Rand exposed on US equity decline

Cape Town - As one of the most liquid emerging market currencies the rand is especially exposed should US equity market decline.

The rand will be used as a hedging tool by money managers keen to reduce overall emerging market exposure, says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.

"SA also has its own particular vulnerabilities: With its reliance on mining resource exports SA is particularly susceptible to the sharp drop in external demand from China.

"Low interest rates during years of central bank quantitative easing has led to substantial growth in SA’s external indebtedness making its economy vulnerable to the current decline in global liquidity.

"SA’s total external debt as a percentage of GDP is near the highest among emerging markets, increasing from 20% to 30% over the past five years," says OAM.

• As expected the SA Reserve Bank (Sarb) Monetary Policy Committee (MPC) left the repo interest rate unchanged at 6.0%. However the fact that the MPC was unanimous in its decision was surprising. The Sarb stated that “it remains on a gradual policy normalisation path” citing upside risks to the inflation outlook suggesting the current interest rate hiking cycle has further to go.

However, the unanimous decision to keep rates on hold suggests the trajectory of rate increases may be more gradual than previously expected. The Sarb lowered its forecasts for consumer price inflation (CPI) for 2015 from 5.0% to 4.7% but raised its forecasts for 2016 and 2017 from 6.1% to 6.2% and from 5.7% to 5.8%.

The Sarb’s GDP forecasts were marked significantly lower from 2.0% to 1.5% in 2015, from 2.1% to 1.6% in 2016, and from 2.6% to 2.1% in 2017, possibly explaining the reluctance to hike interest rates in spite of its concern that CPI will breach its 3-6% target in 2016.

• Consumer price inflation (CPI) fell from 5.0% year-on-year in July to 4.6% in August below the 4.8% consensus forecast attributed to the -3.7% cut in the fuel price during August. Food price inflation also eased from 4.4% to 4.3% on the year in spite of the large 0.8% month-on-month increase with low base effects coming to the rescue.

However, core CPI also eased from 5.4% to 5.3% reflecting weak domestic demand. Although there is little evidence so far of inflationary pressure from the weaker rand there tends to be a substantial lag-time before higher imported costs are passed-on.

A weaker rand, the base effect of low comparative data, and rising food inflation suggest CPI will rise during the first quarter (Q1) 2016 peaking at around 6.5% before returning to the SA Reserve Bank’s 3-6% target range in Q2. Projections however depend to a large extent on the rand exchange rate and oil prices which may alter significantly from current levels.

• The SA Reserve Bank leading economic indicator (LEI) fell in July by -1.7% month-on-month while its year-on-year decline deteriorated from -2.3% in June to -3.6% in July. The LEI is at its weakest since November 2009 with eight of the 11 sectors comprising the index showing declines in July.

Although the coincident indicator measuring current conditions eked out a small 0.1% year-on-year increase the LEI deterioration raises the risk of a second straight quarter of negative GDP growth in the third quarter, which would meet the technical definition of a recession.

• Foreign investors sold a net -R0.6bn worth of domestic bonds and –R2.4bn of equities in the past week. Equity selling was evident in the property sector and resources sector while net buying occurred in the industrial sector followed by the financial sector.

Foreigners’ contribution to total market traded volume was elevated at 39.4% slightly above the year-to-date average of 38.1%. For the year-to-date foreign net buying of bonds and equities amounts to R8.61bn and R35.66bn respectively.

South Africa political overview

• In a surprise move President Zuma replaced Mineral Resources Minister Ngoako Ramathlodi with Mosebenzi Zwane a little known politician who has been a member of parliament for less than a month. The motivation behind the change is confusing especially as Ramathlodi had recently secured an agreement among stakeholders in the mining industry to address job losses in the sector amid falling commodity prices and labour instability.

The “mining lab” initiative which was due to commence in October held potential for bringing about solutions in the troubled industry. Zwane has no real experience in the mining industry, and lacks credibility and support from stakeholders. Of greatest concern Zwane has numerous reported links to the Gupta family, which would potentially provide the family with easier access to mining licenses. The Guptas are considered to hold significant influence over Zuma.

