Market Commentary

 

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2Q21 Market Commentary

Global Overview

Vaccine progress fuels a strong economic rebound; new Delta variant poses risks but unlikely to derail the recovery

The global pandemic led to major disruptions in economic activity as mobility was severely impeded to halt the spread of the novel coronavirus.   Herd immunity, either natural or via widespread vaccination programmes, remains key in sustaining the economic recovery and growth normalisation.

Approximately 2.8 billion (bn) doses have been administered only seven months post the news of a successful vaccine, covering about 23% of the world’s population.  Despite the impressive and rapid penetration, vaccination progress has been divergent across countries, with developing markets (DM’s) at the forefront highlighting the global vaccine divide. This in turn has served to magnify varied recovery rates and performances across developed and emerging markets (EM), with the MSCI World (+7.7%) outperforming MSCI EM (+5.1%) in dollars ($) during the quarter.

Emerging economies are the clear laggards in the vaccination race, but the pace is gathering momentum especially in view of the high transmissibility of latest Delta variant, which was first detected in India.  Whilst the Delta variant could hinder the economic recovery in regions with low immunity, governments and healthcare systems appear to be better equipped and able to manage outbreaks with learnings during the first and second waves.

Global inflationary pressures transitory, but Central Banks’ steadily heading towards tapering

The United States (US) and China led the recovery on the back of unparalleled monetary and fiscal stimulus  Along with a successful vaccination campaign, growth in the US has accelerated to levels last seen decades ago.  This notwithstanding the challenges of rolling waves as targeted restrictions have proven effective.  Global inflation has also surged ahead to unprecedented levels.  Inflation is however thought to be transitory due to pricing normalisation on re-openings and restarts of economic activity and pandemic induced supply constraints.  Further pressure is likely to be muted as the pandemic loses impetus and higher base effects come into play.

June Purchasing Manufacturing Indices (PMI’s) have stalled, but remain at an elevated 54.4.  Whilst growth momentum has likely peaked in the US and China, global growth during the second half of the year should be buoyed by the European Union (EU) and other economies as they play catch up in a more synchronous fashion.  Rising mobility, domestic tourism, pent up demand, a strong consumer and higher savings rates should underpin growth. 

In the wake of improved economic outlooks in the aftermath of the pandemic, DM banks are all steadily heading towards tapering following an almost $10 trillion expansion to their balance sheets.  The timing thereof will likely be well communicated and effected in a measured way.  Interest rate hikes are only expected to be implemented on completion of these asset purchase programmes.

Whilst the US is just starting its path of policy normalisation, China’s credit impulse has been fast fading.  Despite antitrust measures aimed at technology companies, underlying consumer demand remains robust, underscoring continued momentum .  Furthermore, the surprise cut in the required reserve ratio (RRR) on July 9th should further reinforce economic growth, and support lower costs for corporates impacted by rising commodity prices.

The backdrop for risk assets therefore continues to be supportive despite recent concerns of a slowdown.  Reflation beneficiaries should continue to climb with accelerated international re-openings and service-based consumption gaining traction due to a sustained improvement in mobility and economic activity as vaccines are successfully administered globally.

Commodities: Strong performances from Bulk Metals whilst Platinum Group Metals (PGM’s) take a breather

Global energy consumption was strong during the second quarter as demand continued to recover off its pandemic lows. The sudden rally in metallurgical and thermal coal (+49% and 40% respectively) is mostly attributable to China’s supply restrictions amidst robust domestic demand.   China also reportedly implemented stricter safety measures and mine closures in June due to recent incidents.  Furthermore, with restricted Australian imports, China had to source from other regions, resulting in elevated tightness in the seaborne market.

Iron ore prices rallied +28% during the quarter on the back of rising demand from the Chinese steel industry.  This was augmented by supply constraints as a result of lower than expected production from Rio Tinto and the suspension of mining at Vale’s Timbopeba and Alegria mines.

Gold ended the quarter +2% as prices corrected towards the latter part on a more hawkish stance from the US Federal Reserve (Fed) and expectations of global synchronised growth and successful vaccination programmes in DM’s.

Platinum prices moderated -12% in line with a seasonal ramp up in South African (SA) production, which is the largest contributor to global supply.  Whilst Rhodium rallied at the beginning of the quarter due to a delayed ramp up at Anglo Platinum (AMS), it ended the quarter down -25% as production pressures eased.

West Texas Intermediate (WTI) and Brent oil prices had another strong quarter boosting year-to-date (YTD) gains by +51.9% and +45.0% respectively as OPEC+ continues to curtail supply and on demand optimism as COVID-19 restrictions lessen and mobility returns.  Although easing geopolitical risks, supply discipline, lack of investment in the sector and re-openings could continue to support prices, OPEC+ spare capacity, the return of Iranian volumes and rolling infections are likely to pose risks to the outlook.

