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Cape Town - A lower oil price would be unequivocally bullish for South Africa’s equity markets, says Overberg Asset Management is its weekly overview of the SA market landscape.
According to OAM there is a strong probability of renewed oil price declines in the second half of the year.
"One of the questions most frequently asked in today’s financial markets relates to the future of crude oil prices.
"Calling this correctly will add significant value to investment performance. A low oil price would reduce company production costs, lift profit margins and company earnings, provide households with increased disposable income, and lower inflationary pressure thereby enabling interest rates to remain lower for longer," according to OAM.
Market overview
SA economic review
• Consumer price inflation (CPI) accelerated from 4.0% year-on-year in March to 4.5% in April although below the 4.8% consensus forecast. On a month-on-month basis CPI increased by a hefty 0.9% with the transport category contributing the bulk of the gain (0.7 percentage points). Petrol prices were increased during the month by 14.3%. Core CPI excluding volatile food and energy prices eased from 5.7% to 5.6% but significantly above the headline rate indicating the continued disinflationary effect of lower oil prices.
• Growth in retail sales unexpectedly slowed from 3.7% year-on-year in February to 2.0% in March, well below the 4.2% consensus forecast increase. The slowdown is attributed to a contraction in sales of household furniture, appliances and equipment and a pronounced slowdown in sales growth in the general dealers as well as textiles, clothing, footwear and leather goods categories. The negative effect of the fuel price increase on household disposable income is largely to blame for the poor retail sales reading. On a month-on-month basis retail sales fell by -0.5% causing quarter-on-quarter growth to register just 0.9% in the first quarter.
• As expected the SA Reserve Bank (Sarb) kept the benchmark repo interest rate unchanged at 5.75%. However, Sarb Governor Lesetja Kganyago reiterated in the accompanying policy statement that the Monetary Policy Committee (MPC) remained in “tightening mode”. The statement cited rising electricity tariffs, high wage settlements and currency volatility as key risks to the inflation outlook.
The Sarb raised its forecast for consumer price inflation (CPI) in 2015 from a previous 4.8% to 4.9% and for 2016 from 5.9% to 6.1%. CPI is forecast to breach the 3-6% target range in the first quarter 2016 averaging the quarter at 6.8% up from a previous 6.7% before easing in subsequent quarters.
Kganyago said that CPI would remain “uncomfortably close” to the inflationary target range over the forecast period. The increasingly “hawkish” MPC statement raises the prospect of an interest rate hike by September or even the next policy meeting in July. The Forward Rate Agreement market is pricing-in rate increases of 50 basis points by year-end.
• Foreign investors bought R0.04bn worth of SA bonds in the past week and sold R1.3bn worth of equities. Over the month of May-to-date foreign investors sold R1.6bn worth of bonds and bought R1.6bn worth of equities, while for the year-to-date foreign investors bought R7.7bn and R19.4bn worth of SA bonds and equities respectively. Foreign investors accounted for a lower than usual portion of daily trade volume, measuring 34.1% of total market activity in the past week, below the 42.0% year-to-date average. The below average reading is attributed to a global upward move in bond yields which is spilling over into reduced appetite for SA bonds.
SA political review
• The government and public sector unions agreed to a three-year wage deal. The deal comprises a 7% wage increase in year one followed by wage increases of consumer price inflation (CPI) plus 1% in years two and three. Although slightly above the SA Reserve Bank’s 3-6% CPI target range the long-term nature of the deal should provide certainty in budget forecasting. However, the total remuneration package also includes large increases in the housing allowance from R900 to R1200 per month and in the medical aid subsidy from 17.8% to 28.5%. Steep increases in fringe benefits raise the effective public sector wage bill by an additional two percentage points beyond the headline 7% increase. The deal may cause some consternation at the credit rating agencies which have repeatedly expressed concern over public sector wages.
• Deputy President Cyril Ramaphosa announced the findings of the government’s e-toll review which was held in response to widespread public dissatisfaction with the Gauteng Freeway pricing mechanism. Although tariffs for all motorists will be reduced the review maintained the “user pays principle”. Furthermore the system will be more strictly policed. Users will have to pay outstanding e-toll fees before renewing their vehicle license. Although politically unpopular the e-toll review should help the solvency of the SA National Roads Agency (SANRAL) and bolster SA’s fiscal standing.
