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Cape Town - The optimism towards equities, which gripped the market in 2014 after five straight years of solid gains, has been replaced by a sense of unease, disappointment and anxiety.
This is according to Overberg Asset Management (OAM) in its weekly overview of the economic and political landscape in South Africa.
It noted that after three years of paltry gains in which the JSE All Share Index has risen by just 12%, investors are considering cashing up and moving to money markets, residential property or any asset class other than equities.
However, it said the JSE All Share index is also testing an important resistance line.
"[I]f 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," said OAM.
South Africa economic review
• GDP grew in the third quarter (Q3) by just 0.2% quarter-on-quarter annualised in stark contrast to the upwardly revised 3.5% growth in Q2 and below the 0.6% consensus forecast. Manufacturing production, which supported GDP growth in Q2, contracted in Q3 by -3.2% annualised.
Agricultural output shrank for a seventh straight quarter although to a lesser degree, by -0.3% compared with -0.8% in Q2. Surprisingly, trade, catering and accommodation, shrank during the quarter by -2.1%.
On the plus-side, mining production grew by 5.1%. Without the contribution from mining, overall GDP would have contracted by -0.1%. GDP is expected to fare only slightly better in Q4 resulting in overall GDP growth in 2016 of 0.4%. However, GDP growth is expected to lift to 1.2% in 2017, with stronger contributions from manufacturing, mining and agriculture.
Consumer spending should also recover in line with easing inflation and a gradual decline in interest rates in the second half of the year. Expectations for stronger growth should also boost fixed investment spending.
• The South African Reserve Bank (SARB) December Quarterly Bulletin reports a widening in the current account deficit from -2.9% of GDP in the second quarter (Q2) to -4.1% in Q3.
The deterioration is due to the trade account moving from a surplus of R47.9bn in Q2 to a deficit of -R3.8bn in Q3. The balance on the invisibles account, comprising services, income and current transfers payments, increased by a fraction to -R172bn or -4.0% of GDP.
On the financing side the current account deficit was counter-balanced by continued inflows into the capital account. Net portfolio inflows fell over the quarter from R30.9bn to R22.4bn, while net direct investment inflows increased from R2.1bn to R5.6bn.
The current account deficit is likely to resume its downward trend in the quarters ahead in response to improving global demand and the firming in commodity prices.
• According to the SARB Quarterly Bulletin gross fixed capital formation fell for a fourth straight quarter but the pace of contraction slowed from -6.8% quarter-on-quarter annualised in the second quarter (Q2) to -1.0% in Q3. Contraction in private sector capital spending reduced from -4.1% to -1.6% while government sector spending grew by 1.5% up from -11.2% in Q2.
Employee compensation improved in Q3 with annualised real household disposable income growth rising from 1.7% in Q2 to 2.0% in Q3.
Household debt to disposable income fell from 75.1% to 74%, down from a peak of 80% in 2013, while the debt service ratio reduced from 9.7% to 9.6%. Fixed investment spending is expected to recover over the next year on expectations of an improving global and local economic outlook, while household finances and expenditure should benefit from declining inflation and a gradual reduction in interest rates.
• Manufacturing production declined in October by -1.9% month-on-month more than reversing the 1.3% growth in September, while on a year-on-year basis production contracted -2.7% significantly worse than the +0.7% consensus forecast. The contraction is consistent with October’s fall in the Barclays manufacturing purchasing managers’ index (PMI) from 48.6 to 45.9.
The PMI subsequently rebounded to 48.3 in November indicating some recovery in manufacturing activity. Manufacturing production is expected to increase in 2017 off this year’s low base, with domestic demand helped by a recovery in fixed investment and the boost to consumer spending from lower inflation and interest rates. Export-oriented manufacturing should benefit from rising global commodity prices and a US-led increase in global economic growth.
• Mining production contracted in October by -1.2% month-on-month and -2.9% year-on-year well below the consensus forecast of 2.5% growth. The decline is attributed to the platinum group mineral (PGM) sector which suffered a -12.0% year-on-year production decline. Manganese production also fell by a substantial -10.5% on the year.
In contrast, iron ore, coal and metallic minerals grew by 5.9%, 4.3% and 28.9%, respectively. While the overall data are disappointing, the improving outlook for global commodity prices amid growing infrastructure spending in China and now the US, should boost the mining sector in 2017.
• The BER consumer confidence index improved from -9 in the second quarter (Q2) to -3 in Q3. Of the three sub-categories, consumers’ expectation of economic performance in 12 months’ time and expectation of households’ financial prospects in 12 months’ time, both recorded gains. The appropriateness of the present time to make durable goods purchases recorded a decline.
Among income groups, the BER confidence index increased sharply from -15 to +6 for those earning less than R7000 per month but fell from -6 to -10 for high income households.
