Glimmer of hope as SA economy shows signs of upswing | Fin24
 
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Glimmer of hope as SA economy shows signs of upswing

May 09 2017 18:53

Cape Town - The domestic economy is in the very early stages of a cyclical recovery, according to Overberg Asset Management (OAM) in its weekly overview of the economic landscape.

"Despite rising political risk the cyclical economic rebound will take many by surprise fuelled by a recovery in agriculture, manufacturing and mining, falling interest rates and increased business and household spending," it said.

The asset manager also noted that the South African Reserve Bank (SARB) hinted that the interest rate hiking cycle is ended, suggesting that the repo rate, after rising from 5% in early 2013 to 7% currently, is likely to ease in coming months.

Food price inflation is expected to reverse course in 2017, falling sharply in line with increased agricultural production, in turn bringing down CPI, which is expected to average 5.5% over 2017.

South Africa economic review

• While interviewed at the World Economic Forum Reserve Bank Governor Lesetja Kganyago cautioned against expectations of an imminent rate cut. Kganyago’s remarks mirror the recent Reserve Bank Financial Stability Review which cited the likelihood of further credit rating downgrades and risk of continued rand volatility.

Although the interest rate cycle may have ended amid an improving inflation outlook the Review suggested the Reserve Bank may wait for political risk to dissipate after the ANC electoral conference in December before embarking on its rate cutting cycle.

• After holding above the expansionary 50-level for three straight months the Absa manufacturing purchasing managers’ index (PMI) fell sharply from 52.2 in March to 44.7 in April. The survey reported that: “This was the first full survey after the recent cabinet reshuffle and subsequent sovereign credit rating downgrades.

It is likely that respondents now anticipate economic growth and domestic demand to be weaker than before.” Among the PMI sub-indices, the business activity index and forward-looking new sales orders index fell precipitously from 53.5 to 37.0 and from 52.7 to 44.4. The expected business conditions also fell sharply from 68.0 to 55.8 although still above the key 50-level.

The prices index was the only index to show a gain from 63.5 to 69.9 due to the inflationary impact of the weaker rand. While disappointing, the Absa PMI index is likely to recover over coming months as the shock of April’s cabinet reshuffle dissipates. By contrast with the Absa PMI’s sharp decline the Markit PMI fell by only a slight margin from 50.7 in March to 50.3 in April, holding above the expansionary 50-level for an eighth consecutive month.

• The trade surplus increased from R4.8bn in February to a surprisingly strong R11.4bn in March well above the R6.2bn consensus forecast. While exports grew by an impressive 16.0% month-on-month imports also showed a robust 8.9% increase attributed encouragingly to rising demand for capital goods.

The annualised trade surplus for the first quarter (Q1) amounts to R73.9bn up from R13.9bn in the previous quarter, signaling a further decline in the current account deficit from an already narrow 1.7% of GDP in Q4 2016.

• Vehicle sales fell sharply in April by 13.4% year-on-year. Sales of passenger and commercial vehicles fell by 13.7% and 12.8% respectively while export volumes fell by 25.5%. The decline in vehicle sales is partly attributed to the large number of public holidays during April although undoubtedly the post-budget tax increases and credit rating downgrades also affected consumer and business demand.

The latest decline is especially disappointing following signs of stabilization at the start of the year with vehicle sales rising in the first quarter by 1.8% compared with a contraction of 11.3% in 2016. However, there should be some recovery in vehicle sales over coming months as the calendar effect dissipates.  

The week ahead

Reserve Bank monetary policy committee rate decision: Due Wednesday 10th May. Although the Reserve Bank has hinted that it is at the end of its rate hiking cycle it will likely err on the side of caution and resist cutting rates at the upcoming meeting due to the current volatility in the rand.

Manufacturing production: Due on Wednesday 10th May. Having fallen in February by -3.6% year-on-year manufacturing production is expected to show a slight positive reading in March helped by the base effect of low year-ago data. The firming in the manufacturing purchasing managers’ index in March above the expansionary 50-level also signals an improvement in month-on-month growth.

Mining production: Due on Wednesday 10th May. Mining production is expected to maintain its recent uptrend in March lifted by rising international commodity demand and firmer prices. The manufacturing sector is likely to make a positive contribution to first quarter GDP growth compensating for the expected contraction in manufacturing output.