The week ahead

• Unite Against Corruption march: Due Wednesday 30th September. Organisers have promised that the Unite Against Corruption march due to take place in Pretoria and Cape Town will be the largest in the post-apartheid era. The march has been led by former Cosatu general secretary Zwelinzima Vavi and supported by 300 civil organisations. Although non-political the march also has the support of Numsa and the EFF.

• Private Sector Credit Extension (PSCE): due Wednesday 30th September. Following its increase in year-on-year growth from 8.1% in June to 8.4% in July PSCE growth is expected to rise to 8.6% in August according to consensus forecast. While household credit extension is likely to remain constrained by tighter lending standards, slowing wage growth and rising interest rates, credit extension to the corporate sector should be fairly buoyant. Companies are using credit to invest in faster growing economies across the African continent.

• Trade data: Due Wednesday 30th September. The R0.4bn trade deficit in July is expected to reverse in August to a R0.5bn surplus according to consensus forecast. The weaker rand should reduce the demand for imports while promoting the competitiveness of exports.

• Vehicle sales: Due Thursday 1st October. The -8.2% year-on-year decline in vehicle sales reported in August is expected to deteriorate further to -9.4% in September according to consensus forecast.

• Barclays manufacturing Purchasing Managers’ Index (PMI): Due Thursday 1st October. Having dropped sharply in August from 51.4 to 48.9 the PMI is expected to show a slight recovery to 49.3 helped by less load shedding, although still below the key 50 level which demarcates expansion from contraction.

• FNB/BER Consumer Confidence Index: Due Thursday 1st October. Having dropped in the second quarter (Q2) to -15 the lowest in 14 years consumer confidence is expected to improve slightly in Q3 to -11 amid fuel price cuts and fewer days of load shedding.

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%.

• The MSCI World Equity index has broken 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 so far is 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.

• The S&P 500 has broken down from a rising wedge pattern, which is traditionally a trend-changing pattern. The break below the 2070 level confirms a reversal of the upward trend. 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 $1300, $1250 and $1100. Gold’s next target is $1000 which is likely to be breached before the bear market ends.  

• The All Share index has broken below its bull market support level which has been intact since 2009. The downside target for the All Share index is 41,000.

Bottom line

• Global financial markets would normally celebrate a continuation of Federal Reserve monetary policy accommodation. The adverse reaction to the Fed’s decision to keep interest rates on hold rather than hike confirms that all is not well for global markets.

Since the Fed’s policy meeting on 17th September the US dollar index has risen +1.89% and the S&P 500 index has declined -3.42%. The reason is that global economic growth is slowing and global liquidity is shrinking. SA markets have not been immune: The All Share index has dropped -4.37% since the Fed’s rate decision, and the fall would have been over -6% had it not been for the prospect of a take-over of SABMiller.

• There have been three notable global financial threats over the past eight years. The US residential property bubble spilling-over in 2008 into a full-blown global credit crisis, the Eurozone sovereign debt crisis which threatened to break-up the Eurozone in 2011, and now the emerging market crisis sparked by China’s yuan devaluation in August 2015. The sharp decline in China’s economic growth rate and the devaluation in the Chinese yuan are undermining growth and sparking currency depreciation in SA and other emerging markets.

• The severe decline in emerging market growth threatens financial stability in the US and other developed markets. Following their recent expansion emerging markets now account for over 50% of global GDP. Slowing US export growth to emerging markets is already putting US earnings growth under pressure. US equity bear markets normally begin with an earnings recession, which is already evident in half of the sectors making up the S&P 500 index. There is a threat of a vicious circle: Once US equity markets decline the JSE and other emerging markets will normally follow.

• As one of the most liquid emerging market currencies the rand is especially exposed. The rand will be used as a hedging tool by money managers keen to reduce overall emerging market exposure. SA also has its own particular vulnerabilities: With its reliance on mining resource exports SA is particularly susceptible to the sharp drop in external demand from China.

Low interest rates during years of central bank quantitative easing has led to substantial growth in SA’s external indebtedness making its economy vulnerable to the current decline in global liquidity. SA’s total external debt as a percentage of GDP is near the highest among emerging markets, increasing from 20% to 30% over the past five years.

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* 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.