The week ahead
• Consumer price inflation: Due Wednesday 14th December. Consumer price inflation (CPI) is expected to accelerate from 6.4% year-on-year in October to 6.7% in November, according to consensus forecast.
However, this is likely to mark the peak with CPI projected to revert to the Reserve Bank’s 3-6% target range in the second quarter 2017, according to the central bank’s projections.
• Retail sales: Due on Wednesday 14th December. Retail sales growth is expected to fall from 1.4% year-on-year in September to 1.1% in October and on a month-on-month basis from 0.6% to 0.2%, according to consensus forecast. Consumer confidence is under pressure from rising inflation, high interest rates and weak jobs growth.
• Producer price inflation (PPI): Due Thursday 15th December. Producer price inflation (PPI) is expected to rise slightly from 6.6% year-on-year in October to 6.8% in November, according to consensus forecast. PPI should pick-up due to the base effect of weak year-ago comparative data and rising food price inflation.
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 key £/$1.30 level support level has been broken opening up a £/$1.20-1.24 target.
• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
• The US 10-year Treasury yield has broken back above the key support level of 2.0% endangering the multi-year bull trend in US bonds.
• The benchmark R186 SA Gilt yield is now testing the key support level of 9.0% endangering the mini-bull market in bonds which has been in place since the start of the year.
• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdqaq and Russell 2 000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
• The Brent crude price is well supported at $40 a barrel and having broken key resistance at $50 is targeting further gains to the next key level at $60. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $5 000 per ton.
• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 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
• Sentiment towards the JSE is rock bottom. The optimism towards equities, which gripped the market in 2014 after five straight years of solid gains, has been replaced by a sense of unease, disappointment and anxiety.
After three years of paltry gains in which the JSE All Share Index has risen by just 12%, investors are considering cashing up and moving to money markets, residential property or any asset class other than equities.
• We see things differently. The economic outlook is likely to improve and with it the earnings power of companies making up the JSE. Inflation is set to peak this month and we are likely at the peak in interest rates.
The South African Reserve Bank (SARB) forecasts consumer price inflation will peak at 6.6% in the final quarter this year and return to its target range of 3-6% in the second quarter 2017. The SARB has hinted that the interest rate hiking cycle is close to the end, suggesting that the repo rate, after rising from 5% in early 2013 to 7% currently, is likely to ease in coming months.
• GDP growth is expected to rise from its low point this year, amid recovering commodity prices, improving global growth and export demand, while lower interest rates will encourage household spending and business investment. GDP grew in the second quarter by just 0.2% quarter-on-quarter annualised with growth for 2016 as a whole unlikely to exceed 0.4%.
Coming off a low base GDP growth is expected to lift to 1.2% in 2017 and to 1.6% in 2018, according to Reserve Bank forecasts. GDP growth will respond to rising commodity prices and strengthening export markets.
The Commodity Research Bureau (CRB) metals index has increased by 45% since the start of the year, buoyed by Chinese fiscal stimulus and more recently by prospects for US-led infrastructure spending. Export markets are recovering in line with an improving global economy.
World economic growth is expected to rise from around 3.4% in 2016 to 3.9% in 2017 in response to fiscal stimulus, easier credit markets and rising business and consumer confidence.
• South Africa’s export performance is already having a beneficial impact. The current account deficit has steadily shrunk from -5.8% of GDP in 2013 to -5.4% in 2014, -4.4% in 2015 and -4.1% in the third quarter 2016. The trade balance has strengthened in the year to end October to a deficit of just -R14.3bn compared with -R59.5bn in the same period last year.
• In response to the improving global and local economic outlook, rising commodity prices and shrinking current account deficit the rand has strengthened versus major currencies. Since the start of the year the rand has appreciated by 29% versus the British pound, 14% versus the euro and even 13% versus the might US dollar.
• There is the lingering threat of a credit rating downgrade to junk status, which would derail the constructive outlook for the rand, inflation, interest rates and economic growth. However, the credit rating agencies are likely once again to give South Africa the benefit of the doubt in 2017.
The rating agencies have erred on the side of caution, given the substantial boost to structural reforms which could arise from a change in leadership. Therefore, with the next rating reviews in June and December 2017 occurring just prior to the ANC’s national electoral conference, it is likely the rating agencies will hold fire again, given the opportunity for constructive leadership changes.
• The economy is bottoming out and the equity market, being forward-looking, will increasingly discount better times ahead. Far from considering a switch from equities into other asset classes, seasoned investors will most likely be increasing their exposure. In the words of Warren Buffet, one of the greatest investment geniuses of our time: “Be fearful when others are greedy, be greedy when others are fearful.”
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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