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The JSE has suffered a torrid four years. In the four years from 25th June 2014 to 25th June 2018 the JSE All Share Index has increased from 50 350 to 56 116 a return of only 11.45%.
While the JSE All Share has lost 6% since the start of the year, more than half the investible shares on the market have dropped by 18% or more, of these almost a fifth have fallen by over 50%, said Overberg Asset Management (OAM) in its weekly economic and market overview.
The equity market has been a minefield.
Why, despite South Africa’s New Dawn, has the JSE continued to disappoint, unable to build on the stellar returns enjoyed in December last year? According to the analysts at OAM much of the blame is placed on the first quarter GDP numbers, which fell 2.2% in Q1 quarter-on-quarter.
"The level of optimism on the JSE is rock-bottom, which is at odds with the brightening outlook."
South Africa economic review
• The Reserve Bank will be relieved by the benign consumer price inflation (CPI) data. CPI unexpectedly slowed in May to 4.4% year-on-year from 4.5% in April considerably below the 4.7% consensus forecast. CPI had been expected to rise due to the lagged effect of the VAT increase and higher fuel prices. While the fuel price rose 3.6% month-on-month causing overall transport prices to rise 1.2%, the month-on-month gain in CPI was a modest 0.2%. Food price inflation eased from 3.9% on the year to 3.4%. Core CPI, which excludes food and energy prices due to their volatility, also eased from 4.5% to 4.4%.
Despite the VAT increase, inflation for all goods and for all services remained unchanged at 3.5% and 5.3%. Inflation eased across the board for durable, semi-durable and non-durable goods, from 1.0% to 0.9%, from 1.2% to 1.1% and from 4.8% to 4.6%, respectively. While the Reserve Bank will be on the lookout for any second-round inflationary effects from the rand’s recent sharp depreciation, the inflation data so far remains more moderate than expected.
• The current account deficit widened well beyond expectations in the first quarter (Q1) to 4.8% of GDP from 2.9% in Q4 last year versus a consensus forecast of 3.8%.
The trade balance was the main culprit. It deteriorated from an annualised R74bn surplus in Q4 to a deficit of R24.9bn in Q1, attributed to the stronger rand which affected the country’s terms of trade. The terms of trade, the ratio of export prices to import prices, fell by 3.7% in Q1. On an annualised basis net portfolio inflows remained strong in Q1 at R73.8bn although below the Q4 level of R108.8bn.However, foreigners have been heavy net sellers of South African bonds and equities since the end of Q1, due to the global withdrawal from emerging markets generally. Foreigners have been net sellers of local assets since the start of Q2 to the tune of R69.3bn annualised. Net direct investment remained negative in Q1 at R10bn similar to the Q4 deficit of R10.3bn, with offshore investments by South African entities continuing to exceed inbound investments.
While disappointing, the current account deficit is expected to improve as the year progresses, helped by the beneficial impact of the weaker rand on the trade balance. For the year as a whole the current account deficit is likely to reduce to around 3% of GDP.
• Household disposable income, net of inflation, increased in the first quarter (Q1) by just 0.2% quarter-on-quarter annualised sharply down from 2.7% in Q4, marking its weakest growth since Q1 2016. Weak income growth combined with an increase in household debt and household spending caused household finances to deteriorate over the quarter. The ratio of household debt to disposable income increased from 71.2% to 71.7% while the debt service ratio lifted from 9.1% to 9.2%. A sustained improvement in household finances depends on moderate inflation and interest rates, significant jobs growth and rising labour productivity.
• After rising from 31 to 42 in the first quarter (Q1), the FNB/BER Building Confidence Index gave back all its gains for the year in Q2 slipping by 14 points to 29 its lowest score since Q2 2012. The index level indicates that more than 70% of survey respondents are dissatisfied with prevailing business conditions.Of the six survey sub-sectors, confidence of hardware retailers and of manufacturers of building materials suffered the worst declines, from 47 to 2 and from 45 to 13, respectively. More encouragingly, the decline in confidence of main building contractors was more subdued from 41 to 37. Confidence of non-residential building contractors increased for a second straight month, although John Loos, property economist at FNB cautioned that: “There is little macroeconomic evidence to suggest that the rise in non-residential building activity seen so far this year will be sustained.”
The week ahead
• Quarterly Employment Statistics: The community services, construction, manufacturing and business services sectors helped boost employment growth in the first quarter of the year, which saw an additional 56 000 jobs being created.
According to the quarterly employment statistics released by Statistics South Africa (Stats SA) on Tuesday, employment increased from 9.78 million in December 2017 to 9.83 million in March 2018.
• Producer price inflation (PPI): Producer price inflation (PPI) is expected to have slowed slightly in May from 4.4% year-on-year to 4.2% according to consensus forecast. Despite the lagged effects of the VAT increase and upward pressure in fuel prices, PPI will have continued to benefit from the sustained decline in manufactured food price inflation.
• Private sector credit extension: Growth in private sector credit extension (PSCE), having slumped in April to 5.1% year-on-year, is expected to have recovered to 5.4% in May helped by a rebound in corporate credit growth and gradual improvement in household lending.
PSCE, which remains modest despite the earlier spike in both business and consumer confidence, needs to show considerable improvement in order to provide a meaningful boost to GDP growth.
• Trade balance: The trade balance, having narrowed sharply to a surplus of just R1bn in April, is expected to have recovered to a R3bn surplus in May according to consensus forecast. South Africa’s terms of trade and trade balance will have benefited from the rand’s sharp depreciation over the past two months.
Technical analysis
• The rand has broken decisively through key resistance at R13.35/$ indicating further weakness to the R14.00/$ level. However, the rand is deeply oversold at current levels, which suggests a trading range of R13.00/$ to R13.50/$ is more likely.