Technical analysis

• The rand is trading in a range between R/$13.00 and 13.50. A break below R/$13.50 is required to pave the way for further depreciation to the R/$14.50 level.

• 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 announcement of the snap election the British pound has broken above key resistance at £/$1.25 which has now become a key support level and should promote further near-term currency gains. Recent strong gains have diminished prospects for a £/$1.18-1.22 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 2025 SA Gilt yield is trading in a tight trading range of 8.5-9.0%. A break above 9.0% is required for the yield to move decisively higher towards the 10.5% target level.

• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdqaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.  

• Despite failing to hold above the $55 level the Brent crude price is well supported at $50 a barrel. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $5 500 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.

• 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

• GDP growth has been on a declining trend since 2011. In 2016, South Africa succumbed to the perfect storm with year-on-year growth of just 0.3%. GDP growth was undermined by accelerating inflation, rising interest rates, declining consumer spending, slowing mining and manufacturing demand, the impact of political uncertainty on business confidence and one of the worst droughts in living memory.

Despite the loss of our foreign currency investment grade credit rating GDP growth will rebound in 2017 and 2018.

• The South African Reserve Bank’s leading economic indicator, which predicts economic conditions 3-6 months ahead, increased in February for a seventh consecutive month, signalling a significant recovery in economic growth. This increase reflects a rebound in both external and domestic conditions. External conditions are improving as a direct consequence of the steady recovery in the global economy.

According to the World Trade Organisation the world economy is enjoying synchronised growth across all regions for the first time since the global financial crisis in 2008/09.

Amid rising international commodity prices and strengthening global trade South Africa’s trade balance has improved from a trade deficit of -R6.6bn in the third quarter 2016 to a trade surplus of +R55.7bn in the fourth quarter. Our current account deficit has narrowed steadily from -5.8% of GDP in 2013 to an impressive -1.7% its lowest level since the second quarter of 2011.

• Domestic conditions are also improving. Following one of the worst droughts in living memory agricultural conditions will bounce back this year as weather patterns normalise. The US Department of Agriculture forecasts South Africa’s maize output will increase in 2017 by 65% more than reversing the 27% decline in late 2015 and early 2016.

• After years in the doldrums manufacturing activity is finally turning the corner. Notwithstanding the recent aberration following the twin credit rating downgrade, the Stellenbosch-based Bureau of Economic Research purchasing managers’ index (PMI), a forward-looking survey of conditions in the manufacturing sector, has risen sustainably above the expansionary 50-level.

In March this year all major manufacturing PMI sub-indices returned above the 50-level for the first time since March 2012. The South African Chamber of Commerce and Industry’s (SACCI) business sentiment index rose to its highest since October 2015.

• Sub-Saharan Africa is enjoying a solid economic recovery. The neighbouring region accounts for 30% of South Africa’s total exports and an even greater proportion of manufacturing exports, making it the country’s largest export destination.

The strong recovery in Sub-Saharan Africa is good news for South Africa’s economy. Following growth of just 0.7% in 2016 GDP in the region is expected to expand in 2017 by 3.5% accelerating to 4.0% in 2018 amid rising international commodity prices and normalisation of weather patterns, in turn boosting agricultural output and hydroelectricity generation.

• The Reserve Bank has hinted that the interest rate hiking cycle is ended, suggesting that the repo rate, after rising from 5% in early 2013 to 7% currently, is likely to ease in coming months. Food price inflation is expected to reverse course in 2017, falling sharply in line with increased agricultural production, in turn bringing down CPI, which is expected to average 5.5% over 2017.

This is well within the Reserve Bank’s target range of 3-6%, which despite recent rand turbulence should embolden the central bank to cut interest rates. Interest rate cuts will boost consumer and business confidence, household expenditure and investment spending.

• Forecasts for South Africa’s economy have become overly pessimistic. Despite rising political risk the cyclical economic rebound will take many by surprise fuelled by a recovery in agriculture, manufacturing and mining, falling interest rates and increased business and household spending. The domestic economy is in the very early stages of a cyclical recovery.

GDP growth will rebound in 2017 and 2018, potentially by more than currently projected. GDP growth of 1.5% is likely in 2017 as the negative conditions which beset the economy in 2016 begin to reverse.

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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