Publications
Partners
Cape Town – Even though the “hot money” has already left South Africa in anticipation of a rating downgrade, substantial outflows of institutional funds will only leave when the fatal blow strikes, according to Overberg Asset Management in its weekly overview of the economic and political landscape in South Africa.
It also warned that the rand will likely succumb to a further sell-off during the second half of the year as the Fed raises interest rates, the commodity upswing loses its momentum and SA’s short-term interest rates reach their peak.
It said consumer price inflation (CPI) due on Wednesday at 10:00 will likely reveal a deceleration from 7% year-on-year in February to 6.5% in March, helped by a 5% cut in the price of petrol.
SA economic review
- The rand rallied in the past week buoyed by rising commodity prices and easier global monetary conditions. Against the US dollar, euro and pound sterling the rand gained from R14.93 to R14.61, from R17.03 to R16.51, and from R21.06 to R20.72 respectively.The rand also rallied against other emerging market currencies helped by growing optimism over political developments and prospects of leadership without President Jacob Zuma. The rand appreciated against most emerging market currencies in the past week. Bond yields also fell with the benchmark R186 ten-year bond yield moving below 9% for the first time since early December, falling over the week from 9.18% to 8.95%.
- Mining production increased in February by 1.3% month-on-month (m/m) but on a year-on-year basis the contraction gathered pace from -5.5% in January to -8.7% far worse than the -5.4% consensus forecast. The key culprits were iron ore, which fell -32.5% on the year, manganese ore -18.9%, and platinum group metals -18.1%. While recent data reflect stronger than expected manufacturing production and retail sales, the mining figures are likely to dampen analysts’ forecasts for first quarter GDP growth. Mining production declined in the three months to end February by -2.2% quarter-on-quarter (q/q) suggesting that for the first quarter mining output will likely contract by around -12% q/q annualised given the spate of public holidays in March. The outlook for the mining sector in 2016 remains poor, constrained by weak global demand, especially from China which buys around half of global mining output. Meanwhile local production is constrained by regulatory uncertainty, infrastructure bottlenecks, and potential lab
our disruptions. Wage negotiations are due to start in mid-2016.
- Retail sales increased considerably more than expected rising in February by 4.1% year-on-year (y/y) well above the 2.7% consensus forecast, boosted by an upward revision to January’s increase from 3.1% to 3.6%. Six of the seven retail categories recorded growth: The “general dealers” category grew 5.5% on the year, “textiles, clothing, footwear and leather goods” by 4.2%, and “pharmaceuticals, and medical goods, cosmetics and toiletries” by 7.8%. Notably, the “household furniture, appliances and equipment” category fell -0.1% on the year reflecting a reluctance to spend on durable goods. The unexpected strength in retail sales should provide the SA Reserve Bank with a degree of confidence in maintaining its monetary tightening bias, adding to the likelihood of a further rate hike at the upcoming meeting in May.
- After falling from -5 to -14 in the third quarter (Q3) 2015 The BER Consumer Confidence Index recovered ground in Q4 to -9 better than the -12 consensus forecast. Among the three main sub-indices, households’ assessment of whether it is the right time to buy durable goods fell from -21 to -22. However, households’ assessment of the economic outlook increased from -24 to -14. The largest increase was recorded in households’ assessment of their own financial position which gained from +4 to +10. While households’ are becoming more optimistic about their finances the outlook towards durables expenditure reflects a greater propensity to save rather than spend. Overall the consumer confidence index at -9 remains far below the +5 long-term average and lower than during the 2008/09 global financial crisis.
- In its World Economic Outlook, the International Monetary Fund (IMF) trimmed its forecasts for SA GDP growth from 0.7% to 0.6% in 2016 and from 1.8% to 1.2% in 2017. The IMF attributed the downgrade to tighter monetary and fiscal policy, weaker export prices, and political uncertainty. While stronger growth is expected in 2017 based on a recovery from drought conditions and improved commodity prices, the growth rate is far less than previously expected due to weakening global conditions. The IMF forecasts the current account deficit will register -4.4% of GDP in 2016 widening to -4.9% in 2017, while the unemployment rate is expected to increase from 26.1% to 26.7%.
The week ahead
Consumer price inflation (CPI) is due on Wednesday. According to consensus forecast, CPI is expected to decelerate from 7% y/y in February to 6.5% in March, helped by a 5% cut in the price of petrol. On a m/m basis CPI is expected to slow from 1.4% to 1.2%. However, core CPI, which excludes food and energy prices is expected to tick-up slightly from 5.7% to 5.8% in response to a broader-based increase in inflationary pressure.
