The Weekly Focus A Market and Economic Update 14 May 2018
Contents Newsflash...3 Market Comment... 3 Other Commentators... 4 Economic Update...6 Rates...8 STANLIB Money Market Fund... 8 STANLIB Enhanced Yield Fund... 8 STANLIB Income Fund... 8 STANLIB Extra Income Fund... 8 STANLIB Flexible Income Fund... 8 STANLIB Multi-Manager Absolute Income Fund... 8
Newsflash A rise in commodity prices and commodity shares is normally late in the economic cycle as infrastructural spending picks up Market Comment Locally, the All Bond Index remains the Queen bee amongst the four SA asset classes with a 2018 return to-date of +6%, then cash, then the JSE All Share Index with -0.9% (improving of late) and finally SA Listed Property at -15.1%, attempting to stabilise after a downward interruption to its recovery from a nasty fall earlier this year. The ALSI has recovered very nicely from its low of 54,500 six weeks ago to the current 58,423, halving the loss from its late January high to -5.3% and seemingly breaking the back of its downtrend. The JSE Resources Index has been the biggest contributor to this. It is at a 3.5 month high and is +5% in 2018, excluding dividends. A rise in commodity prices and commodity shares is normally late in the economic cycle as infrastructural spending picks up. The JSE Financial & Industrial Index is -4.2% so far in 2018. Sasol is playing a big role in the Resources Index on the back of oil price strength (+7.2% so far in 2018), as are BHP Billiton (+12.6% in 2018, at a 3-year high) and Anglo American (+16.7% in 2018, at a 6-year high). Meanwhile the platinum shares remain extremely depressed on the back of an almost 4- year low in the rand platinum price. Gold shares are also very depressed, thanks to a low rand gold price. Last week Naspers rose by +6% (still down -11% in 2018) and Sun International by +5.4%, while platinum and gold shares fell between -14 to -21%. Meanwhile, on the offshore markets, the Nasdaq Index, with its heavy weighting in Technology shares, has recovered quite strongly (+2.7% last week) and is now +5.7% in 2018 and only -2.4% from its record high. It does appear to be leading US and global stock markets out of the 3.5 month correction, with shares like Apple and Amazon reaching new record highs last week and Facebook recovering to a level where it traded before the Cambridge scandal hit it. The S&P 500 Index rose by +2.4% last week to a 2-month high. It is now -5% from its late January high. The Information Technology sector of the S&P 500 Index is now up +9.5% in 2018, way ahead of the 2 nd placed Energy sector s +6.5% and Consumer Discretionary s +6.3%, although the Energy sector has rallied strongly from a negative number a couple of months ago. Financials have turned positive again at +1.7%, but the other seven sectors are still negative in 2018, with the worst being Consumer Staples at -12.8%. One thinks of British American Tobacco and AB Inbev on our market, both down this year in rand terms. Also our SA food producers are negative so far this year. US listed property gained +1.9% last week, but is still -5% in 2018. The MSCI World Index is also -5% from its late January record high and showing signs of recovering from the 3.5 month correction. The MSCI Emerging Markets Index has turned upwards a bit, but is still -8.5% below its late January high, affected by weaker currencies versus the stronger dollar. The dollar gained over +5% against the euro from the $1.25 low on 25 th January to last week s high of $1.185. It has weakened a tad since then, to $1.198. The call on the dollar for the rest of the year is a big one. Will it resume its downward trend against the euro (and most other currencies), or will it strengthen further to, say, $1.15 to the euro?
