Publications
Partners
Cape Town - State-funded infrastructure spending offers the easiest and most realistic means for SA to achieve an inclusive economic recovery, according to Overberg Asset Management (OAM).
In its weekly overview of the economic and political landscape in South Africa, OAM said infrastructure spending would address the bottlenecks which are hampering production capacity and exports.
Being labour intensive, it added that infrastructure spending would also rapidly reduce unemployment through the creation of large numbers of unskilled jobs.
South Africa economic review
• The rand continued its gains into a third week bolstered by Fitch’s decision that it would not be downgrading SA’s sovereign credit rating either. All three major credit rating agencies have now given SA a temporary reprieve.
The rand strengthened over the past week from R15.31/$ to 15.10, from R17.35/€ to 17.06, and from R22.23/£ to 21.64, gaining against the dollar, euro and pound by 1.4%, 1.7% and 2.6%, respectively. The rand’s gains versus emerging market currencies were more impressive, strengthening against the Argentinian peso, Indian rupee, Malaysian ringgit and Mexican peso by 3.1%, 3.3%, 3.1% and 2.9%.
• The decline in mining production eased from -17.8% year-on-year in March to -6.9% in April. Although marking the eighth consecutive annual drop in mining production, led by a -23.4% year-on-year fall in iron ore production, overall mining production increased month-on-month by 2.7% in April. This marks a substantial improvement from the -2.6% month-on-month contraction in March.
The monthly rebound in mining production is attributed to a normalization in the platinum group metals (PGMs) sector following the safety stoppages at the start of the year. PGM production increased in April by 12.6% month-on-month.
• Manufacturing production grew in April by 0.8% month-on-month rebounding from the -0.6% contraction in March. On a year-on-year basis manufacturing production increased 2.9% beating the 1.5% consensus forecast.
Of the ten manufacturing sub-sectors, seven reported month-on-month growth with the strongest readings recorded by food and beverages at 3.6%, textiles and clothing at 1.2%, vehicles and parts at 1.9%, and furniture and related at 11.2%.
The recovery in manufacturing output mirrors the recent upturn in manufacturing purchasing managers’ indices (PMIs). The PMI index has been above the key 50-level, which demarcates expansion from contraction, for three straight months signaling a continued expansion in manufacturing production in May.
• GDP contracted in the first quarter (Q1) by -1.2% quarter-on-quarter annualised far worse than the -0.1% consensus forecast. The contraction is attributed to the primary sector: Mining fell by a substantial -15.5% quarter-on-quarter annualised and agriculture by -6.5%. Excluding these two sectors, GDP would have increased by 0.4% in Q1.
While the transport sector, which includes communication, shrank -2.8% the manufacturing sector grew 0.6% an improvement on Q4’s -2.5% contraction.
On the expenditure side, gross domestic expenditure shrank in Q1 by -0.7% compared with growth of 1.4% in Q4. Household consumption expenditure fell -1.3% and gross fixed capital formation fell -6.0% with private sector investment falling -6.8% amid weakening business confidence. While disappointing, GDP should rebound strongly in Q2 led by a stabilisation in mining and agricultural output.
The safety related stoppages which beset the mining industry in Q1 have not carried over into Q2, while receding drought conditions should lead to a gradual normalisation in agricultural output. Manufacturing output should also maintain its recent positive momentum according to the recent upturn in manufacturing purchasing managers’ indices.
GDP growth of around 1.3% - 1.7% is expected in Q2 removing the risk of technical recession, defined as two consecutive quarters of negative growth.
• Fitch credit rating agency joined the two other major rating agencies, Moody’s and Standard & Poor’s, in keeping SA’s sovereign long-term credit rating unchanged. Fitch kept SA’s foreign currency and local currency ratings unchanged at BBB- and BBB and surprisingly kept its outlook at “stable” despite citing concerns over economic growth and rising political risks.
Fitch had been expected to change its outlook to “negative watch”. Fitch stated that: “The dismissal of two finance ministers in a week in December, and subsequent tensions between the new finance minister Pravin Gordhan and other parts of the government have raised questions about the commitment of the government to sustained fiscal consolidation and prudent governance of state-owned enterprises.”
However, Fitch also stated that while “Political risk has increased since the previous rating review in December 2015….it is not out of line with “BBB” peers.”
• The Bureau of Economic Research (BER) quarterly business confidence index fell from 36 in the first quarter (Q1) to 32 in Q2, indicating that less than a third of surveyed respondents viewed business conditions as satisfactory. The BER business confidence reading has dropped from 43 to 32 in the past year to its lowest level since 2009. Among the different sectors surveyed retailers led the decline falling from 44 to 26 its lowest since 2001.
According to the BER report: “Not even during the global financial crisis-related downturn of 2008 and 2009 have retailers been this downbeat.” The weak overall readings indicate little prospect for increased private sector fixed investment.
The week ahead
• Current account balance: Out on Tuesday, June 14. The most closely watched component of the SA Reserve Bank’s June Quarterly Bulletin is the current account deficit. Reserve Bank data out earlier today that showed the first-quarter current account deficit to gross domestic product ratio widened to 5.0% from a downwardly revised 4.6% of GDP in the fourth quarter of last year. This was against the consensus forecast of the current account deficit improving to -4.1%.
• Retail sales: Due out Wednesday, June 15. Retail sales will be affected by weakening consumer confidence and declining household disposable income, which despite the extra trading days in April should cause retail sales growth to slow from 2.8% year-on-year in March to 2.4% in April, according to consensus forecast.
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 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 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 $1 100 resistance level. An extended break above $1 250 is needed to confirm the end of gold’s bear market.
• 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 50 700 in turn opening a downside target of 45 000 and an ultimate target of 43 000.
The bottom line
• The All Share index is trading on a price earnings (PE) multiple of around 22x. These are extreme valuations, well above the 14.8x historic average.
• While the broader market appears over-priced there are segments of the market which offer considerable relative and absolute value. The JSE construction and building materials sector trades on a 7.85x PE multiple, around a third of the broader market’s 21.77x PE.
• The construction and building materials sector would be a clear beneficiary of any ramp up in infrastructure spending. State-funded infrastructure spending offers the easiest and most realistic means for SA to achieve an inclusive economic recovery.
• Infrastructure spending would address the bottlenecks which are hampering production capacity and exports. Being labour intensive infrastructure spending would also rapidly reduce unemployment through the creation of large numbers of unskilled jobs. The construction and building materials sector would be the main beneficiary of what amounts to an obvious economic policy choice.
• As it is, even in the absence of substantial state-funded infrastructure spending, the construction sector is not performing too badly. In the first quarter, SA’s GDP shrank -1.2% quarter-on-quarter annualised. By contrast, value added by construction grew by +0.5%. In the expenditure breakdown of GDP, construction works grew by an impressive 7.9% quarter-on-quarter annualised.
• The construction and building materials sector offers a typical “value” style investment opportunity. Although out of fashion with investors, the discounts to book value at which many shares in the sector trade, should provide significant downside protection in any equity sell-off.
• “Value” investing has consistently underperformed “growth” investing in recent years. However, the trend is gradually changing especially in developed markets. As the broader market’s valuations become increasingly excessive and out of synch with depressed economic fundamentals, the time for value investments to outperform is fast approaching.
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.
