SA political turmoil not enough to sway rand

Cape Town - Despite political turbulence relating to fraud charges against Finance Minister Pravin Gordhan, the rand did not disappoint, notes said Overberg Asset Management.

Under normal circumstances, these shock politicised developments would send the rand tumbling but the currency was remarkably poised, it said in its weekly overview of the South African economic and investment landscape.

"The local currency and bond markets, which are forward-looking barometers, are telling us that despite unsettling current events the outlook is improving."

OAM said further that financial markets are increasingly discounting a South Africa under improved leadership. 

Although there is unlikely to be a change in ANC leadership until the end of 2017, there is light at the end of the tunnel, OAM said.

South Africa economic review

• During the past week, Finance Minister Pravin Gordhan was summoned to appear in court and Public Protector Thuli Madonsela was prevented by President Jacob Zuma’s interdict application from releasing her much-awaited state capture report.

READ: Gordhan will stand his ground

• Mining production increased in August by a stronger than expected 2.5% month-on-month, reversing a similar magnitude decline in July.

On a year-on-year basis, mining output fell by 0.2% - a substantial improvement on July’s -5.4% and the -4.0% consensus forecast. By sector, iron ore and platinum group metals (PGMs) increased production on the month by 11.7% and 8.5%.

Iron ore production has soared around 40% over the past five months while PGM production is recovering on confidence that a strike will be averted in the sector. Firmer global commodity prices should maintain the recent stabilisation in mining output although the long-term health of the industry will depend on greater regulatory certainty.

• Manufacturing production fell again in August by -1.0% month-on-month following the -1.9% decline in July. Of the ten manufacturing sectors, only two showed positive growth in August.

Glass and non-metallic minerals, and furniture and related, grew production by 0.6% and 3.7%. On a year-on-year basis manufacturing production growth gained from -0.3% in July to 2.2% but this is attributed to base effects.

The latest decline is consistent with the slump in the manufacturing purchasing managers’ index (PMI) from 52.5 in July to a sub-50 contractionary reading of 46.3 in August.

The PMI subsequently gained to 49.5, which although still contractionary, signals a stabilization in manufacturing output in the final month of the third quarter.

The week ahead

• Consumer price inflation: Due on Wednesday 19^th October. According to consensus forecast consumer price inflation (CPI) is expected to nudge higher from 5.9% year-on-year in August to 6.3% in September moving back above the SA Reserve Bank’s 3-6% target range.

The previous month’s low CPI number was helped by a 99c/litre petrol price cut, which in September was followed by a price cut of just 18 cents. Core CPI, excluding food and petrol, is expected to remain unchanged at 5.7%.

Retail sales: Due on Wednesday 19^th October. Retail sales growth is expected to slow further from 0.8% year-on-year in July to 0.5% in August, hampered by declining consumer confidence. Consumer confidence is being affected by poor jobs growth, rising interest rates, weak credit demand, and declining expansion in household disposable income.

Technical analysis

• While the rand has broken below key resistance levels versus the dollar at R/$ 14.20 and 13.80 the strengthening trend is not confirmed by momentum indicators, signalling that the currency is overbought.

• 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.

• Following the Brexit vote the British pound hit its weakest level against the US dollar since 1985. The £/$1.30 level provides key support, which if broken would open up a Fibonacci projected target of £/$1.20-1.24.

• 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 1.6% 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 has compressed to its lowest level since “Nenegate” last year falling below key resistance at 9.0%. The yield is now testing the bottom of the current consolidation channel at 8.5%, which if broken will target a yield of 8.0%.

• The MSCI World Equity index has broken downward from a rising trend-line 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 to new record highs but the rally is not being confirmed by momentum indicators, which suggests the market is overbought and in danger of correction.

A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is underperforming the broader index.

• Despite this year’s 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 developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1400 target level.

• 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 50 900 in turn opening a downside target of 45 000. A break above 54 200 on the JSE All Share index would project an upward move to 60 000 marking a new high for the JSE.

The bottom line

• In June Goldman Sachs’ Christian Mueller-Glissman, based in the UK, warned of a rising risk of a large global equity market decline: “With bond yields close to all-time lows and a large proportion of fixed income offering negative rates, “safe assets” and “hedges” for equities are more scarce. Real bond yields are low despite the start of a Fed rate hike cycle and bonds discount too little inflation in our view. As a result, they are also a source of risk.”

• Inflation expectations have increased sharply over the past month. In the UK, the five-year “break-even” rate, a gauge of inflation expectations derived from the yield difference between conventional sovereign bonds and inflation-linked bonds, has surged higher in the past month from 2.6% to 3.1%. The US five-year break-even rate has climbed from less than 1% in February to just under 1.6%.

• Inflation expectations have been fanned by Federal Reserve chair Janet Yellen’s speech at the weekend at a Boston Fed conference. Yellen stated that it might be wise for the Fed to run a “high pressure economy”, whereby the Fed maintains accommodative monetary policy for longer in order to boost the labour participation rate. The speech hints at a willingness to overshoot the Fed’s 2% inflation target.

• China, which rocked global financial markets last year on fears that it would export deflation to the rest of the world, reported a rapid acceleration in inflation readings in September. China’s consumer price inflation (CPI) surged from 1.3% year-on-year in August to 1.9% in September, while producer price inflation (PPI) accelerated from -0.8% to 0.1 turning positive for the first time since 2012.

• At this stage one cannot be sure whether the uptick in inflation expectations and concurrent rise in bond yields is a short-term reaction or the start of a sustainable change in trend. A rise in global inflation would require a shift towards inflation-driven investing. 

• What would inflation-driven investing entail? Higher than expected inflation would damage the outlook for emerging market currencies, as markets increasingly discount a tightening of global monetary conditions.

Global bond prices would also fall accompanied by the prices of so-called “bond-proxy” stocks, which have been favoured in the current zero interest rate environment for their high dividend yields. Such stocks would typically include consumer staple stocks with attractive dividend yields but modest real growth prospects.

• Certain sectors would benefit from the effect of rising inflation. Gold and precious metals would flourish. Among equity sectors, bank stocks in developed economies would celebrate the return of higher interest rates and a steepening in the yield curve, promoting greater interest margins and bank profitability.

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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