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Cape Town - A Brexit vote will have a significant effect on the SA economy and SA financial markets, cautioned Overberg Asset Management in its weekly overview of the economic and political landscape in South Africa.
A Brexit vote will lead to rand weakness, increased inflationary pressure, further tightening in interest rates and a greater risk that SA will fall into recession.
According to the latest BOA Merrill Lynch monthly fund managers’ survey, the possibility of the UK voting to leave the EU was deemed the biggest risk to financial markets.
South Africa economic review
• The rand lost ground last week against both developed market currencies and its emerging market peers, in response to rising global risk aversion after Brexit opinion polls pointed to majority support for a “Leave” vote. The rand weakened over the past week from R15.10/$ to 15.19, from R17.06/€ to 17.09, and from R21.64/£ to 21.72.
The rand also fell versus emerging markets, losing against the Argentinian peso (-1.5%), the Indian rupee (-1.8%), the Malaysian ringgit (-1.5%), the Philippian peso (-1.5%) and the Thai baht (-2.1%).
• Retail sales growth slowed from 2.9% year-on-year in March to 1.5% in April, its weakest since June 2014 and well below the 2.3% consensus forecast. On a month-on-month basis retail sales fell -1.7% and for the three months to end April on a quarter-on-quarter basis by -0.5%.
The decline is attributed to the “general dealer” and “household, furniture and appliances” categories, which each fell by -1.3% on the year and subtracted 0.5 and 0.1 percentage points from the headline figure.
In the absence of any contribution from mining and manufacturing, GDP growth has been reliant on household spending, which makes the latest fall in retail sales all the more worrying. The slowing pace of household spending is expected to continue in the current environment of growing unemployment, weak income growth, rising inflation and rising interest rates.
• The current account deficit unexpectedly widened from a downwardly revised 4.6% of GDP in the fourth quarter (Q4) to 5.0% in Q1 far higher than the 4.3% consensus forecast. The improvement in the trade deficit from -R41bn to -R38bn was offset by a widening in the services deficit from -R150bn to -R174bn.
The services, income and current transfer payments deficit increased from 3.6% to 4.1% of GDP. The current account deficit is expected to narrow this year as the weaker rand constrains imports.
The weaker rand should also boost export competitiveness although the terms of trade, the ratio of export to import prices, declined by -0.2% in Q1.
Export growth is being undermined by infrastructure bottlenecks and rising domestic production costs, in an environment of lackluster global demand and weak commodity prices.
The week ahead
• SA Reserve Bank leading indicator: Due Tuesday, 21 June. The leading indicator for April will provide clues to the trajectory for economic growth. The leading indicator, which fell in the first two months of the year, signaled the economic contraction in the first quarter (Q1). The leading indicator increased from 91.6 to 91.9 in March and any further increase will indicate positive GDP growth in Q2.
• Consumer price inflation (CPI): Due Wednesday, 22 June. CPI is expected to increase slightly from 6.2% year-on-year in April to 6.4% in May according to consensus forecast. CPI has exceeded the SA Reserve Bank’s 3-6% CPI target since January mainly due to steep drought-induced food price inflation. However, there is growing evidence of pass-through inflation from the weaker rand.
• Brexit vote: Due Thursday, 23 June. A Brexit vote will have severe repercussions for the SA economy and SA financial markets. Being dependent on foreign capital inflows, SA will be particularly vulnerable to a Brexit vote, which would be a shock to global capital flows. A Brexit vote will lead to rand weakness, increased inflationary pressure, further tightening in interest rates and a greater risk that SA will fall into recession.
Technical analysis
• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation.
• 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 1.8% and 1.6% confirming that the major bull trend in US bonds is likely to continue as the deleveraging phase is still in its early stages.
• The benchmark R186 SA Gilt yield broke out of its long-term bull trend as a result of “Nenegate”. The new bear trend for the R186 is underpinned by resistance at 9.0% with a risk of further upside to 10.50%. While SA bond yields may fall in line with global bonds they are unlikely to return to the bull trend.
• The MSCI World Equity index has broken downward from a rising trendline which has been intact since the 2008/09 global financial crisis. Given the magnitude and duration of the 2009-2015 bull market the overall correction is likely to reach a downside target for the MSCI World Equity index of 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 is likely to have just occurred. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur between mid-2016 and mid-2017.
• The S&P 500 index has broken 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.
• Despite the recent price rally Brent crude’s break below the key $30 support level in February suggests a continuation of the weakening long-term trend to a downside $25 target. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. Despite its recent rally the copper price broke below the key $4 500 support level in February suggesting further downside ahead.
• Gold has broken its recent downtrend by rising decisively above the $1 100 resistance level. An extended break above $1 250 is needed to confirm the end of gold’s bear market.
• The JSE All Share index is testing an important resistance line but if this remains unbroken the index is likely to move back below the 24-month moving average at 50 700 in turn opening a downside target of 45 000 and an ultimate target of 43 000.
The bottom line
• Britain’s EU referendum vote is just two days away. The outcome will have profound financial, economic, political and policy implications for both the UK and the rest of Europe. The Brexit vote is arguably the biggest risk facing global markets in 2016.
According to the latest BOA Merrill Lynch monthly fund managers’ survey, the possibility of the UK voting to leave the EU was deemed the biggest risk to financial markets.
• A Brexit vote will have a significant effect on the SA economy and SA financial markets. Being dependent on foreign capital inflows, SA will be particularly vulnerable to a Brexit vote, which would be a shock to global capital flows. A Brexit vote will lead to rand weakness, increased inflationary pressure, further tightening in interest rates and a greater risk that SA will fall into recession.
• Opinion polls have fluctuated wildly over the past week. Last week the “Leave” camp moved into the lead for the first time causing turmoil in global financial markets: Gold increased to its best level in 22 months, the US 10-year Treasury bond yield fell to its lowest since August 2012, and sterling volatility increased to all-time record highs.
• The first opinion polls on the EU referendum since the killing of MP Jo Cox have shown a significant return of support for the “Remain” camp. A YouGov poll for the Sunday Times found support for “Remain” up 5 points to 44% while support for “Leave” fell 3 points to 43%.
The bookmakers now suggest a Remain vote is twice as likely as a Leave vote. However, bookmakers have been wrong before. This time last year they gave Donald Trump a 2% chance of winning the Republican nomination.
• Previous referenda suggest a swing towards the status quo is often seen in the final vote. In the Scottish independence referendum for example, the eventual 10 percentage point win for Remain compared with an average 5 percentage point lead in the polls on the eve of the vote.
• With the vote too close to call, we summarise the implications for both the UK and Europe of a Brexit vote. David Cameron would resign as prime minister within hours of the vote result and Boris Johnson would likely take over subject to the Conservative party leadership election process.
• The pound would collapse versus the dollar from the current £1.46/$ level to around £1.20-1.30/$. Uncertainty around the UK’s future trading agreements with the EU would impact firms’ employment and investment plans, and depress consumer confidence and household consumption. GDP growth would drop by around 1 percentage point over the coming year, which would likely prompt further monetary easing by the Bank of England. The BOE already has contingency plans in place for emergency liquidity auctions.
• A Brexit vote would hit Eurozone confidence and the region’s financial markets prompting further ECB monetary stimulus. Anti-Eurozone political parties would be re-energised in the lead-up to key general elections in Germany and France in 2017.
• If the UK votes to stay in the EU the rally in sterling and UK equities would be short-lived. A Remain vote would only serve to keep us where we already are, with sluggish GDP growth, slowing company earnings, and stretched valuations.
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.
