The Weekly Focus A Market and Economic Update 16 October 2017
Contents Newsflash...3 Market Comment... 3 Other Commentators... 4 Economic Update...6 Rates... 10 STANLIB Money Market Fund... 10 STANLIB Enhanced Yield Fund... 10 STANLIB Income Fund... 10 STANLIB Extra Income Fund... 10 STANLIB Flexible Income Fund... 10 STANLIB Multi-Manager Absolute Income Fund... 10
Newsflash It might seem ironic that the both the ALSI and the listed property index are at record highs, considering the weak economy. Market Comment As of Friday s close, the JSE All Share Index has returned +16.5% (including dividends) in 2017 (record high), followed by the SA Listed Property Index with +11.7% (also a record high), then the All Bond Index with +7.7% and finally Cash with +5.9%. It may seem ironic that the both the ALSI and the listed property index are at record highs, considering the weak economy, the potential for further rating downgrades in the near future and the political shananigans underway. However, we probably passed the point of maximum pessimism in June at 51,000 (58,000 this Monday morning), when all the bleak news about our country was at its most intense. At this stage, the global stock market is very strong, on the back of a strengthening global economy, yet inflation and interest rates remain low. After moving sideways for about 2.5 years, it was eventually time for the ALSI to break out and upwards and join the global markets (see chart below of the JSE All Share Index). The fact that it took 2.5 years of broadly sideways movement implies that the JSE has plenty of energy stored up and the sudden sharp lift-off shown below on the chart illustrates how this happens. It is exciting, to say the least, even if not quite bitcoin exciting. After all, when one is expecting the worst, it usually works out somewhat better. That could well happen with our economy and politics. There are some early signs of this. Source: I-Net Bridge So far in October the S&P 500 Index is up +3%, while the JSE ALSI is +4.4%. The Japanese Nikkei Index is up +10.4% in the past five weeks at a 21-year high, having risen for nine consecutive days. The MSCI Emerging Markets Index, which had corrected a bit recently, hit a new high on Friday for 2017 (a five-year high in dollar terms). This index is +58% since the January 2016 low and +30.5% so far in 2017, excluding dividends (both in US dollars). Our ALSI is said to be around 60% (possibly more) or so affected by economies and earnings outside of our borders, because of the big rand-hedge element. Likewise the SA Listed Property Index is now 40% rand-hedged. Apart from the huge boost from Naspers this year, +61% in 2017, the ALSI is enjoying 2017 highs today from BHP Billiton, Anglos and Glencore, amongst a number of other mining shares like Exxaro and Kumba, although gold and platinum shares remain very depressed.
Today the all-important copper price is trading at a 3-year high, benefiting from stronger global economies, a firm Chinese economy with factory-gate inflation at 6.9% for September and from the weaker dollar. Then we re seeing a rally in banking shares and a pickup off depressed bottoms from life insurers like Liberty and MMI Holdings, as well as many other shares like Aspen, Grindrod, Trencor, EOH, MTN, some of the hospital shares, as well as the JSE Mid-Cap and JSE Small-Cap indices. The JSE Mid-Cap Index of share 41 to 100 is still down -2.6% in 2017, although it is picking up quite nicely of late. The JSE Small-Cap Index is flat for the year so far, although it also seems to be starting a good uptrend. Anchor Capital, one of the very depressed shares showing a small pickup of late, notes that the JSE All Share Index is trading at 14.9 times earnings expected in one year versus the 16.7 times that the MSCI Developed Markets are trading at. They are forecasting a 12% return from the ALSI in the next 12 months (2% from Resources, 10% from Financials and 17% from Industrials) and 10% from SA Listed Property. It is impressive the way the JSE has continued its rally lately, despite the rand gaining sharply last week from 13.80 to 13.30. Initially, some thought the rand s fall to 13.80 was solely to thank for the JSE s rise to record highs, but lately the rally has broadened out to some of the non-rand hedges. Other Commentators US Market Analyst, Elaine Garzarelli Garza s quants model remains bullish at a reading of 83.5% (out of a maximum 100%). She recommends portfolios have full exposure to equities because any corrections should be limited to 4-7%. She expects quarterly earnings in the US to peak this quarter at +25% year-on-year, but to continue rising by double-digits through next year. The S&P 500 Index is nearing her fair valuation level of 2,628, which is based on her forecast for S&P 500 earnings of 146 (+14% year-on-year) next year and her PE or priceto-earnings model which suggests a fair PE is 18x. (18 x 146 = 2,628). However, she notes that when her quants model is as bullish as it is now, shares generally rise above fair value, sometimes by as much as 25-50%. Overall, US consumer spending looks good, with sentiment at a 13-year high. This should continue to support the economy. With the S&P 500 Index up +14.2% in 2017, excluding dividends, the IT sector remains number one with +25.2%, followed by Health Care with +19.7%, then Materials, which includes mining, with +17.5%, Industrials with +16% and Financials +12.5%. Energy or oilrelated is -9.2%. BCA Research BCA recommends switching partly out of defensive US shares into cyclical shares, based on the likelihood of a pickup in the capital expenditure cycle, synchronised global growth in general and firming emerging market growth in particular and US dollar softness, amongst other issues. BCA sees the global economy remaining firm over the next twelve months (it is currently firing on all cyclinders), with the US surprising on the upside, but the global economy will fall into recession in 2019. The OECD (Organisation of Economic Co-operation and Development) sees all 46 economies that it monitors showing positive growth this year for the first time in 10 years.
