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Cape Town - Moody’s credit rating agency, which cited the Treasury’s inability to manage the country’s debt and cautioned against the risk of further shocks to economic growth, is currently in the country to meet with critical role players before its decision to downgrade SA's credit rating.
The agency announced last week that it had placed SA’s credit rating on negative watch suggesting the next move could be a further downgrade, says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.
A downgrade would bring SA’s rating in line with Standard & Poor’s which is one notch above 'junk' status.
According to OAM Moody’s said that although the Budget was fiscally prudent there were growing constraints on SA’s medium-term growth prospects amid the country’s weak investment climate.
Moody's' visit occurs as Finance Minister Pravin Gordhan works hard to reassure overseas investors and tell that SA is open for business.
South Africa economic review
• According to the SA Reserve Bank Quarterly Bulletin domestic expenditure increased in the fourth quarter (Q4) by an annualized 4.3% compared with 1.4% growth in Q3 which was revised upwards from an initial 0.8% estimate.
The improvement is attributed to higher household consumption expenditure, which rose from 0.9% to 1.6% and gross fixed capital formation (GFCF), which rose from 0.6% to 2.4%. Household consumption expenditure was boosted by income growth which accelerated from 0.8% to 1.1%.
As a result, despite households incurring more debt the household debt to disposable income ratio fell from 78.0% to 77.8%. Household spending on durable goods picked up by 3.5% following a contraction in Q3 attributed to buying ahead of rand-induced price increases.
The rise in GFCF was led by public corporation spending which increased from 0.5% to 3.3% due to water and transport projects and the acquisition of locomotives by Transnet and the Passenger Rail Agency of SA.
Private sector GFCF also increased from -0.6% to 1.7% attributed to the Renewable Energy Independent Power Producer Procurement Programme. Excluding the energy programme however, private sector investment spending remained constrained by persistently weak business confidence.
• The current account deficit widened to -5.1% of GDP in the fourth quarter (Q4) last year compared with -4.3% in Q3 which was revised upwards from an initial -4.1% estimate. The deterioration is attributed to the trade deficit increasing from –R22bn to –R57bn between Q2 and Q3.
The deficit on net service, income and current transfer payments only widened slightly from –R150bn to –R151bn mainly due to the decrease in gross dividend receipts. The current account deficit is expected to narrow in 2016 as the weaker rand constrains imports and boosts SA’s terms of trade.
However, export growth may be disappointing due to weakening external demand from key export and commodity markets.
• Mining production shrank in January by -4.9% month-on-month far worse than the -0.5% consensus forecast and December’s output was revised lower from the initial +1.5% estimate to -0.5%. Among the four main mining categories only coal showed an increase in January at +2.5% on the month while output of iron ore and platinum group metals (PGM) fell by -13.2% and -8.4%.
Gold output fell by -1.5%. While metals prices have firmed in recent weeks the demand outlook remains uncertain which could add further pressure on mining production in the months ahead.
• Manufacturing production contracted in January by -1.8% month-on-month well below the consensus forecast for a +0.3% increase. The production decline is attributed to weakness in food and beverages which fell -4.8% on the month, iron and steel which fell -1.9%, and petroleum and chemicals down -1.6% on the month.
The manufacturing purchasing managers’ index (PMI) improved from 43.5 in January to 47.1 in February which although still in sub-50 contractionary territory suggests some respite in that month’s manufacturing output.
• The Bureau of Economic Research (BER) Business Confidence Index remained unchanged at 36 in the first quarter (Q1) 2016 after falling to this level, a five year low, in Q4 2015. Among the main sectors manufacturing suffered the biggest decline from 34 to 18 which means only 18% of survey respondents reported satisfactory business conditions.
The retail and wholesale sectors were the most resilient rising from 40 to 44 and from 47 to 50, respectively. The overall data is nonetheless disappointing, indicating weak business confidence and a poor outlook for private sector investment.
• Absa’s house price index increased in February by 6.1% year-on-year up from 5.8% in January marking the fastest pace since June 2015 and a substantial improvement on the recent low of 4.8% in October last year.
While nominal house price growth is improving it remains negative in real terms with consumer price inflation rising in January to 6.2%. Among the different housing categories the price increase in large- and medium-sized houses moderated to 5.3% and 7.2% year-on-year while the price increase in small-sized houses picked-up from 3.4% to 4.2%.
