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Student demands have 'ominous' effect on rand

Cape Town - Beside the threat to fiscal discipline the student demands have a more ominous effect on the rand, says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.

Comparisons are being drawn between the current student protests and the 1976 Soweto uprising, says OAM.

"The protests are about more than just fees reflecting a broader feeling of dissatisfaction, causing trepidation among domestic and foreign investors."

The “born free” generation (those born after the end of apartheid), is for the first time finding a voice and dauntingly the voice is one of extreme dissatisfaction, according to OAM.

The “born free” generation amounts to 26.7 million according to the latest census, comprising around half the country’s population.

"The students’ dramatic protests and the unstable political and social environment could produce further challenges to the rand in the months leading up to the local government elections next year," OAM said.

South Africa economic review

• Finance Minister Nhlanhla Nene’s Medium-Term Budget Policy Statement (MTBPS) lowered the Treasury’s economic assumptions. Economic growth in 2015 is expected to be just 1.5% down from the Treasury’s 2% forecast in February.

GDP growth forecasts for 2016 and 2017 were lowered from 2.6% to 1.7% and from 3.0% to 2.5%. Despite slower economic growth the budget deficit this year is expected to be 3.8% of GDP down slightly from the Treasury’s 3.9% forecast in February.

However, the deficit falls more gradually than previously expected to 3.3% in 2016/17 and 3.2% in 2017/18 compared with earlier forecasts of 2.6% and 2.5%. A disappointment is the far greater than expected public sector wage agreement which pushes up remuneration this year by 10.1% and by more than two percentage points above inflation in the next two years.

Unfortunately total debt is expected to rise further from 49.0% of GDP this year to 49.4% in 2018/19 in danger of breaching the key 50% level. While retaining the Treasury’s fiscal prudence the MTBPS signals little room for manoeuvre with regards to any unexpected increases in expenditure.

• Following the Medium-Term Budget Policy Statement Moody’s credit rating agency reported that SA’s efforts to stabilise its debt over the medium-term could prove more challenging than initially expected.

Moody’s estimated that slowing economic growth will raise the state’s financing needs by around 0.5% of GDP.

At the same time the rising wage bill will leave the Treasury with very little room for manoeuvre. Moody’s said the lack of detail on new revenue raising measures combined with the prospect of higher financing requirements from state-owned enterprises raise the risk of causing further fiscal slippage next year.

• Retails sales growth unexpectedly improved from 3.3% year-on-year in July to 3.9% in August well above the 2.9% consensus forecast. The improvement is attributed to the "general dealers” category which accounts for 40% of total sales, with sales rising 5.2% on the year adding 2.1 percentage points to the headline reading.

A detractor was the “household furniture, appliances and equipment” category which declined -5.5% on the year. The higher than expected public sector wage agreement is evidently having a beneficial effect on overall retail sales, which in the three months to end August showed quarter-on-quarter growth of 4.2%.

Retail sales should come to the rescue of GDP growth during the third quarter (Q3) although the boost may be temporary amid slow employment growth, high household debt, rising inflation and prospects for higher interest rates. Although the FNB/BER consumer confidence index recovered from a 14-year low of -15 in Q2 to -5 in Q3 it still remains well below the +5 long-term average.

• Consumer price inflation (CPI) remained unchanged in September at 4.6% year-on-year below the 4.7% consensus forecast. On a month-on-month basis CPI was flat at 0.0% helped by a -0.3% decline in the “transport” category as the petrol price fell -5.3% in September. Food price inflation was lower than expected rising 0.1% on the month well below expectations of a 1.1% increase.

However core CPI, which excludes volatile food and energy prices, also showed little upward pressure remaining unchanged at 5.3% year-on-year. So far there has been little inflationary effect from the weaker rand although this remains a threat.

Despite lower than expected inflationary readings in September CPI is expected to breach the SA Reserve Bank’s (Sarb) 3-6% target range in the first quarter of next year. The Sarb is expected to hike interest rates at its November policy meeting ahead of a likely increase in US rates in December.

• The SA Reserve Bank (Sarb) composite business cycle indicator measuring current conditions increased in August by 0.1% month-on-month and by 1.1% year-on-year. In contrast the Sarb leading economic indicator decreased by -0.1% on the month with the year-on-year decline deteriorating from -3.6% in July to -4.7%.

The main culprits were falls in the dollar-based export commodity price index and the BER business confidence index. There were some bright spots with positive contributions to the index from improvements in job advertising space and new passenger vehicle sales.

• Foreign investors bought a net R1.5bn worth of domestic bonds in the past week, remaining net buyers for a third straight week bringing cumulative year-to-date net buying to R25.07bn. The net foreign inflow into domestic equities was R1.1bn, which although positive did little to reverse the cumulative –R18.2bn outflow over the prior three weeks.

Foreign equity buying was skewed towards the industrial and resource sectors and selling towards the financial and property sectors. While net foreign equity purchases for the year-to-date remain positive at R20.38 billion the heavy –R17.1bn net selling over the past month lifts the chances of a market correction in the near-term.

South Africa political overview

• Following the findings of an inter-ministerial committee headed by Deputy President Cyril Ramaphosa the government announced measures to mitigate the negative impact of the controversial new visa regulations imposed last year. Visa applications will no longer need to be done in person but rather through accredited travel agencies while biometric data can be captured at the point of entry into SA. Parents travelling with children will still require birth certificates but the requirement for “unabridged” certificates will change to birth certificates which contain parental details.

