deteriorated visibly since, and the
20
complex nature of Eskom’s challenges has become
10 more apparent:
0
1. Eskom is insolvent. Years of corruption, coupled
2000/1
2001/2
2002/3
2003/4
2004/5
2005/6
2006/7
2007/8
2008/9
2009/10
2010/11
2011/12
2012/13
2013/14
2014 /15
2015/16
2016/17
2017/18
2018/19
2019/20
with a failure to invest in adequate capacity,
and falling revenues have resulted in a debt
South Africa’s gross debt, % of GDP Eskom guarantees, % of GDP stock of R420 billion, and its revenues cannot
Emerging markets’ gross debt, % of GDP meet the combined cost of servicing this debt
Source: South African Reserve Bank and its operating expenses. By our estimates,
without dramatic remedial intervention, Eskom
will need direct financial assistance (taxpayers’
transfers) for the foreseeable future.
Figure 3
GDP PER CAPITA 2. The remedy requires difficult decisions. At
%, year on year group level, recurrent expenditure (wages and
20 debt service) continues to rise, and there is
little appetite to reduce these costs. To add to
15
these woes, revenue is constrained by a shrink-
ing customer base and chronic non-payment.
10
3. Eskom as an entity is an anachronism and
needs to be restructured. This includes verti-
5 cal disintegration, higher tariffs, and, impor-
tantly, a new way of managing its excessive
debt burden.
0
4. Eskom is unable to meet the energy needs of a
-5 growing economy.
2000 2003 2006 2009 2012 2015 2018
GDP per capita, constant GDP per capita, nominal 5. It isn’t clear that decision makers realise the
Source: IMF urgency with which this needs to be addressed.
14 COROSPONDENTFigure 4 moderation in China, compounded by falling
GLOBAL POLICY RATES global trade volumes and the escalation in trade
% tensions between the US and China. At the same
2.5 time, political tensions remain high. China-
related protests in Hong Kong are ongoing, with
2.0 little obvious source of diffusion; the Middle East
remains a source of great potential unrest; and
1.5
the UK’s EU exit date is fast approaching, with
1.0 its own fraught political uncertainty. And, US
President Donald Trump continues to be a dis-
0.5 ruptor across a range of issues and geographies.
0
Central banks in the US, the EU, Japan and across
-0.5
emerging markets have increased monetary
Jan 16 Jul 16 Jan 17 Jul 17 Jan 18 Jul 18 Jan 19 Jul 19 support for their economies in response to this
Australia European Central Bank Bank of Japan Bank of England
weakness and the uncertainty it poses to domes-
US Federal Reserve Board
tic growth. At the September news conference
of the Federal Open Market Committee, Jerome
Source: Haver
Powell, Chairman of the Federal Reserve Board,
reiterated that the decision to cut the fund’s rate
for the second time this year, despite decent
growth in the US, was due to a weaker external
Probably the most important parallel require- environment, with growing risk and inflation per-
ments for stability are a detailed (and agreed) sistently below the 2% target.
turnaround strategy for a disintegrated entity,
and what Eskom and the government propose Similarly, outgoing European Central Bank
to do with its debt. The former is up to the President, Mario Draghi, announced not only a
Department of Public Enterprises, the President deposit rate reduction into deeper negative ter-
and stakeholders; the latter requires that these ritory, but open-ended direct support for asset
agree and then negotiate with the bondholders. markets in the form of a renewed targeted longer-
At this late stage, while there has clearly been a term refinancing operation. Japan’s stance is also
lot of consultation, there seems to be little agree- accommodative and “more keen to ease than
ment. As we head into the tabling of the Medium- before since overseas risks are heightening” (see
Term Budget Policy Statement in October, we Figure 4).
have yet to see any evidence of real progress.
Ultimately, the outlook for global growth in
This means that there is real risk that Minister coming quarters will be in the balance between
Mboweni will table a policy statement with a supportive monetary and fiscal policies for rea-
fiscal position considerably worse than was esti- sonably solid domestic demand, and an ongoing
mated at the time of the February National deterioration and heightened escalation in
Budget (which is widely expected), but with few uncertainty playing out in global trade.
compensating measures. In this case, domestic
debt to GDP will not only rise above 60% this For now, we expect global growth to stabilise at
year, but is also unlikely to reflect the necessary weaker levels as policy support matures, acknow-
conditions for stabilisation. In this dim light, ledging the pronounced uncertainty.