South African political review
• In an article detailing the controversial relationship between the Gupta family and President Jacob Zuma the Financial Times alleged that senior members of the Gupta family offered the position of Finance Minister to Deputy Finance Minister Mcebisi Jonas in the weeks prior to Nhlanhla Nene’s dismissal. The report has been corroborated by other publications including the Sunday Times. Although the ANC denies that the meeting ever took place Mr Jonas is reported to have vehemently rejected the offer. If accurate this news may contain the most brazen attempt yet by the Gupta family to influence the country’s executive. These reports may galvanise factions within the ANC and the tripartite alliance who are opposed to President Zuma’s system of patronage and especially his relationship with the Guptas.
• According to reports last week some ANC branches in Gauteng are planning to nominate Kgalema Motlanthe for the ANC Presidency. Mr Motlanthe has not publicly accepted the nomination and according to elective protocol is unlikely to do so until other nominations are forthcoming. Mr Motlanthe has in the past year issued vehement attacks on President Zuma’s government and its lack of moral rectitude, and may be seen by those who are nominating his candidacy as the person to restore stability to the tripartite alliance.
The week ahead
• Retail sales: Due Wednesday 16th March. According to consensus forecast retail sales growth is expected to slow form 4.1% year-on-year in December to 3.7% in January and on a month-on-month basis the rate of contraction is expected to moderate from -0.9% to -0.4%.
• SA Reserve Bank (SARB) monetary policy decision: Due Thursday 17th March. The forward rate agreement market is attributing an 80% probability of a 25 basis point rate increase.
Inflation risks are rising: consumer price inflation breached the SARB’s 3-6% inflation target in January and producer price inflation surged from 4.1% to 7.6% indicative of a broad-based increase in production costs.
Despite the fact that economic growth is hamstrung by shrinking mining and manufacturing output, which fell in January by -4.9% and -1.8% respectively, and lackluster household expenditure, the SARB will likely hike the key repo rate by a further 25 basis points from 6.75% to 7.0%.
Although the SARB’s actions will have little effect on the rand exchange rate or drought-induced food price increases, it believes that rate increases will prevent rising inflation expectations from becoming entrenched.
Technical analysis
• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. Although the rate of the rand’s depreciation is accelerating there is little sign so far of panic selling or capitulation. This stage needs to be reached before a reversal in the rand’s move can occur.
• 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 wedge formation which has been intact since the 2008/09 global financial crisis. Given the magnitude and duration of the 2009 to 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 around June 2016.
• 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 needs to break decisively above the 24-month moving average at 50 400 in order to end the recent period of consolidation. Alternatively the JSE All Share index is likely to break to the downside to an initial target of 45 000 and an ultimate target of 43 000.
Bottom line
• Resource shares have stolen the limelight on the JSE this year. After a shaky start the JSE Resources 20 index is up a substantial +17.62% in the year-to-date a massive outperformance of the JSE All-Share index which has eked out a gain of just 2.06%. Anglo American [JSE:AGL] has increased from a low of R50.00 to R122.00 in just six weeks, a gain of 144%. Kumba Iron Ore [JSE:KIO] has gained 268% over the same period from R25.00 to R92.00.
• Underlying base metal prices are rising. The price of copper, seen as a barometer for base metals prices, has risen above its 100-day moving average for the first time since mid-2015. The iron ore price has increased 33% so far this year.
Metals prices are rising on hopes of added fiscal stimulus in China. However, China is sticking to its objective of rebalancing the economy from investment-led to consumer–led growth and so any fiscal stimulus is likely to be modest compared to the 2009 stimulus programme.
With China’s fixed asset investment now four times larger than it was in 2009 the incremental effect of fiscal stimulus on commodities demand will be extremely modest by comparison.
• The recent sharp increase in metals prices is due largely to speculative activity, especially amongst Chinese investors who are currently starved of new investment ideas. In a single day on 7th March the iron ore price jumped 20% on China’s Dalian Commodity Exchange.
The iron ore futures volume on the 9th March alone represented more than China’s entire annual imports. Inventory levels in the Shanghai Futures Exchange warehouses sit at all-time record levels rising in March by 25% year-on-year.
• China’s economic fundamentals do not warrant a sustained increase in base metals prices. China’s metals inventories are still rising and the economy is still suffering from excess capacity and excess leverage.
Meanwhile, the consumer and service-led sectors of the US economy are performing well but the commodity-dependent sectors of the economy continue to contract. Throughout developed and emerging economies weak purchasing managers’ indices testify to a distinct downward trend in manufacturing, construction and fixed investment, sectors which are vital to a prolonged increase in commodity prices.
• Ironically the sharp rise in base metals prices undermines the longer-term investment attraction of mining shares. As metals prices rise so too the likelihood that producers will abandon or postpone their plans to cut capex in turn prolonging a rebalancing of the commodities market. The mining resources market needs to reach a new equilibrium in order for mining shares to embark on a sustainable bull market.
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.
