Market Commentary

 

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Global Overview

Developed Markets: Global monetary policy moving onto a less accommodative path
Positive growth momentum in the US continues despite the short-term weakness seen in core inflation data and GDP. In June rates were raised 25bps and in the most recent FOMC meeting, the Fed suggested that financing conditions remained accommodative which provides leeway to continue tightening. Recently published US job data confirmed the health of the job market. The US central bank is therefore likely to continue its monetary policy normalisation and gradual shrinking of its balance sheet, which should be supportive of the dollar and sovereign yields. Market participants expect one more hike this year and then three in 2018, subject to inflation trends. Under the Trump administration, the lack of definitive fiscal plans, coupled with the inability to pass healthcare reform has tempered expectations of a fiscal boost.

 Further afield, in the UK, Theresa May lost 12 parliamentary seats, losing the majority and weakening her position ahead of Brexit negotiations. Political uncertainty remains elevated. Brexit poses a threat to trade, given the UK’s unfavourable bargaining position. There is also the potential for increased unemployment, which could be a material threat to the building housing bubble. The Bank of England Governor’s recent speech pointed to some removal of monetary stimulus if the economy improves. However, any tighter policy requirement is largely due to a spike in inflation and less due to growth signals. Employment trends have been sluggish and consumer confidence has been weak with retail sales under pressure. The macro backdrop will therefore limit the BoE’s ability to follow the Fed.

In sharp contrast to the UK, this month’s ECB meeting indicated tapering to start early next year on growth and inflation optimism, indicative that policy normalisation is now underway. PMI indices are at peak levels, boosted by the acceleration of new orders. There has also been renewed confidence in the Eurozone economy and political situation after the victory of Emmanuel Macaron in the French elections.

In summary, key global central banks are signalling a co-ordinated unwinding of the loose monetary policy and low interest rate regime in place over the last few years.

Commodity prices weak over the quarter
Leading PMI’s remain robust for mature and emerging markets due to the strength of global trade.

Despite a better global growth outlook, commodity prices have been trending lower, reflecting supply rather than demand factors.

Oil continues to slide in the face of a growing supply glut, shedding -9.3% and -16.7% during the quarter and 6 months ended June respectively despite efforts by both OPEC and non-OPEC countries to curtail production. Brent Crude appears decisively in bear territory reaching a recent low of $45/barrel.

Gold lost some of its lustre during June given the hawkish rhetoric from various central banks. In a higher real interest rate environment, gold’s value is perceived as lower given the higher opportunity cost. Gold could therefore face further headwinds on the back of stronger global growth forecasts and rising US interest rates.

Base metals and bulk commodities saw a huge sell-off in 2Q17 despite a rebound in June. Buoyant supply and a Chinese industrial sector slowdown have weighed on prices. With China’s housing market decelerating, there could be more downside to commodity prices.

Platinum continues to lose out in favour of Palladium as the industry continues to burn cash in a well-supplied market.

Emerging Markets: Flavour of the year
Emerging markets (EM) continued its outperformance relative to developed markets (DM) for the 6th consecutive month, with gains being led by Poland, Turkey and Korea.

Inflows into EM markets remained strong post the first quarter given robust demand for yield and low volatility. However, YTD, SA equities recorded outflows of $4.1bn, significantly lagging inflows into EM equities of $42.8bn. As a result, MSCI SA (+8.4%) continued to underperform MSCI EM (+18.7%) in $.

Whilst SA Bonds received a decent share of inflows recording $2.9bn YTD, there seems to be some tapering off with June having seen the largest outflow since December 2016.

SA Overview

Local markets suffer post cabinet reshuffle
The quarter started off in a state of frenzy amidst the cabinet reshuffle and the subsequent downgrade to sub-investment grade of our foreign currency credit ratings by both S&P and Fitch. In June Moody’s moved to cut SA’s foreign and local-currency ratings to Baa3 (one notch above junk). The outlook was kept at negative, highlighting political volatility, as well as the weaker growth outlook and fiscal challenges.