• The rally in the US dollar index has reached its medium-term goal suggesting a correction from current levels. The dollar remains below a major 30-year resistance line suggesting the bull run in the dollar may be over.
• The British pound has broken back below key resistance at £/$1.35 suggesting a trading range of £1.30/$ to £1.35/$. The £1.30/$ level is expected to provide strong resistance.
• 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 decisively above key resistance at 3.0%, targeting the next key resistance level at 3.6%. A break above long-term resistance at 3.6% would indicate an end to the multi-decade bull market in bonds.
• The benchmark R186 2025 SA Gilt yield has broken above key support levels of 8.6%% and 9.0% indicating a new target trading range of 9.0% to 9.5%.
• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
• The Brent oil price has broken above key resistance at $75 indicating a new trading range of $75 to $85 per barrel. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $7 000 per ton.
• Gold has developed an inverse “head and shoulders” pattern, which indicates a price recovery and a test of the $1400 target level.
• Despite the consolidation since the start of the year the break in the JSE All Share index above key resistance levels at 56 000 and 60 000 in December signals the early stages of a new bull market.
Bottom line
• The JSE has suffered a torrid four years. In the four years from 25th June 2014 to 25th June 2018 the JSE All Share Index has increased from 50 350 to 56 116 a return of only 11.45%.
If this is bad, consider that while the JSE All Share has lost 6% since the start of the year, more than half the investible shares on the market have dropped by 18% or more. Of these almost a fifth have fallen by over 50%. The equity market has been a minefield.
• On a compounded annualised basis the JSE All Share Index has gained just 2.75% per year well below the return on money markets. After four years of almost non-existent returns, share investors are considering throwing in the towel but this would be a mistake. Although returns have been extremely disappointing, over time, equities provide the best returns, by far, compared with all other asset classes.
Bonds and cash are safer in the short-term. However, in the long-term they provide lower returns and hence less protection against inflation. Admittedly, equities can suffer extended bouts of underperformance. They can also suffer severe short-term losses, as in the 12-month periods following market peaks in April 1998, May 2002 and June 2008, when the All Share Index suffered losses of -39%, -30% and -38.5%.
In each case, patient investors who stuck it out were rewarded, outperforming money market returns on an annualised basis in less than four years after the initial decline.
• The equity market rarely performs as expected and so investors who try and time the market may lose out on periods of strong performance. Around 80% of the equity market’s gains occur in just 20% of the time. Time in the market is more important than timing the market. In the past fifty years, there has never been a period longer than five years in which South African equities have not outperformed cash.
Excluding dividends, the JSE All Share Index has gained an annualised return of just 2.75% over the past four years, less than money markets, but over the past five years the annualised return is 8.06%, marginally better than money markets, especially once dividends are included. Will the track record remain intact? To keep the track record intact, the JSE would have to rise over the next twelve months by around 45%.
• This seems a stretch. However, it is not unheard of. Share price gains are always strongest in the early stages of a new economic cycle. Research by professors Elroy Dimson, Paul Marsh and Mike Staunton, published in the Credit Suisse Global Investment Returns Yearbook 2018, confirms that since 1900 the South African equity market has produced the best annualised returns worldwide. Since 1900 the real compounded annualised return, net of inflation is a world-leading 7.2%.
• Why, despite South Africa’s New Dawn, has the JSE continued to disappoint, unable to build on the stellar returns enjoyed in December last year? Much of the blame is placed on the first quarter (Q1) GDP numbers. GDP fell in Q1 by 2.2% quarter-on-quarter. Put in context, the figure is not so bad. It is an annualised figure.
The actual quarter-on-quarter contraction was 0.54% and some pullback had been expected following the substantial 0.76% GDP expansion in the prior quarter. On a year-on-year basis GDP grew by a more respectable 1.5%. Yet, forward-looking surveys point to a far brighter outlook.
The FNB/BER Consumer Confidence Index, surged from -7 to an all-time high of +26 in Q1, exceeding its previous record of +23 reached in Q1 2007. The dramatic improvement signals a considerable recovery in consumers’ willingness to spend. Put in context, this is the first reading since Q2 2014 that has been above “0”.
The Reserve Bank (SARB) Leading Business Cycle Indicator dipped slightly in March from 108.3 to 107.4 its first decline since April 2017 but some easing had been expected given the increase in February to its highest level since June 2011.
The SARB leading business cycle indicator, a barometer for expected business conditions 6-9 months ahead, remains close to multi-year highs signalling, together with other independent forward-looking business and consumer surveys, a rebound in economic activity in the second half of the year.
• Policy certainty in South Africa has improved greatly under Ramaphosa, with positive news emanating from the State Budget, credit rating agencies, cabinet appointments, corruption court hearings and the re-capture of state-owned enterprises. Financial market anxiety over the ANC’s resolution to support land expropriation without compensation is misplaced.
In its final set of resolutions, the ANC clearly emphasised the need to accelerate the rollout of title deeds to “black South Africans in order to guarantee their security of tenure and to provide them with instruments of financial collateral.”
The ANC resolution stressed its focus on the “redistribution of vacant, unused and under-utilised state land.” The most likely target for land expropriation will be the former homelands and government-owned land, around 30% of South Africa’s landmass and home to an estimated 17 million people. The land expropriation that is envisaged would provide a massive boost to the country’s GDP growth rate.
• The level of optimism on the JSE is rock-bottom, which is at odds with the brightening outlook. It is worth heeding the advice of investment guru John Templeton: “The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.”
Warren Buffet, one of the greatest investment geniuses of our time, reiterated the same message with his now famous words: “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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