Political review
The Department of Mineral Resources unexpectedly published a new Mining Charter, which has added to uncertainty in the mining industry by insisting that the 26% black ownership threshold must be maintained at all times. Although the revised charter is open for public comment for a month and likely to be re-drafted, the ownership ruling comes in the midst of the pending court action on the “once empowered, always empowered” debate. As such the new charter does not help Finance Minister Pravin Gordhan’s drive to boost business sentiment, and indicates a strong divergence in priorities within government.
The ANC kicked off its local election campaign with the launch of its election manifesto in Nelson Mandela Bay. The ANC probably chose this venue due to its waning support in the region. From winning 51.91% of the vote in Nelson Mandela Bay in the last local elections in 2011 the ANC gained just 49.17% of the vote in the 2014 general election, losing its majority share. With the prospect of coalition agreements among the opposition there is therefore a possibility that the ANC could lose control of Nelson Mandela Bay. The election campaign launch was poorly attended with the press reporting that the stadium was unusually empty, while the election manifesto was described as being short on detail on how to improve service delivery. The ANC’s subdued election campaign launch likely reflects increasing unease with Zuma’s leadership and does not bode well for the party’s showing on the 3rd August.
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.
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 1.8% and 2.0%. 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 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 seven-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 around June 2016.
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 $1100 resistance level. An extended break above $1250 is needed to confirm the end of gold’s bear market.
The JSE All Share index needs to break decisively above the 24-month moving average at 50 400 in order to end the recent period of consolidation. Alternatively the JSE All Share index is likely to break to the downside to an initial target of 45 000 and an ultimate target of 43 000.
Bottom line
Since the start of the year foreign investors have purchased a net R18.4bn worth of SA government bonds, despite the threat that Standard & Poor’s credit rating agency will downgrade SA sovereign bonds to sub-investment grade. At the same time foreign investors have been net sellers of -R23bn worth of SA equities, so that on balance there has been a net outflow of portfolio capital since the start of the year.
Net portfolio capital outflows are normally associated with rand weakness. However, the rand has strengthened +6.47% against the US dollar since the start of the year. The rand has strengthened over 13% against the US dollar from its low of R/$17.00 in early January. The rand’s strength is attributed to firmer commodity prices, a general uplift in emerging market bonds as a consequence of a more accommodating US Federal Reserve (Fed), and a vigilant SA Reserve Bank.
A stabilisation in China’s economy and a weaker dollar has led to strong gains in commodity prices. Since the start of the year the Commodity Metals Price index has gained +11.83% boosting the appeal of commodity producing currencies such as the rand. However, there are concerns that the commodity rally is built on weak foundations. China’s economy is still vulnerable to industrial over-capacity adjustment and unlikely to spark a sustainable upswing in commodity demand. Much of the commodity rally over the past three months is attributed to short-covering, speculation and temporary dollar weakness.
According to US interest rate futures the Federal Reserve (Fed) is not expected to hike interest rates until the second quarter 2017. There is even a slim 4% probability attached to a US interest rate cut, which seems anomalous given that the personal consumption expenditure index, the Fed’s most closely watched inflation measure, has increased to 2.3% above the Fed’s 2% inflation target. Markets may be too optimistic in their US interest rate outlook. The Fed is likely to announce two further interest rate hikes this year, in response to rising wage pressure. Renewed Fed tightening will put pressure on the rand.
The SA Reserve Bank (Sarb) has done a good job in staying “ahead of the curve” hiking interest rates prior to any upward breach of the 3-6% inflation target. The interest rate tightening cycle began more than two years ago in January 2014 so is already far advanced. The forward rate agreement market predicts we are close to the end of the rate cycle with only 75 basis points worth of rate hikes to come. This is a likely scenario considering the economy is close to entering recession. In the past week, the IMF reduced its forecast for 2016 GDP growth from 0.7% to 0.6% and for 2017 from 1.8% to 1.2%. The attraction to foreign investors of high short-term interest rates may soon dissipate as the Sarb reaches the end of its rate hiking cycle.
The factors currently favouring rand strength appear to be temporary in nature. The rand will likely succumb to a further sell-off during the second half of the year as the Fed raises interest rates, the commodity upswing loses its momentum and SA’s short-term interest rates reach their peak.
The expected credit rating downgrade will also have an impact on the rand. According to SA’s five-year credit default swaps the implied future credit rating is already sub-investment grade. Although “hot money” has already departed in anticipation of the rating downgrade, institutional funds, which are restricted to investing in investment grade bonds, have not yet left. Therefore, the credit rating downgrade would result in substantial outflows.
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.