The after effects of the cabinet reshuffle are still being felt and the political backdrop remains frail. Confidence has been hit across all sectors. YTD SA business confidence has slipped 4.5 points. Persistently depressed business confidence will dampen fixed investment. Similarly, SA consumer confidence dropped to -9 during 2Q17 from -5 the previous quarter. Notably, the consumer confidence index has been in negative territory for three consecutive years. The consumer outlook remains constrained despite inflation pressures abating. This has translated into volatile and moderating retail sales, with durable goods bearing the brunt of the slowdown.

SA GDP saw an unexpected -0.7% quarter-on-quarter contraction during 1Q17, with the economy now firmly in a technical recession. Manufacturing production is still declining year-on-year and the PMI is at depressed levels.

The Rand had a volatile month on the back of a few key happenings, including the Public Protector’s comments on altering the SARB’s mandate, SA going into technical recession and the current account widening to 2.1% of GDP in 1Q17 vs. 1.7% during 4Q16.

Despite expectations of a delayed macro recovery, the R/$ remained resilient YTD (+5.1%) buoyed by EM risk appetite. However, the Rand depreciated against most other trading partners including the Euro, GBP and CHF.

The SARB’s committee’s stance remains firmly neutral in the face of elevated political turmoil. Markets remain focused on fiscal slippage, despite a considerable rise in terms of trade during 1Q17, lifting the trade surplus to 1.3%.

Notwithstanding the GDP print and benign interest rate outlook, there are significant risks limiting the SARB’s ability to cut rates, one being the risk of local currency downgrade by either S&P and/or Moody’s.

Politics: State capture and radical economic transformation
The Gupta leaks have exposed the extent of state capture and corruption within the ANC leadership, but for now the status quo remains.

The ANC policy conference which kicked off at the end of the quarter exposed deep divisions in the ANC. But it remains to be seen whether the Dlamini-Zuma camp will lose momentum in favour of Deputy President Ramaphosa. The ZAR tested R13.50 on the final day of the conference as the debate around nationalisation of the central bank emerged.

Risks of a shift to a populist policy with radical economic transformation plans remain in the run-up to December’s National Conference.

Investors are likely to be concerned around these issues as well as the SARB’s operational independence, resulting in potential ongoing pressure to risk premia in SA Equities and increasing the risk of a local currency downgrade by rating agencies.

Market review
Post the cabinet reshuffle, cash (+1.9%) outperformed both SA Bonds (+1.5%) and SA Equities (-0.4%) during 2Q17.

The SA equity market posted a -0.4% return for the quarter (vs. a strong +3.8% during 1Q17). June saw a significant pull back of -3.5%, with SA Industrials returning the worst performance at -4.2%, led by Consumer Services (-5.2%). Only Technology bucked the trend with a showing of +6.1% in June. Notable sector moves included index heavyweight Naspers, which regressed 6.3% on global tech concerns, Steinhoff (-4.2%) after releasing a poor set of results and British American Tobacco (-5.4%) on a probe into suspected collusion. But despite a weak June, SA Industrials posted a +2.2% return for the quarter.

For the quarter, Media posted a healthy +9.9%, as did Food Retailers (+5.3%) and Forestry and Household Goods (both returning +4.5%). Detractors over the quarter included Travel and Leisure (-18.2%), Industrial Metals (-16.3%), Platinum (-14.7%) and Fixed Line Telecoms (-14.4%).

SA Resources continued to struggle, ending the quarter down 7.0%. The quarter saw weaker precious metal prices, exacerbated by the introduction of the new mining charter which brought about significant uncertainty as firms are required to increase their BEE shareholding to 30% (from 26%) within a year. In addition, it advocates that 1% of mining revenue be given to the empowerment shareholders. The outcome of the charter should it be enacted in its current proposed form is likely to be detrimental to SA miners.

SA Financials also remained in negative territory during June, but posted a flat quarter overall. During June, banking stocks were down -2%, with the likes of Nedbank and FirstRand declining -5.1% and -4.4% respectively, whilst Barclays Africa rallied +3.4% as Barclays PLC sold its stake down to below 15% via a private placement. This substantially reduced the risk of overhang risk on the stock. Banks’ share price performances remain volatile post the credit downgrade.

SA bonds were also under pressure, losing -1% during June, but ending the quarter +1.5%. Bonds are pricing in SA’s relatively poor credit risk profile to a large degree. SA Listed Property continues to see positive returns across 1, 3, 6 and 12 months.