Yet inflation and interest rates remain at very low levels, causing risk assets to take off. BCA sees US inflation picking up quite sharply in late 2018/early 2019, compelling the Fed to hike rates aggressively. So BCA remains pro-risk for now, but is trimming their overweight in global equities from moderate overweight to small overweight and cutting high yield bonds too because they think valuations have become stretched, thus differing from Garzarelli, who sees the US market at about fair value currently. BCA does note though that the MSCI World Index had gained +11.9% in the first nine months of 2017, not much more than the +9.1% gain in earnings. So the world market is now trading at 16.1 times forward earnings versus 15.7 times at end 2016, i.e. it is now only slightly more expensive than it was at end 2016. The US is trading at 18.2 times earnings expected in twelve months, while Europe is at 14.6 times and Japan at 14.3 times, the UK is 14.5 times and Emerging Markets at 12.5 times. They recommend a defensive position in global bonds (below benchmark duration). As mentioned above, they recommend favouring cyclical shares over defensive shares, but look to turn outright bearish on shares in late 2018. Stay overweight Euro area and Japanese shares relative to US shares. In the emerging market space, they continue to believe that Chinese H shares, being the Chinese shares that trade in Hong Kong, will outperform. They are more tilted towards financials and deep cyclicals and trade at just seven times earnings expected one year out, plus a much higher dividend yield. While it is a close call, they see more upside for developed market shares than for emerging market shares, as developed markets are less vulnerable to a US dollar rebound and a more aggressive Fed. Style-wise, they prefer small cap value over large cap growth shares. Small caps tend to do better during times of strong economic growth and also will benefit more from tax cuts. They think it is too early to buy gold. Paul Hansen Director: Retail Investing
Economic Update 1. IMF revised world growth higher for both 2017 and 2018, boosted by Europe, China, Japan, and the United States, as well as emerging Asia. SA is an outlier in the growth theme 2. US confidence levels remain high by historical standards despite the September decline in the NFIB optimism index. Data remains encouraging, but downside risks cannot be ignored 3. China's forward looking indicators remain strong, but economy likely to slow somewhat in 2018 4. Kenya GDP Q2 2017 edges up although downside risks remain 5. Key highlights for the week 1. The IMF released their updated World Economic Outlook forecasts last week. According to their latest estimates world growth is projected to improve from 3.2% in 2016 to 3.6% in 2017 and 3.7% in 2018. (These forecasts are based on PPP estimates). The growth forecasts for 2017 and 2018 are above the long-term average growth rate of 3.5% and up 0.1 percentage point relative to the IMF s world economic outlook in July 2017. The IMF highlighted that the global recovery is continuing, and at a faster pace. This accelerating cyclical upswing is, according to the IMF, boosted by Europe, China, Japan, and the United States, as well as emerging Asia. For 2017, most of the IMF s growth upgrades are due to an improved outlook for the advanced economies, whereas the 2018 s positive revisions are largely due to emerging markets. Notably, the IMF expects sub-saharan Africa, where growth in per capita incomes has on average stalled for the past two years, to improve overall in 2018. The IMF s downward revision to South Africa s growth outlook is unfortunate and an exception to the overall trend. The current upswing in world economic growth should support SA s growth outlook over the coming year, especially if SA s political environment improves, helping to lift business and consumer confidence. The current global acceleration in economic growth is also notable because it is broad-based. From the IMF s perspective this broadening of growth is more evident than at any time since the start of this decade. This breadth offers a global environment of opportunity for ambitious policies that will support growth and raise economic resilience in the future. On the downside the IMF highlighted that nominal and real wage growth in advanced economies remains low, emerging market and low-income commodity exporters, especially energy exporters, continue to face challenges, and that the current cyclical upswing masks slow productivity growth in most of the developed world, which is being aggravated by an ageing of the population. The IMF indicated that in advanced economies, per capita output growth is now projected to average only 1.4% a year during 2017 22 compared with 2.2% a year during 1996 2005. Overall, the tone from the IMF s latest world economic outlook is upbeat, with the IMF encouraging policy officials to use the improved global economic conditions in order to implement important economic reforms. It is much easier to undertake tough structural adjustments when economies are growing strongly, rather than when economic conditions are deteriorating and social pressures are rising. 2. Earlier this year we introduced a new economic research product that aims to score US confidence, especially business confidence, on a monthly basis. This has been done as part of our ongoing evaluation of the effectiveness of President Trump s policy initiatives. In that regard, we have become increasingly focused on the possibility that US private sector fixed investment activity will gain momentum in the coming year. A pick-up in private sector investment could lift the overall economic growth rate of the US, including an improvement in productivity, which has slowed appreciably in recent years.
