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The year 2018 has been a bumpy year for the JSE, with the All Share Index shedding -11.37% cementing the worst five-year period for the JSE in fifty years.
But could the year 2019 bring with it better prospects? Domestically focused South African equities offer the greatest value and the potential for the strongest re-rating.
This is according to Overberg Asset Management (OAM) in its weekly overview of the economic landscape in South Africa.
"The key catalysts will likely be global forces comprising a weakening US dollar and a reflation of China’s economy, which both bode well for emerging markets generally," said OAM.
The analysts at OAM holds the view that South Africa’s general election should also provide a positive catalyst.
According to OAM, markets may suffer some volatility in the lead-up to the election, although a clear mandate for Ramaphosa should usher-in bolder stage-2 reforms from May onwards, providing a solid boost to consumer and investor confidence, household expenditure and investment spending.
"Good news has been a long time coming. We are confident that investors will be rewarded for their patience in 2019."
South African economic review
• As expected, the South African Reserve Bank (SARB) left the repo interest rate unchanged at 6.75%. Significantly, its Quarterly Projection Model indicates just one more hike of 25 basis points in contrast to November’s projection of four hikes over two years.
The SARB dramatically lowered its consumer price inflation forecast for 2019 from 5.5% to 4.8% and slightly for 2020 from 5.4% to 5.3%. Contributory factors were a drop in its oil price assumption for 2019 from $73 per barrel to $62 and an appreciation in the rand versus the dollar and euro.
The SARB’s softening attitude towards monetary tightening can also be attributed to a “dovish” shift from the world’s major central banks, especially the US Federal Reserve, which is now guiding for a pause in its rate hiking cycle. The SARB lifted its GDP forecast for 2018 from 0.6% to 0.7%, reduced it for 2019 from 1.9% to 1.7% and for 2020 kept it unchanged at 2.0%. In its longer-range projection, it forecasts growth to rise to 2.2% in 2021.
• Boosted by Black Friday discounting retail sales surged in November by 3.3% month-on-month lifting year-on-year growth to 3.1% from 2.1% in October. The year-on-year growth rate beat the market consensus forecast of 2.5%. Growth was led by the “general dealers”, “textiles, clothing, footwear and leather goods” and “household furniture, appliances and equipment” categories, which grew on the year by 3.7%, 4.2% and 13.5%, respectively.
The outlook for retail sales should brighten with the expected steep decline in inflation, more than compensating for November’s 25 basis-point interest rate hike. However, the longer-term outlook for retail sales depends on a sustainable rise in consumer confidence which rests on strong jobs growth and greater certainty over government policy.
• Mining production slumped in November by 5.8% month-on-month causing a year-on-year contraction of 5.6% compared with October’s slim growth of 0.2% on the year. The main culprits were iron ore, gold and diamonds which suffered year-on-year contraction of 19.7%, 14% and 21.7%, respectively. Year-on-year production declined in nine of the 12 mining categories.
Chromium, manganese and platinum group metals bucked the trend with respective increases of 15.5%, 15.8% and 0.9%. From a low base, mining production is expected to improve during 2019 helped by greater mining policy certainty and prospects for improved demand from China as the country pursues increased fiscal stimulus and infrastructure investment.
The week ahead
• Consumer price inflation: Having nudged higher to 5.2% in November, consumer price inflation is expected to have dropped sharply to a year-on-year rate of 4.5% in December, well within the SA Reserve Bank’s 3-6% target range. The expected decline is attributed to the sizeable R1.84/litre cut in the fuel price during the month.
• FNB/BER Consumer Confidence Index: According to consensus forecast the FNB/BER Consumer Confidence Index (CCI) is expected to have recovered slightly in the fourth quarter (Q4) to +10 having dropped precipitously from +22 to +7 in Q3. This would be above the long-term average of +2.
Bottom line
• In 2018 the All Share Index shed -11.37% cementing the worst five-year period for the JSE in 50 years. The euphoria which pushed equity markets higher at the start of the year after Cyril Ramaphosa wrested control of the ANC and was sworn-in as President rapidly unwound in the face of South Africa’s first recession since 2009, with the economy shrinking for two straight quarters in Q1 and Q2.
The downturn was exacerbated in the second half of the year by a global sell-off in emerging market currencies attributed to faster than expected US interest rate hikes and a strengthening dollar combined with a slowdown in China’s economy and a brewing trade conflict between the US and China.
• Does 2019 offer better prospects? Local equity markets are now offering considerable value with the All Share Index price-earnings multiple currently at 16.7x compared with 21.0x this time last year. Excluding Naspers, the PE multiple falls to 13.8x well below the long-term average of 14.7x.
• The JSE’s sizeable valuation discount suggests the equity market is extrapolating current economic weakness far into the future. Is this fair? Recent government initiatives under Ramaphosa and prospects of greater structural economic reforms post the election indicate that the extrapolation of past trends, which are a lagged effect from the end of the Zuma era, is unreasonable.
• Blame for the worldwide underperformance in emerging market equities is largely attributed to the strengthening dollar and unpredictable US trade policy. Encouragingly, these key global market forces may be close to a crucial inflection point.
An inflection point in the appreciation of the US dollar and the deterioration in US trade relations at the same time as an acceleration in China’s fiscal and monetary stimulus should pave the way for a re-rating in emerging market equities. What is good for emerging markets, as an asset class, is also good for the rand and South African equities.
• Domestically focused South African equities probably offer the greatest value and the potential for the strongest re-rating. The key catalysts will likely be global forces comprising a weakening US dollar and a reflation of China’s economy, which both bode well for emerging markets generally.
• South Africa’s general election should also provide a positive catalyst. Markets may suffer some volatility in the lead-up to the election, although a clear mandate for Ramaphosa should usher-in bolder stage-2 reforms from May onwards, providing a solid boost to consumer and investor confidence, household expenditure and investment spending.
• As well as propelling stronger economic growth and a pick-up in company earnings, the equity market should also enjoy an upward re-rating in this likely scenario. Good news has been a long time coming. We are confident that investors will be rewarded for their patience in 2019.
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.