growth prospects are further diminished. And
there is little relief in looking to the rest of the For South Africa, there is much to be gained
world to find it. This time, there is cold comfort to from clarified policy direction, despite rising
be found abroad. global headwinds. In particular, decisive action
on Eskom could go a long way to restoring confi-
A WORLD AT SEA dence among businesses and consumers. Recent
South Africa is a small, open economy operat- data from the Bureau for Economic Research con-
ing in a very uncertain world. More than ever, firmed that confidence among these key growth
political signalling is driving asset markets and drivers hit multi-decade lows in the third quarter
economic policy in a global environment that is of 2019, inhibiting consumption and capex deci-
more disconnected than it has ever been in the sions. With few easy short-term drivers of growth
post-war period. Across economies, growth has available, restoring confidence is key to the start
decelerated since late-2018, owing mostly to of any growth recovery. +
TRUST IS EARNED™ 15S T O C K A N A LY S I S
Next-generation
entertainment
Cable operators leading US broadband
internet momentum
By C H R I S C H E E T H A M
The TV shift from Broadband is now the
THE The average US Broadband internet
linear to OTT is still primary product sold
cable household will be the backbone
QUICK nascent in the US
consumes over of next-generation
by cable operators,
TAKE and momentum will while pay TV is less
250GB per month entertainment
increase relevant
IN THE LAST edition of Corospondent, we entertainment, the importance of which will
discussed how consumer habits have evolved continue to rise, and our view is that the cable
with respect to entertainment and how viewer- investment case is misunderstood and under-
ship continues to shift away from traditional live appreciated by the market.
television to on-demand video streamed over
the internet. The transition of entertainment and As reflected in Figure 1 on page 17, these strong
Chris is a global communication to online is still in its infancy and structural trends have resulted in a rapid increase
developed markets we expect the trend to continue. Against this back- in data demand, with the average US cable
analyst with more
than eight years of drop, we believe cable operators are well placed household consuming over 250 Gigabytes (GB) of
investment experience. as the leading providers of broadband internet in data per month, while households that don’t sub-
the US. scribe to traditional pay TV use roughly double
that.
Both Charter Communications and Altice USA
have materially outperformed the market year This is a clear illustration that cord cutters
to date, up around 45% and 70%, respectively, consume more data as video content is streamed
and we continue to hold both as core positions via the likes of Netflix and other over-the-top
in our active global equity portfolios. Although (OTT) providers. Data consumption is only set
the market has traditionally focused on cable’s to increase further, with Altice USA disclosing
declining pay-TV business, broadband internet is that its most data-hungry homes (the top 10% of
the primary product sold into the home. With the users) consume one Terabyte of data per month
strong growth in its customer base, broadband and have 15 or more connected devices. In time,
now contributes almost all of the free cash flow it’s fair to expect this to become the norm as
generated by the cable operators. As consumers streaming-use cases expand to include higher-
continue to shift to streamed video, broadband quality video as well as connected home and
will become the backbone of next-generation gaming applications.
16 COROSPONDENTFigure 1 The cable-use case soon shifted from broad-
AVERAGE DATA USAGE PER HOUSEHOLD PER MONTH cast to pay TV, leading to the establishment of
well-known channels such as ESPN and HBO.
GB
300
Average For many subsequent years, cable was primar-
data usage
ily focused on selling a traditional bundle of
250 pay-TV channels, as DSTV does today. Cable is a
Data usage
growth p.a. scale game, and years of footprint consolidation
c.25%
200 means that the three major listed US operators
– Charter Communications, Comcast and Altice
150
USA – now pass 51 million, 58 million and nine
million homes or businesses, respectively!
100
THE SHIFT TO BROADBAND
50
It’s no secret that traditional, ‘linear’ TV sub-
0 scriber numbers are declining, and we expect this
Q4 2013 Q4 2014 Q4 2015 Q4 2016 Q4 2017 Q4 2018 to continue. Cable operators have repositioned
Source: Altice USA 2018 results presentation themselves with broadband as the primary
focus, enabled by extensive plant upgrades that
started at the turn of the century and continue
to this day.
WHAT IS CABLE? Much of the original footprint has been replaced
Cable was initially conceived to bring free broad- with fibre, and networks have been digitised
cast television to mountainous areas unable and upgraded, resulting in speeds of one
to receive adequate signal through the air via Gigabit per second (Gbps) being readily avail-
antenna systems. A cable system can be thought able. Operators have already identified a real-
of as an electricity grid transmitting data from istic, low-cost path to 10Gbps.
one point to another, and at its core consists
of a mix of copper and fibre transmission lines. As a result of its well-established position and
Today, most US homes and businesses have advantaged infrastructure, cable has contin-
cable running past them, dug into the pavement ued to take share of the US broadband market
decades before, and cable has both an advan- and today serves two thirds of all broadband-
taged infrastructure and natural monopoly in connected homes. Most US homes are passed by
most US towns and cities. The rapid construction both cable and a telco line offering DSL (think
of cable infrastructure started in the mid-50s and Telkom); the latter offers insufficient speeds and
was followed by decades of footprint expansion continues to lose market share as data consump-
and consolidation led by players such as the tion explodes.
legendary John Malone.