Healthy gains in global trade has also resulted in significant tensions in global shipping markets, underlying the 65.3% rise in the Baltic Dry Index.

Prospects for commodity prices are expected to remain upbeat as the key demand drivers, such as new order flow and constrained capacity, continue to be conducive for raw materials and energy.

South African (SA) Overview

SA recovery hampered by the third wave, slow vaccination progress and political events

During the first quarter, the economy expanded by a faster than expected 4.6% quarter-on-quarter (q-o-q) seasonally adjusted annual rate (saar).  Though the recovery has driven by the global commodity boom advancing the mining and agricultural sectors, the latest print was bolstered by strong household consumption and restocking.  The consumer has been reasonably resilient, with household consumption almost fully recouping its lockdown losses.  Strong commodity prices have also strengthened terms of trade providing support to the Rand at current levels.

There are, however, a number of recent risk factors that are likely to obstruct the upward trajectory.  This quarter coincided with the advent of the third wave and the associated move to Adjusted Level 4 lockdown (currently extended until 25 July 2021), once again placing restrictions on social mobility through curfews, alcohol trading and leisure activities.  There are tentative signs that the current third wave has peaked in terms of new daily infections, but deaths (which usually lag infections) are still rising. 

Travel into and out of Gauteng, the epicentre of this wave, has served to limit the spread interprovincially, but other provinces are now also seeing rapid increases in infections and are yet to peak as the Delta variant continues to be highly contagious.

SA has seen a sluggish ramp up in vaccinations, initially impacted by restricted vaccine supply.  At the time of writing, approximately 6.0% and 2.0% of the population have received one vaccination and full vaccinations respectively.  Supply bottlenecks have since been alleviated and additional funding has been made available to intensify vaccination efforts.

On the political front, in a landmark Constitutional Court ruling, former president Jacob Zuma was sentenced to a 15 month imprisonment sentence for contempt of court.  This should fuel renewed investor and business confidence in the judiciary.  However, since the arrest, mass civil unrest and violent protest action have been evident in Gauteng and KwaZulu-Natal, placing additional stress on resources and an already frail economy.  Ongoing public sector strike action is also a looming risk as the government implements austerity measures.

SA growth remains susceptible to cyclical risks from further waves of COVID-19 in the absence of widespread herd immunity, which will undermine recovery efforts.  Despite some reforms in the energy sector, structural headwinds from unplanned outages, high unemployment, weak job creation and fiscal pressures continue to weigh on the long-term outlook.

Local Market Review: Financials lead the pack; Resources lose steam

SA Property was the best performing asset class during the quarter (+12.1%), followed by SA bonds (+6.9%) and SA Cash (+0.9%) and SA Equity (0.0%).  Small cap stocks have staged a solid recovery YTD, returning +30.9%.

Within equities, Financials posted a strong performance (+7.9%) during the quarter led by General Financials (+22.8%) and Banks (+9.6%).   Within Banks, Investec PLC (INP) and Nedbank (NED) posted strong gains (+26.4%  and +22.1% respectively).  Although revenue growth remains subdued, prospects for banks’ earnings have improved on the expectation of credit impairment reversals and excellent cost containment.

Industrials posted a small gain +0.8% with varied intra sector performances.  Industrial Support Services rose a stellar +31.0%, followed by Personal Goods (+21.9%) and Beverages (+18.8%).  The latter was driven by a +43.1% return from Distell (DGH), which was the top performing stock in the All Share Index during the quarter.  This followed the announcement in May that Heinekin, the world’s second largest brewer, was in talks to acquire DGH.  Luxury goods company Richemont (CFR) rose +21.9% on improved operational momentum and speculation on a tie up with competitor Kering. 

On the downside, Media heavyweights, Naspers (NPN) and Prosus (PRX) declined -15.1% and -14.5% respectively, despite a strong result and positive fundamentals.  Aside from investor concerns around the e-commerce business not generating profits, there has also been apprehension around Johannesburg Stock Exchange (JSE) benchmark weightings.  The most recent share swap transaction is meant to decrease the free-float of NPN and increase that of PRX.  The market has however been underwhelmed due the unfavourable swap ratio and the likelihood that the deal will still not address the narrowing of the discount and unlock value.  The deal will further entrench the complicated cross holding structure.

Resources lost some ground this quarter (-5.1%) as Precious Metals and Forestry and Paper retraced -13.5% and -10.0%  respectively.  AMS regressed -23.4% during the quarter, returning the worst performance amidst the large and mid cap universe.  The underperformance was largely due to a pull back in the PGM basket of circa 23%.  Gold stocks also declined this quarter as safe haven demand weakened.

Sources: Refinitiv, JP Morgan, MRB Partners, HSBC, Macquarie, Investec, Noah Capital Markets, SBG Securities