A stronger US economy than, say, Europe and Japan, together with rising interest rates in the US and flat rates in most other countries, is the driver of a strong dollar. Lower-than-expected US core inflation for April (2.1% year-on-year) helped arrest the dollar s uptrend for now, because it implies that the Fed has no need to be overly aggressive in raising rates. The euro is still +8.8% versus the dollar over the past 12 months. RMB Morgan Stanley says Morgan Stanley in the US is still forecasting a weaker dollar over the next 12 months in its The end of Easy report. They have lowered their allocation of global equities to neutral and upweighted their allocation to government bonds to neutral, leaving cash as their biggest overweight. They see the US 10-year bond yield lower in twelve months at 2.7% (currently 2.96%), meaning bonds will gain in price/value over the next year as the yield declines. This is an unusual view. Most forecasters expect bond yields to be higher (prices lower) as inflation heats up. Morgan Stanley believe that the rate of global growth has peaked, leading to a better environment for bonds on a 12-month view. Other Commentators US Market Analyst, Elaine Garzarelli Garza expects the bull market to continue. Her quants model reading is at 77.5% (out of a maximum of 100%). She recommends using dips to add to equity positions. She expects another rate hike from the Fed on 13 June. US company earnings have improved more than even she expected. They are now on track to rise by an impressive +28.6% year-on-year for the 1 st quarter, of which tax cuts contributed just over 7%, meaning without tax cuts earnings would still be up over +20%. This is the strongest gain in earnings in about 8 years. Fair value for the S&P 500 Index is now 2,808 or +2.9% above current levels. The Bloomberg Financial Conditions Index in the US has been rising steadily this month after a volatile couple of months. Healthy financial conditions are important since it gives one an indication of the strength of the financial industry. The US economy has substantial momentum going into the second half, so Garza believes a slowdown is unlikely. Garza thinks inflation in the US is still very reasonable, with core inflation at 2.1% and headline inflation at 2.5%, while producer price inflation is at 2.6%. The longer inflation remains moderate (as it is now), the longer the expansion will continue. Small business in the US is booming, with support from consumer spending, lower regulatory barriers and lower tax laws. Garza expected GDP growth of 2.8% in 2018 and again in 2019, with consumer spending being a significant contributor. She also expects to see solid growth coming from business fixed investment. BCA Research Cyclically and structurally the path for US bond yields is up, per BCA (clearly differing from Morgan Stanley). They believe that the Fed is behind the curve in raising rates. The combination of higher US interest rates and a stronger dollar will put pressure on some emerging markets. Last week s turbulence in Turkey and Argentina may be a sign of things to come. So BCA recommends being underweight emerging market assets. On the higher oil price (and higher petrol prices), BCA thinks that the robust US labour market will boost wages and incomes sufficiently to insulate the consumer from both rising energy costs and higher interest rates.
Conditions that crushed the consumer ahead of the 2007/8 recession are not in place and will not be for some time. At 41.8% household purchases of essentials as a percentage of disposable income are near all-time lows. So the consumer is not stressed at this time. In contrast, spending on necessities rose by a record 3% in the five years ending in 2008. Energy represents 3.8% of consumer spending on necessities, close to the lowest in the past 50 years, while interest costs are 15.9%. BCA thinks the West Texas Intermediate oil price will average $70 per barrel in 2018 and $64 in 2019, although it could briefly rise to $80 or even $90 if the Iranian sanctions are instituted and Venezuela s oil production falls further. They believe the US consumer can easily withstand a rise to $90, assuming natural gas and electricity prices remain at current levels. BCA continues to believe that the US dollar still has meaningful upside against other currencies, especially against certain emerging market currencies, including the rand. In fact they believe we are witnessing the beginning of a major down-leg in emerging market currencies versus the dollar. This is the opposite of Goldman Sachs latest view, which is that the rand is one of their favourite currencies over the next year and it could get to 11.50 or even 11.00 to the dollar. BCA expects a stronger dollar and a slowdown in China to eventually suppress commodity prices in the months ahead, which will further pressure many emerging market currencies. This will in turn hurt emerging market bonds. Foreign investors own 42% of SA government bonds. Paul Hansen Director: Retail Investing
Economic Update 1. SA manufacturing output improved slightly in March, but has stagnated over the past year. Furthermore, production declined meaningfully in Q1 2018, which will hurt the Q1 2018 estimate of GDP growth. 2. The IMF released their latest Sub-Saharan Africa Outlook last week which highlighted that the recovery remains slow and domestic revenue mobilisation is still behind the rest of the world. 