Many media stories still focus on the negative social and political aspects associated with President Trump for good reason - but don t monitor the sharp jump in US business confidence that occurred immediately after Trump was elected. It seems clear that the initial boost in US business confidence was linked to Trump s promises regarding tax cuts, less business regulation, greater trade protection and increased spend on economic infrastructure. Importantly, there is a strong and positive correlation between US confidence and economic growth; hence a sustained rise in business confidence should lead to a noticeable improvement in GDP growth. The confidence indicators we have chosen to monitor each month include the following: ISM manufacturing index ISM non-manufacturing index NFIB Business Confidence NFIB Hiring Plans Wells Fargo Small Business Confidence US consumer confidence (Conference Board) US prospective home buyers US leading indicator Each of the above indicators is scored (subjectively) on a scale of 1 to 10, with 10 being extremely high confidence. Currently (mid-october 2017), the average of all eight indicators scored an impressive 7.9 out of 10, which is slightly above the previous month s score of 7.8, and the highest score since we started scoring confidence in February 2017. A score of 7.9 would suggest that the US is experiencing a very high level of confidence overall. It is, however, important to highlight that the NFIB small business confidence index moved lower in September. Furthermore, this decline cannot be entirely attributed to the recent hurricanes. In fact the NFIB suggested that the temptation is to blame the September decline in confidence on the hurricanes in Texas and Florida, but that is not consistent with our data. Small business owners across the country were measurably less enthusiastic last month. Notably the number of small business owners who expected better sales plunged a net 12 points in September, while owners who think that it s a good time to expand dropped a net 10 points. Also within the Index, expected better business conditions (-6) and capital expenditure plans (-5) retreated in September. Despite this decline, the NFIB confidence index remains very high by historical standards. Other key US confidence indicators we measure improved this month. In particular, the ISM manufacturing index jumped to an impressive 60.0 index points, while there has also been a welcome improvement in US durables goods orders (excluding aircraft and defence equipment). Consumer confidence also remains elevated helped by a strong labour market. Overall, it still seems fair to argue that the business sector is very optimistic by historical standards, but waiting to see if Trump can deliver on most of his election promises, in particular a cut in corporate and other taxes. Ironically, the devastating impacted of the recent hurricanes (Harvey and Irma) will lead to a boost in local infrastructure spending. (The current tensions with North Korea are an unnecessary distraction and extremely concerning). If the current level of confidence can be sustained, US economic growth would be expected to improve. Equally, a fall-off in confidence would argue that Trump's policies have been largely ineffective and the economic discussion will then start to focus on the prospect of the US economy slowing into a rising interest rate cycle. At this stage the data continues to support the upside scenario, as highlighted by the IMF World Economic Outlook that was released today, but the downside risks are meaningful and cannot be ignored.
