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Rand suffers as foreigners sell equities

Cape Town - The heavy selling by foreign investors of SA’s equities lifts the probability of further rand depreciation, says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.

Foreign investors sold a net –R1.9bn worth of domestic bonds and –R1.6bn of domestic equities in the past week, taking respective net sales since the start of the month to –R5.1bn and –R3.5bn.

This marks the fourth straight month in which there has been a net outflow of portfolio capital from SA, which largely explains the continued depreciation in the rand.

South Africa economic review

• Manufacturing production increased in September by 0.9% year-on-year which although modest is better than the -0.3% contraction in August and outstrips the -2.0% consensus forecast.

While the "motor vehicles, parts, accessories and other transport equipment” and “basic iron and steel, non-ferrous metals, metal products and machinery” categories suffered sharp declines, the “petroleum, chemicals, rubber and plastic products” and “food and beverages” categories grew by 5.5% and 2.1% on the year.

Although manufacturing grew in the third quarter by 1.4% quarter-on-quarter annualised the outlook remains constrained by a weak global demand environment.

• Mining production contracted in September by -3.7% month-on-month and on a year-on-year basis by -4.8%, in sharp contrast to the 3.6% increase in August. Mining production contracted in the third quarter by -2.5% quarter-on-quarter.

The data brings to an end seven months of expansion as the benefit of last year’s low base associated with the platinum strike fades away. Annual growth in platinum group metal production slipped from 63% to 25%. The biggest culprits in the latest contraction were iron ore, which fell -17.9% on the year, coal which fell -12.5%, diamonds by -38.5%, and gold down -4.9%.

The outlook for mining output remains bleak: The boost from a weaker rand is likely to be outstripped by weakening global demand especially from China, and local supply impediments including infrastructure constraints and policy uncertainty.

• Water and Sanitation Minister Nomvula Mokonyane cautioned that rising water demand and a continuation of El Nino drought conditions until at least March, would lead to water outages of a similar magnitude and frequency to Eskom’s load shedding earlier in the year.

Mokonyane said supply cuts in Gauteng last week were due to surges in demand rather than supply constraints. However, her assertion that Gauteng’s dams are 84% full contradicts other data from her own department that dam levels are much lower.

• In its quarterly system update Eskom’s CEO Brian Molefe reiterated that the state energy utility should be able to avoid load shedding through the summer months. Molefe reported that residential customers had only suffered 2 hours and 20 minutes of load shedding in the past three months.

READ: Eskom does not have demand crisis - as it happened

However, the build programme for new power plants was less encouraging. Eskom is only expected to bring all units of Medupi and Kusile on line in March and July 2018 behind its previous target of early 2017.

The week ahead

• Consumer price inflation (CPI), due on Wednesday, 18 November. According to consensus forecast CPI is expected to increase from 4.6% year-on-year in September to 4.8% in October exacerbated by the 2.8% increase in the petrol price during the month.

The outlook for CPI has deteriorated since the SA Reserve Bank’s last policy meeting in July, due to the continued sharp depreciation in the rand and the prospect of drought-induced increase in food prices.

• Retail sales, due on Wednesday, 18 November. According to consensus forecast retail sales growth is expected to slow from 3.9% year-on-year in August to 3.6% in September due to growing strains on household disposable income from rising inflation, weak jobs growth and declining consumer confidence.

However, the generous public sector wage increase is providing some support to otherwise sluggish household expenditure and retail sales.

• SA Reserve Bank interest rate decision, due on Thursday, 19 November. According to the Forward Rate Agreement market the probability is split 50/50 that the SARB will hike interest rates by a further 25 basis points on Thursday.

READ: No obvious reason for Sarb to hike rates - expert

The SARB last raised the benchmark repo interest rate in July by 25 basis points to 6.0%.

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 $5,000 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

• Our thoughts and condolences go out to the families and the victims of the weekend’s tragic attack in Paris. Unfortunately there is likely to be a rising number of terrorist attacks as the Islamic State, which is rapidly losing the military conflict in the Middle East, turns increasingly to attacking unarmed civilians. However, even this strategy is futile. Numerous studies have shown that terrorist attacks have a very short-term impact on social behaviour, the economy and financial markets. Life quickly returns to normal.

• This week’s SA Reserve Bank (SARB) interest rate decision will be far more eventful in the lives of SA’s citizens. The Forward Rate Agreement market ascribes a 50/50 probability that the SARB will hike the repo rate by 25 basis points from 6.0% to 6.25% when it meets on Thursday. The catalyst for the potential rate hike is the growing certainty that the US Federal Reserve will raise its Fed Funds rate by 25 basis points in December. The SARB will be keen to limit the rand’s rate of depreciation by narrowing the interest rate differential between SA and the US.

• In a recent speech SARB Deputy Governor Francois Groepe reiterated that the central bank’s core mandate is “price stability”, which suggests the SARB will continue to hike interest rates despite the fact that the economy is close to descending into recession. Groepe cautioned that consumer price inflation is expected to breach the upper end of the SARB’s 3-6% target range over two quarters in 2016, which may drive inflationary expectations upwards.

• A rate hike would have limited effect on inflation, which currently is almost entirely “supply-side” driven due to rising supply pressures rather than increased demand. Examples include higher drought-induced maize prices, rising state administered prices such as municipal rates and taxes, and escalating Eskom tariffs.

• Moreover, due to the anaemic domestic demand environment there has been little sign so far of pass-through inflationary pressure from the weaker rand. The low oil price is a big help in this regard: The Brent oil price, currently at $44 per barrel is well below the recent peak of $70 in May and the $56 level when the SARB last hiked rates in July.

• The effects of a rate hike will be numerous, most of them negative: Household disposable income will contract and the cost of investment will increase, together putting economic growth under further pressure. Slower economic growth will put the state budget deficit under increasing strain, leading to a further rise in sovereign debt. Company earnings growth will decelerate which combined with rising interest rates is probably the least attractive environment for equity markets. Rising interest rates will impact an already over-valued JSE. Equity investors will be rewarded for having a large short-term tactical exposure to cash.

• Property prices will also suffer from a rate hike. The Absa house price index has already slowed sharply with a month-on-month rise of just 0.2% in October, which mean residential property prices are contracting in real terms. The year-on-year increase has slowed to 4.8% down from a recent peak of 9.7% in the same month last 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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Rand - Dollar
18.93
-0.2%
Rand - Pound
23.91
-0.1%
Rand - Euro
20.44
+0.1%
Rand - Aus dollar
12.34
+0.1%
Rand - Yen
0.13
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Platinum
906.59
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Palladium
1,012.66
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Gold
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Silver
24.85
+0.9%
Brent Crude
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Top 40
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All Share
74,536
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Resource 10
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