New competition is unlikely due to the cost of
laying fibre and the questionable return on
investment in doing so because of the difficulty
Figure 2
in prying customers away from entrenched pro-
CHARTER: STEADY GROWTH IN BROADBAND SUBSCRIBERS IN THE US viders. Much of this cable was originally put
million down decades ago and it’s often near impossible
30
28.2
to overbuild this infrastructure from a town plan-
27.4
26.6 ning or regulatory perspective. Today, the pro-
25.8
25 23.6
24.8
vision of broadband internet is cable’s primary
cash generator.
20
WHAT ABOUT CABLE’S TRADITIONAL VIDEO
16.1 15.7 15.2 BUSINESS?
14.7
15 14.2
13.7
Figure 2 illustrates that while broadband is now
clearly the primary service being sold into the
10 home, video still comprises a significant pro-
portion of cable operator revenue, although
5 video users continue to decline by 2% to 3%
2018 2019 2020 2021 2022 2023
per year. The video backdrop is one of intense
Broadband subscribers Video subscribers competition, with traditional distributors like
Source: Coronation estimates cable and satellite losing out to OTT platforms.
TRUST IS EARNED™ 17Furthermore, new services from deep-pocketed Table 1
companies such as Disney and Apple are due to
CONTRIBUTION TO REVENUE, EBITDA AND FREE CASH FLOW
launch imminently.
Altice USA Charter
This fight for eyeballs is driving content costs
Revenue contribution
up, with timeless shows like Seinfeld and Friends
recently costing around the $400 million to Video 42% 38%
$500 million mark for new multiyear carriage Broadband, business services and other 58% 62%
deals, according to press reports, while Apple is
EBITDA contribution
reportedly spending over $15 million an episode
on The Morning Show starring Jennifer Aniston Video 17% 8%
and Reese Witherspoon. Broadband, business services and other 83% 92%
IS IT VIDEO’S TURN TO DIE? Estimated 2020 free cash flow yield 9% 7%
What does this challenging backdrop mean for Sources: Published financials and Coronation estimates
cable operators?
Table 1 clearly shows that video’s contribution to
cable is smaller than the revenue headline sug-
gests. Due to significant programming costs paid moves to leverage its primary broadband rela-
to channel and content owners, video is a very tionship into being the aggregator of choice in
low-margin business and is estimated to contri- the modern world of streamed video, with set-top
bute under 20% of total earnings before interest, boxes now including OTT options in an easily
tax, depreciation and amortisation (EBITDA) for searchable format.
the likes of Charter and Altice USA. Content costs
are paid on a per-subscriber basis, and so natu- WHAT ARE THE KEY RISKS TO CONSIDER?
rally decrease in line with declines in the video Could technological change challenge cable’s
subscriber base, smoothing the overall impact of advantage in the provision of broadband inter-
video’s downward trajectory. net? We continue to monitor global develop-
ments around 5G and its potential to allow
Furthermore, video contributes only marginal free mobile operators to play a larger role in home
cash flow to cable operators due to the high cost broadband. 5G is the next generation of radio
of putting set-top boxes into homes. We believe network technology and should bring signifi-
that the current pace of video subscriber declines cant benefits to the average mobile phone user,
is very manageable, and that new cable initia- including higher speeds and increased capacity.
tives, such as the launch of aggressively-priced US telecom giants like Verizon and T-Mobile have
bundled mobile plans, will bring benefits such as different strategies, but both envisage using 5G
broadband churn reduction, filling the gap that technology to provide home broadband. While
video once filled. While video is still an important we are not dismissive of this threat, the amount of
element of the cable triple-play bundle, its contri- data consumed by the average US household and
bution to free cash flow and therefore company the growth thereof make it difficult for mobile
valuation must not be overestimated. technology to compete with fixed alternatives
such as cable and fibre.
TRADITIONAL VIDEO’S LOSS IS BROADBAND’S
GAIN The average US mobile customer uses under 10GB
While content owners slug it out for eyeballs and of data per month; even a tenfold increase in
continue to write bigger cheques for new shows, mobile capacity – the upper range suggested by
a fast and consistent internet connection remains industry experts – will struggle to compete with
paramount to delivering the required streaming the average cable household consuming over
experience. It’s estimated that over 75% of inter- 250GB per month and growing rapidly. 5G will
net traffic is video use, which clearly illustrates also allow the use of previously untapped spec-
how a traditional video subscriber loss is broad- trum1 bands, and certain use cases will enable
band’s gain. high-capacity home broadband solutions in
limited circumstances. This high-frequency signal
As the traditional television bundle is replaced does not travel far and therefore requires more
with skinnier online options and individual apps, towers (connected with fibre) near to the end-
a complicated experience arises for consum-
ers used to having all their video needs met in 1
Spectrum refers to a range of radio waves used by telecommunication
one place. In response, cable is making the right providers for wireless communication purposes.
18 COROSPONDENTYou can also read