1. In March 2018, SA manufacturing production rose by 1.3%m/m, after declining by a revised and substantial -2.5%m/m in February 2018 (monthly data is seasonally adjusted). The market was expecting production to rise by a modest 0.3%m/m. Despite the increase in March, during the first quarter of 2018 production was down a very substantial - 1.7%q/q. This will clearly hurt the Q1 2018 estimate of SA GDP growth. Unfortunately, over the past year, manufacturing has fallen by a concerning -1.3%y/y, with the overall level of production remaining far below the level of activity that prevailed prior to the onset of the global financial market crisis in 2008. In addition, South African manufacturing has massively under-performed global manufacturing in the past ten years. The SA manufacturing sector comprises of ten major sub-sectors. The largest being food and beverages (25% of overall manufacturing), followed by the chemical sector (24%), and iron and steel (19%). At the other end of scale, the clothing and textile sector comprises a mere 3% of total manufacturing, while the manufacture of electrical machinery is only 1.6%. Each of these ten major manufacturing sectors are comprised of a number of additional sub-sectors, which means that in total South Africa s manufacturing sector is divided into more than 40 distinct industries, each with its own performance characteristics. Remarkably, while the manufacturing sector (in total) has declined by -1.3% growth over the past year, there is a very wide dispersion in performance at a sub-industry level that fluctuates substantially from month-to-month. This dispersion is highlighted by the massive growth gap between the production and food products (+6.1%y/y), motor vehicle parts (+14.6%y/y), and plastic products (+3.6%y/y) vs. clothing (-14.2%y/y), footwear (-9.3%y/y), publishing (-15.3%y/y) and petroleum products (-15.3%y/y). In 2015 as a whole, South Africa s manufacturing sector averaged growth of 0%, which was the worst annual performance since the 2009 recession, and signalled that the sector experienced stagnation or a low intensity recession. This trend continued in 2016 with growth of 0.8% and under-performed further in 2017, recording a decline of -0.6%y/y. Unfortunately, this weakness appears to have continued in early 2018, although there is an expectation that industrial activity will improve somewhat as the year progresses supported by relatively strong growth in many of the major developed and emerging economies, some revival in Sub-Saharan Africa growth, a systematic uplift in business confidence due to more a stable domestic political environment, relatively consistent electricity production, and a higher degree of labour market stability when compared with prior years. 2. The IMF released their latest Sub-Saharan Africa Regional Economic Outlook. In it they mention the improvement in growth across the region since 2016 with more synchronized growth. Acceleration in growth is expected in two-thirds of the countries in the region. However this is still aided by external factors such as stronger global growth, higher commodity prices and improvement in market access. The IMF expects growth to plateau below 4% in the medium term, well off the average of 6.6% achieved between 2004 and 2008. The latest outlook suggests that per capita growth is only 1 percent per year, not enough for meaningful poverty reduction and increase in incomes. However on the fiscal front the challenges still remain as the percentage of countries in, or close to, debt distress has increased markedly.
Growth is still very different across the region with oil exporters growing well below trend. The two largest economies, South Africa and Nigeria (nearly 50% of SSA GDP) are growing well below trend which is weighing on regional prospects. Most countries across the region experienced deteriorating fiscal balances which resulted in increasing debt issuances. The search for yield across the globe made external financing easier to access and cheaper. However this favourable external environment is expected to fade. The normalization of US rates is likely to result in higher debt roll-over risk in the future for countries that over-indulged in external debt in the region. The IMF highlighted that the next leg of growth will need to come from change in policies that are business friendly and reduce dependence on commodities. This will allow governments to be able to step back from being the main source of economic stimulus which caused fiscal expenditure to increase noticeably. Fiscal discipline will be required going forward in combination with inflation targeting monetary policy. The solution to sustainable growth remains quite different for countries in the different parts of the region. For oil exporters the priority remains diversification of economy structure and especially revenue sources. For those that have pegged currencies, to allow some adjustment to exchange rate flexibility and the elimination of multiple currency windows. This will allow domestic currencies to reflect economic fundamentals. For the oil importers, growth should now be allowed to be driven by the private sector from infrastructure led investment programs by the public sector. This has led to high levels of government debt which has highlighted the need for fiscal consolidation and debt reduction. Especially as interest costs on debt is expected to rise. The increase in private investment was also highlighted as critical to achieving sustainable growth and improving social outcomes. Quite interestingly public investment levels in the region are at similar levels to elsewhere in the world however private sector investment is lagging the rest of the world. Revenue mobilization has been a difficulty in the region. Sub-Saharan Africa is still the region with the lowest revenue to GDP ratio at around 15%. The IMF estimates that 3 5% of GDP in additional tax revenues could be collected if the structural issues are attended to. This is more than is received by the region in international aid. This would include strengthening VAT systems and expanding coverage of incomes taxes. This largely requires the implementation of an effective tax administration. Additional sources of tax revenue would also need to be considered such as property taxes. The risks clearly remain in the region namely increasing oil prices, elections which could reduce the likelihood for much-needed reforms. The recovery itself is fragile and the region has become more vulnerable to external shocks. The concern is mainly on the fiscal side. Debt, especially externally financed, puts countries in the region at risk in an environment when developed market yields are increasing. Unless policies are put in place which could improve private sector led growth then it is unlikely that growth will return to the levels last seen in the commodities boom. Please follow our regular economic updates on twitter @lingskevin Kevin Lings, Laura Jones & Kganya Kgare (STANLIB Economics Team)
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