3. China s economic growth gained significant momentum in early 2016. This was reflected in a range of data including the leading indicators, but also the PMI, consumer confidence, railway freight and electricity usage as well as IVA (industrial value-added). This improvement in the rate of growth occurred partly in response to easier housing policies. For example, mortgage loans increased by 23% in 2015 and 35% in 2016. In addition, the requirements for fixed asset investments were lowered and the National Development and Reform Commission (NDRC) accelerated the approval of infrastructure projects. Furthermore, China Development Bank - the policy bank - invested heavily in private equity (using debt), and PPPs (Public-Private Partnership). Local governments also picked up their pace of investment, as reflected by the fixed asset investment (FAI) in roads. Finally, the sales tax rate for passenger cars was cut from 10% to 5% in Q4 2015, helping to lift vehicle sales in 2016. Crucially, some of the measures that were introduced in 2015/2016 to stimulate higher economic growth in China have now eased-off. This includes a tightening of housing finance and the lifting of the sales tax on passenger cars, which is back up at 7.5%. (The sales tax on cars is scheduled to increase to 10% in January 2018). Consequently, after growing by 36% in 2016, home sales slowed to 18% in the first half of 2017 and only 3.8% in August. Similarly, the sales of passenger cars also slowed from 15% in 2016 to 2% in the first half of 2017. This is also the reason why there has been a moderation in the rate of growth in credit and money supply. (M2 growth slowed further in August 2017 to 8.9%, after accelerating meaningfully in 2015/2016). These changes in the implementation of economic policy leads to the obvious conclusion that a big reason for China s economic stimulus in 2015/2016 was to bolster the performance of the Chinese economy ahead of the 19 th Communist Policy Conference in October 2017, as well as in direct response to a surge in capital outflows from China in 2015/2016 that led to a very significant reduction in China s foreign exchange reserves and pronounced currency weakness. While the scaling back of the economic stimulus does not automatically mean that China s overall rate of economic expansion will lose significant momentum in 2018 - at this stage China s leading economic indicators remain convincingly buoyant and the broadening of global growth has helped boost China s exports it does suggest that there is likely to be some moderation in the rate of expansion over the coming 12 to 18 months. This moderation could be accentuated by adoption of a tougher stance on environmental protection in 2017 that has started to weigh on a range of industrial activities. (Environmental protection is likely to emerge as a very strong theme after the 19 th Communist Party Conference). Lastly, it is clear that in longer-term China needs to undertake important structural reforms on various levels and cannot simply continue to grow rapidly based largely on debt (the growth in China s debt continues to exceed the growth in nominal GDP). In fact one of the key questions raised about China at the IMF meetings this month is can China grow fast without debt and kick its debt habit? and the answer appears to be unequivocally no unless there are significant structural reforms over the coming years. 4. The Kenya National Bureau of Statistics released GDP data for Q2 2017 which revealed that Kenya s economy has grown by 5.0% y/y from 4.7% y/y in the first quarter. This was lower than the 6.3% y/y recorded in last year s second quarter GDP print. Agriculture improved to 1.4% growth in the period as opposed to the contraction of - 1.1% in the first quarter of the year. Although there was an improvement, agriculture dragged overall growth down. The low growth in Agriculture was driven by a severe drought in the first half of the year which resulted in food prices rising by as much as 21.5% in the period. We expect the agricultural sector to remain at positive, but subdued levels for the rest of the year. The lower rainfall also affected electricity production as hydro power is a key source of electricity for Kenya. This led to energy prices increasing in the first half of the year as the nation switched to the more expensive thermal power.
Manufacturing, in line with PMI figures, has slowed to 2.3% from 2.9% in the first quarter of 2017. The latest PMI statistics suggest that this category fell even further in the third quarter. The manufacturing sector was largely affected by the agro-processing division which was impacted by the drought. The finance sector slowed to 4.3% from 5.3% in the first quarter and 8.1% in the second quarter of 2016. This was as a result of the lower private sector credit extension likely caused by the interest rate cap regulation implemented. Credit extensions have fallen to as low as 2.1% in May 2017 and banking sector earnings were lower in the period under review. At the same time bank lending rates were lower at an average of 13.63% from 18.15% at the same time last year. Tourist accommodation slowed to 13.4% from 15.8% as security concerns over elections started building. Tourism is one of the larger foreign exchange earners for Kenya so this sector of the economy is critical for reserves build up. Looking ahead, economic activity may slow in the uncertainty of the current environment. Business decisions have essentially been put on hold until election results are resolved and accordingly, robust activity is not expected to resume in the economy until the first quarter of 2018. In 2015 Kenya grew by 5.6% and then accelerated to 5.8% in 2016 as the rest of the continent s growth slowed. This year however we are expecting Kenya s growth to slow to 4.5% before accelerating again to 5.5% in 2018. 5. Key highlights for the week: China s 19 th Communist Policy Conference on Wednesday - environmental protection is likely to emerge as a strong theme. China GDP also on Wednesday - the Chinese economy advanced 6.9% y/y in the second quarter of 2017 beating market expectations. Q3 China GDP may lose a little ground. SA CPI on Wednesday - SA inflation is expected remain under control in the short term as a whole, largely supported by moderation in food inflation however, the recent hikes in the petrol price and the volatility of the rand will in all likelihood make a dent. SA retail sales on Wednesday - the consumer has less discretionary income available for general retail activity. At the same time consumer confidence has fallen and is well below the long-term average. Fortunately, inflation has moved back inside the target range during 2017 and is likely to remain accommodative. This coupled with a possible further reduction in interest rates should provide some support to the household sector, helping retail sales avoid an outright recession despite the weak labour market. Please follow our regular economic updates on twitter @lingskevin Kevin Lings, Laura Jones & Kganya Kgare (STANLIB Economics Team)
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