The week ahead

• Unemployment rate: South Africa's unemployment rate increased to 25.5% in the third quarter of 2015, Statistics SA announced on Tuesday. This was up by 0.5 of a percentage point from the second quarter rate of 25%, but is still an improvement from the first quarter rate of 26.4%.

• Private sector credit extension: Due Thursday 29th October. According to consensus forecast year-on-year growth in private sector credit extension (PSCE) will pick-up slightly from 8.6% in August to 8.7% in September.

The main driver of PSCE is likely to be the corporate sector which is making use of credit to expand into faster growing neighbouring economies. By contrast household credit extension should remain weak due to inflationary pressures and weakening consumer confidence.

• Producer price inflation: Due Thursday 29th October. According to consensus forecast producer price inflation (PPI) is expected to increase slightly on a year-on-year basis from 3.4% in August to 3.6% in September due mainly to the effect of higher food prices stemming from the drought and poor maize crops earlier in the year. A weaker rand, rising utility costs and higher wages are also contributory factors.

• Trade balance: Due Friday 30th October. According to consensus forecast the trade balance is expected to show a further deficit in September of –R5bn following the two deficits in July and August of –R1.1bn and –R9.9bn. The outcome would be an aggregate trade deficit in the third quarter (Q3) in contrast to the trade surplus in Q2. The reversal would be disappointing especially given the boost to SA’s terms of trade from the weaker rand.

Technical analysis

• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. Although the rate of the rand’s depreciation is accelerating there is no sign yet of panic selling or capitulation. This stage needs to be reached before a reversal in the rand’s move can occur.

• The US dollar index is testing a major 30-year resistance line, which if broken will pave the way for further strong gains in the currency.

• Despite the recent uptick in bond yields the long-term JPMorgan global bond index bull trend remains intact, with the yield targeting a new low during the fifth and final wave.

• The US 10-year Treasury yield has broken above key resistance levels of 2.0% and 2.2%. However, there is unlikely to be a major bear trend in US bonds as the deleveraging phase is still in its early stages.

• The benchmark R186 SA Gilt yield is testing support at 8.70% which if broken could open a new target of 9.5%.

• Although recently recovered the MSCI World Equity index broke downward from a rising wedge formation which has been intact since the 2008/09 global financial crisis. It is unlikely that the downward move is over as the correction was too small for a bull market of the magnitude and duration of the 2009-2015 bull market. The downside target for the MSCI World Equity index is 1 400.

• Since the 1950s the Dow Jones and S&P 500 have displayed 7-year up-cycles and the top of the current US equity cycle can be expected in the next year. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur around June 2016.

• Although recently recovered the S&P 500 index broke downward from a rising wedge pattern, which is traditionally a trend-changing pattern. The downward trend is likely to remain intact unless the index decisively regains the 2070 level. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is leading the broader market lower on the downside.

• Brent crude’s break below the key $50 support level suggests a continuation of the weakening long-term trend. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the key $5 300 support level suggesting further downside ahead.  

• Despite recent advances Gold is in a protracted bear market signalled by rapid declines through successive support levels at $1 300, $1 250 and $1 100. Gold’s next target is $1 000 which is likely to be breached before the bear market ends.  

• Although recently recovered the All Share index broke below its bull market support level which has been intact since 2009. The downside target for the All Share index is 43 000.

Bottom line

• The rand fell -4% versus the US dollar last week making it the weakest of all the emerging market currencies. The performance was especially dismal considering that the previous week the board of SABMiller unanimously agreed to a revised take-over offer from Anheuser-Busch InBev (ABI), which may entail substantial capital inflows.

• The takeover offer comprises a combination of cash and shares in ABI. ABI will have a secondary listing on the JSE. The SA-based stake in SABMiller currently stands at around 17% of SAB shares. Depending on whether SA-based shareholders elect to receive cash or a combination of ABI shares and cash, the amount of capital inflow into SA could be anywhere between R7bn and R255bn. The mid-point suggests a capital inflow of around R131bn.

• The benefit to the rand seemed lost due to concern the SAB/ABI deal may take several months to conclude as a result of potential regulatory delays. In addition given the current thirst for rand hedge stocks there is a strong likelihood that shareholders will elect to receive as many shares as possible rather than cash, limiting the size of the capital inflow.

• Unfortunately the currency benefit of the SAB/ABI deal was undermined by the Medium-Term Budget Policy Statement (MTBPS). Following the release of the MTBPS, Moody’s credit rating agency reported that SA’s efforts to stabilise debt over the medium-term could now prove to be more challenging. Moody’s cited a much weaker growth environment and a swelling public sector wage bill, which will raise financing needs by around 0.5% of GDP over the next two years.   

• Within days of presenting the MTBPS the Treasury was asked to add a further R3bn to state expenditure after the government capitulated to student demands over university tuition fees. Although the tuition fees represent less than 0.1% of GDP, the public wage deal has already taken-up most of the Budget’s contingency reserve.

• Beside the threat to fiscal discipline the student demands have a more ominous effect on the rand. Comparisons are being drawn between the current student protests and the 1976 Soweto uprising. The protests are about more than just fees reflecting a broader feeling of dissatisfaction, causing trepidation among domestic and foreign investors. The “born free” generation (those born after the end of apartheid), is for the first time finding a voice and dauntingly the voice is one of extreme dissatisfaction.

• The “born free” generation amounts to 26.7 million according to the latest census, comprising around half the country’s population. The students’ dramatic protests and the unstable political and social environment could produce further challenges to the rand in the months leading up to the local government elections next year.


For the full report, including a look at international markets, click here.

* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.

Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.



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