• Energy Minister Joemat-Peterson announced that the state would begin the procurement process to build 9600 MW in new nuclear generation capacity in line with the 2010 Integrated Resource Plan. Selection of strategic partners will be presented to cabinet by year-end. The announcement was unexpected and appears to be in contradiction with the Treasury which previously stated that the nuclear programme will be subject to rigorous affordability assessment. The contradiction is confusing and runs counter to recent announcements which downplayed nuclear power generation as a viable option.
The week ahead
• On Tuesday, Statistician-general Pali Lehohla said South Africa’s unemployment level increased to 26.4%, the highest level since 2003, when it hit 30% at the first Quarterly Labour Force Survey (QLFS) on Tuesday 26 May.
• A significant drop in gross domestic product (GDP) in the agriculture sector as well as a drop in the manufacturing sector contributed to the 1.3% increase in year-on-year (y/y) GDP in the first quarter of 2015, Statistics SA said on Tuesday.
• Producer price inflation (PPI): Due on 28 May. According to consensus forecast PPI is expected to accelerate from 3.1% year-on-year in March to 3.4% in April.
• Money supply and private sector credit extension (PSCE): Due on 29 May. According to consensus forecast growth in PSCE is expected to remain unchanged in April at 8.9% year-on-year.
• Trade balance, also out on 29 May. According to consensus forecast the trade balance is expected to deteriorate from a surplus of R0.5bn in March to a deficit of –R5.0bn in April.
Technical analysis
• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. A break above the key “Fibonacci” level of R/$12.15 would open up a further depreciation in the rand to the R/$13.00 level.
• 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.
• 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 below key resistance levels of 2.40% and 2.0% indicating a trading range of 1.70-2.2% over the medium-term. 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 8.15% and needs to break below resistance at 7.90% in order to resume its bull trend.
• The MSCI World Equity index is in the 5th and final wave of a rising-wedge formation. A rising-wedge formation is a typical trend-ending signal. European equities are set to outperform US markets. The Nikkei exhibits the most bullish pattern.
• 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.
• In the meantime the S&P 500 is displaying a bullish short-term pattern. The index is moving into an advanced triangle pattern which normally signals the continuation of an upward trend. This view is corroborated by the “downward flag” of the Dow Jones index, which is also associated with an upward break-out.
• Although enjoying a temporary respite Brent crude’s previous break below key support levels at $60 and $50 suggesting 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 2011 low of $6,500 suggesting a further downside move to $5,500.
• Despite recent advances Gold is in a protracted bear market signalled by rapid declines through successive support levels at $1400, $1300 and $1250. Gold’s next target is $1100 and is likely to breach $1000 before the bear market ends.
• The All Share index has broken to new highs exceeding the 55,000 level for the first time indicating a continuation of the long-term upward trend.
Bottom line
• One of the questions most frequently asked in today’s financial markets relates to the future of crude oil prices. Calling this correctly will add significant value to investment performance. A low oil price would reduce company production costs, lift profit margins and company earnings, provide households with increased disposable income, and lower inflationary pressure thereby enabling interest rates to remain lower for longer. A lower oil price would be unequivocally bullish for South Africa’s equity markets. There is a strong probability of renewed oil price declines in the second half of the year.
• OPEC production continues to rise. Saudi’s output in 2015 is likely to increase by 8% from last year’s level. Iraqi output is also rising and Russia’s output jumped to record levels in March and April. Iranian exports are likely to hit the market in the second half of the year adding around 0.75 million barrels per day (mbd) to global supply. The level of OPEC and US inventories are at record highs.
• Since 2011 US crude oil production has nearly doubled making the US the swing global oil producer. With Saudi Arabia willing to flood the oil market at any cost the oil price will be driven over the longer-term by free market economics rather than OPEC. The price of oil will be determined on the supply-side by the break-even cost, currently estimated at around $60. Technological improvements are bringing the marginal cost of oil production steadily lower. Industry analysts estimate that shale production costs could reduce by a further 30% in the next few years.
• Shale production rigs can be fully mobilised to begin production within a month. In addition production in shale formations occurs quickly with the bulk of total output over the first two years of production rather than the decades it takes with conventional production. The quick response ability of shale producers profoundly changes the supply-side of the oil industry and will cap any substantial advance in the oil price. While total rig counts in the US have dropped by around 60% since the collapse in the oil price, they could resume just as quickly.
For the full report, including a look at international markets, click here.
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.
