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No time to relax for SA investors

Cape Town - Any major correction in US stocks will spill over into global markets including the JSE, Overberg Asset Management said in its weekly overview of the SA economic landscape.

"While China’s equity market has led the JSE downward over the past three months Wall Street is likely to pick up the baton and lead the charge lower over the remainder of the year," OAM said.

"The All Share index has had a torrid time over the past month, losing over 7.0% in response to China’s currency devaluation, weakening commodity prices and impending Federal Reserve interest rate hikes," according to OAM.

"Although tempting to buy shares at current levels there is likely to be further downside pressure in the near-term and patience should be rewarded."

South Africa economic review

• Consumer price inflation (CPI) increased in July by 0.1% month-on-month and 5.0% year-on-year up from 4.7% in June. The acceleration in CPI is attributed mainly to higher administered prices with electricity tariffs rising 11.2% on the month and water and other service tariffs rising 9.8%.

CPI is expected to breach the SA Reserve Bank’s (SARB) 3-6% inflation target range at the end of the year and during the first half of 2016 due to the base effect of last year’s low comparative figures. However, core CPI which excludes fuel and food prices eased further from 5.5% to 5.4% the lowest since February 2014.

Core CPI showed little impact from a weakening rand with rand-sensitive categories such as vehicle prices and household appliance prices remaining subdued due to weak domestic demand. The surprisingly subdued core CPI reading may be sufficient for the SARB to refrain from hiking the key repo interest rate at its policy meeting in November.

READ: CPI inflation increased by 5% in July - Stats SA

• Retail sales increased in June by 3.5% year-on-year up from 2.4% in May and in line with consensus forecast. However, the improvement is due mainly to the base effect of weak comparative data resulting from last year’s mining strike. On a month-on-month basis the data is less encouraging with retail sales increasing just 0.1% below the 0.2% consensus forecast.

Retail sales increased in the second quarter (Q2) by 1.5% quarter-on-quarter annualized down sharply from 3.9% in Q1. Consumer expenditure is under pressure from rising interest rates at the same time as high administered price increases, accelerating inflation and weak employment growth. Consumer spending is unlikely to come to the rescue of GDP growth in Q2 or the second half of the year.

READ: Truworths sales growing

• In its quarterly review the National Automobile Association of SA (NAAMSA) lowered its forecast for 2015 domestic car sales from 659 000 to 626 500 which would mark a decline from the 644 500 sold in 2014. Furthermore NAAMSA forecasts total car sales will increase in 2016 by just 1.1% year-on-year. NAAMSA also lowered its 2015 car production forecast from a previous 627 500 to 609 500 although this would be 7% above the 2014 level. Production volumes are being supported by robust export demand. NAAMSA raised its forecast for 2015 vehicle exports from a previous 321 500 to 326 000.

READ: June car sales down

South Africa political overview

• Following discussions between the National Treasury and the Department of Energy on funding of the state’s nuclear procurement programme Finance Minister Nhlanhla Nene said that he would stand against the plan if it proved unaffordable. The Treasury’s resistance to the plan will be welcomed by credit rating agencies.

Moody’s cautioned in the previous week that a faltering in the government’s commitment to fiscal consolidation and debt stabilization would lead to a downgrade in the country’s credit rating.

The Presidency has announced that the government will start the 9 600 megawatt procurement process and select strategic partners by the end of 2015 but this may not be the case unless there is a funding approval from the Treasury.

READ: Three guidelines for SA's nuclear deal

The week ahead

• GDP growth. SA’s real Gross Domestic Production (GDP) contracted by 1.3% in the second quarter of 2015, according to Statistics South Africa. GDP growth has been affected by electricity supply constraints and a contraction in manufacturing output during the quarter. Exports have also been weak due to slowing demand from key export markets such as China and the Eurozone.

Meanwhile rising interest rates and higher inflation have impacted the service sector which contributes around 60% of SA’s GDP.

READ: SA GDP contracts by 1.3% in second quarter

• Mining output. Iron ore (-21%), coal (-6.2%) and gold production (-2.3%) decreased year-on-year (y/y) in June 2015, while overall mining production increased by 4% in June and mineral sales increased by 5.7% y/y in May, according to Stats SA.

On a year-on-year basis mining output has grown strongly since the start of the year due to the base effect of low comparative production last year due to the crippling platinum strike.

However, the rate of growth in mining output has slowed from 19.9% on the year in March to just 2.7% in May and is expected to slow further in June as a result of declining mining resource prices and slackening demand.

READ: Iron ore, coal hit mining output

• Producer price inflation (PPI). Due Thursday 27th August. According to consensus forecast PPI is expected to accelerate slightly from 3.6% year-on-year in May to 3.9% in June due to the rise in oil prices earlier in the year and higher labour and utility costs. The upward trend in PPI since the start of the year is expected to continue in the second half due to the depreciation of the rand.

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/$12.45 signals 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.

• 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 8.15% 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.

• The S&P 500 is breaking down from a rising wedge pattern, which is traditionally a trend-changing pattern. A break below the previous low of 2067 will confirm a trend reversal. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, has already broken down from its rising wedge.

• 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 $5 500 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.  

• The All Share index has lost most of its gains since the start of the year. The All Share Index is testing the key support line which has been in place since 2009. A break below 50 000 would signal a sharp move lower to the October low of 47 000.

Bottom line

• The All Share index has had a torrid time over the past month losing over -7.0% in response to China’s currency devaluation, weakening commodity prices and impending Federal Reserve interest rate hikes. Although tempting to buy shares at current levels there is likely to be further downside pressure in the near-term and patience should be rewarded.

• The All Share index is trading on a price-earnings multiple of 16.9x which is still expensive relative to the 14.3x long-term average. One could argue that the long-term average is a more realistic rating given the weak domestic economic outlook: Slowing GDP growth, rising interest rates, troubled labour relations, policy uncertainty, and fragile export markets.

• With foreign investors accounting for around 40% of trading volume on the JSE the global equity outlook is extremely relevant to the All Share index. US equities, representing by far the world’s largest equity market, are exhibiting numerous warning signals.

• US equity valuations are close to record highs with the cyclically adjusted price earnings multiple at 26x almost one standard deviation above the historic average. Perhaps the most worrying signal is being emitted by the credit markets which tend to be far more efficient and therefore a reliable lead-indicator for equity markets.

Corporate bonds have been re-pricing steadily lower which eventually will spill over into other asset classes including equities. The sharp rise in the yield spread between high-yield US corporate bonds and Treasury bonds indicates trouble ahead for equities.

• Meanwhile a strong US dollar and imported deflation from the rest of the world is suppressing US earnings growth. There is a close correlation between US producer price inflation (PPI) and earnings growth. With US PPI turning negative the outlook for US earnings growth is bleak. A looming earnings recession coupled with rising US interest rates does not bode well for US equities.

• While China’s equity market has led the JSE downward over the past three months Wall Street is likely to pick-up the baton and lead the charge lower over the remainder of the year. Any major correction in US stocks would spill-over into global markets including the JSE.

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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