Market Commentary

 

Ideas001

 

By Shoaib Vayej – Portfolio Manager
Global overview
More macro uncertainty, synchronised easing, complacent markets

The second quarter witnessed further weakness in the global economy, most evident in declining trade volumes and manufacturing production. The current trade war is a significant economic event, in that it represents a reversal in the multi decade trend of globalisation. While trade tensions have undoubtedly impacted both sentiment and activity, it has not been the only factor contributing to the slowdown. Central banks, while remaining accommodative, have been tightening policy at the margin. The combination of the US Fed’s quantitative tightening and the end of the ECB’s quantitative easing saw aggregate central bank balance sheets contracting in aggregate. 2018 was also the low point for the Chinese credit cycle, with a concomitant lagged impact on economic activity. Several developed countries also targeted Huawei, the Chinese technology giant, on security concerns. The result was a significant disruption to global technology supply chains.

Markets enjoyed a strong start to the year in anticipation of a resolution of the trade disputes, from the depths of December 2018. Optimism was derailed at the beginning of May when the US President threatened China with additional tariffs. This immediately saw world markets sell-off 6% in a month. If the US were to impose additional tariffs on Chinese and automotive imports as threatened, its aggregate level of tariffs would revert to levels last seen in 1974, shifting it from one of the world’s most open economies to one of the most closed. The impact of tariffs on the US economy have been masked thus far by tax cuts, which will fall out of the base from the second
quarter data.

China’s retaliatory response thus far has been far more targeted and strategic, for example targeting Donald Trump’s rural support base or the supply of rare earth metals, a group of strategic commodities that China dominates globally. A month later, the US and Mexico announced a resolution of their trade and border dispute which relieved some of the risk priced by markets.

The shift by major central banks to a more dovish stance is another major event that emerged in the second quarter. At the June US Federal Reserve meeting, Governor Jerome Powell hinted strongly at the possibility of rate cuts, which put a floor under markets and drove markets to new highs. The MSCI World index added 2% in the quarter, adding to the 13% gain in the first quarter. The outgoing ECB President, Mario Draghi, also signalled the possibility of further quantitative easing in the face of weak data coming out of European economies.

The incoming president, Christine Lagarde, is expected to provide policy continuity at the ECB. The shift in yield expectations, at both the short and long end, has boosted precious metals, especially gold.

Chinese policy makers are supporting their domestic economy by easing credit and direct stimulus in the form of infrastructure investment. Besides the supply disruptions in the iron market stemming from Brazil and Australia, the stimulus is evident in Chinese steel production which has increased almost 10% so far in 2019. This combination saw iron prices rally by a third during the quarter.

In the UK, Theresa May’s spectacular failure to reach consensus on the UK’s exit agreement from the EU, saw her resign. While the deadline has been shifted to October this year, there is still a significant probability of a “no-deal BREXIT”, a risk which has weighed on UK asset prices and sterling. UK REITs have been notable underperformers on the JSE given depressed trading in their core markets.

The quarter also saw rising tensions in the Middle East, with separate but seemingly coordinated attacks on a Saudi pipeline and two oil tankers navigating a major shipping chokepoint, the Straits of Hormuz. Another incident was the destruction of an unmanned US drone flying close to Iranian airspace. The US, suspecting Iranian involvement in these attacks, has increased sanctions pressure on the country. Towards the end of the quarter, OPEC and Russia extended their production targets beyond June 2019. The oil markets are stuck between these emerging geopolitical tensions and record supplies coming from the US shale industry. Oil prices lost 5% over the quarter.

The end of the quarter witnessed a meeting of the G20 in Osaka, Japan. A US-China trade truce emerged from these meetings, with the countries reopening trade talks and suspending further tariff increases. Besides trade negotiations, markets will look forward to the next US Fed meeting as well as the Chinese Politburo meeting towards the end of July.

SA overview

Global tailwinds present since 2016 have turned into headwinds for the South African economy. At the beginning of June Statistics SA published a shocking 3.2% annualised contraction in the South African economy for the first quarter of 2019. This decline was driven by cyclical sectors of the economy: agriculture, mining and manufacturing. The slowdown reflects the global slowdown described above as well a lack of reforms locally. Future growth expectations are continually downgraded, with expected levels implying that per capita GDP will continue declining. Against this negative backdrop, the MSCI South Africa index bounced back strongly in Q2 2019, keeping pace with the MSCI Emerging Markets index thus far in 2019.

At a stock level the best performers were gold mining stocks and Telkom. Gold mining stocks responded to record high rand metal prices, as well as a re-rating of the majors, Anglogold and Goldfields, on increased speculation that they could be acquisition targets. Telkom has enjoyed the continued turnaround in its performance, exploiting the growth in demand for data services and managing its costs closely. The market is also speculating over the value of its property portfolio, which may be disposed.

Tongaat Hulett was the latest company to join a list of recent South African corporate scandals. The company voluntarily suspended its JSE listing in June as it was unable to publish audited financial statements in time, after earlier reporting the need to restate past audited results to the extent of a R3.5bn to R4.5bn write down to the groups equity value. At the time of suspension Tongaat shares had already lost almost 40% for the quarter. Steinhoff which remains listed amid a similar scandal over the last 18months, published audited year end results to September 2018, reported a €1.2bn loss, on the back of a restated €4bn loss the previous year. Steinhoff shares lost more than 30% over the quarter.

Data Sources:
Refinitiv, CPB (Netherlands), SBG Securities, UBS