Monthly Market Update

– Rich Mashayanyika, Director Cornerstone Asset Management

Pessimism over global growth prospects and hopes of successful trade negotiations between the US and China fading had a negative effect on the local market, causing it to close in the red, down 2.4%. The news of a R59 billion Eskom bailout was viewed as negative by rating agencies. The downside effect of this bailout on the fiscus resulted in Fitch downgrading our sovereign outlook from stable to negative.  On the other hand, the Reserve Bank decided to cut the interest rate by 25bps in July given contained inflation and inflation expectations as well as the sluggish economic growth. Flat interest rates are forecasted over the medium term with Economic growth of 0,6% now expected for 2019, down from the previous estimate of 0,9%[1].

On the Global front, the Fed had a 25bp rate cut and has raised the uncertainty over the possibility of future rate cuts. This was below a market expected rate cut of 50bp. While the market viewed the Fed as hawkish, it still projects a 100% probability of a further 25bps cut in September[2].

Implications of the news

  • Global Growth Prospects

The fears of a deeper world economy slowdown have increased as trade wars intensify. After a period of improved optimism in June and early July, market volatility and increased risk aversion have returned as policy uncertainty deepens. The increased likelihood of a hard Brexit and continuing geopolitical tensions have added to the negative mix. While the Fed and other central banks have responded with monetary easing, the global bull market seem to have stretched for too long with the US having the longest bull market. However, research by Franklin Templeton suggest that bull markets do not die of old age alone. Historical triggers that typically have signalled the end of a bull market have included rapidly rising inflation or interest rates, the build-up of speculative excesses or bubbles, or a geopolitical shock that impacts demand[3].

The current US economic expansion has certainly been long by historical standards, but investors should remember that it has also been very shallow and slow compared to past periods of economic expansion. This slower rate of growth is a result of the severity of the global financial crisis a decade ago, but also the low-inflation, low-interest-rate environment that followed. Currently, we don’t see any of the above-mentioned classic signs the that a recession is on the horizon in the short to medium term[4].

  • Bailouts and Rating Agencies

The apparent, never-ending government bailouts to State Owned Enterprises (particularly Eskom) have not only provoked the depressed South African taxpayer, but also credit rating agency (Fitch Ratings). Fitch kept South Africa’s long-term foreign and local currency debt unchanged at BB+, the first notch of sub-investment grade, and downgraded its outlook from stable to negative. Fitch noted that the increased government spending on SOEs has a direct impact of increasing the debt to GDP ratio. Debt-to-GDP ratio is the ratio of a country’s public debt to its gross domestic product (GDP). By comparing what a country owes with what it produces, the debt-to-GDP ratio indicates its ability to pay[5].

Considering that a high debt to GDP ratio may make it more difficult for a country to pay external debts and may lead creditors to seek higher interest rates when lending. We think that South African government should consider a more sustainable restructuring or turnaround plan for these SOEs, stop the bailouts and redeploy our taxpayer`s money into productive sectors of the economy like infrastructure. While some SOEs like Eskom are very important to the South African economy, continued bailouts will be very negative for economic growth.

  • Local Growth Prospects

The combination of global growth concerns, low domestic growth and subdued inflation forced the SA Reserve Bank to reduce the interest rate by 25bps to 6.5% at its July policy meeting. This was in line with market expectation. The MPC statement was dovish, with the inflation outlook and inflation expectations remaining moderate, while global oil price projections were revised lower.  The Reserve Bank downgraded its current year GDP growth forecast for the fourth consecutive time, citing the slower global economic momentum, while domestically, business confidence remained low. The revision brought the Reserve Bank’s forecast to 0,6% for 2019. Risks to growth are assessed to be balanced in the near term, but the MPC is concerned about the longer-term outlook as structural impediments which have reduced the potential growth rate significantly over the past decade, constrain overall growth[6].

On a positive note, the seasonally adjusted Absa Purchasing Managers’ Index (PMI) measured 52.1 index points in July, up from 46.2 in June. This is the first reading above the neutral 50-point mark since December 2018. The purchasing managers’ index (PMI) is an economic indicator that surveys purchasing managers at businesses that make up a given sector. Investors use PMI surveys as leading indicators of economic health, given their insight into sales, employment, inventory, and pricing. While this is short term data, it implies that we might see economic recovery going forward.

Source: Cornerstone Asset Management; www.ber.ac.za

Markets During the Month

  • Local equity market (as measured by the JSE All Share Index) had a lacklustre performance, down 2.4% in July 2019, depressed partly by the downgrade of the sovereign outlook from stable to negative by Fitch. The renewed trade dispute between China and the US also had a downside effect on the market performance.
  • Global equities were up 0.5% for the month as investors remain cautious on trade talks between China and the US.
  • Listed property (SAPY) was down by 1.2% for the month.
  • Bond index (ALBI) ended the month down 0.7%, on the back of the negative news by Fitch
  • Cash posted a modest +0.6% for the month.

Source: Cornerstone Asset Management; Morningstar

The rand appreciated by 2.8% against the GBP and 1.3% against the EUR. This was mainly due to the sharp weakening of both the EUR and GBP against the USD.  The never-ending trade dispute between the US and China, coupled with the Fitch downgrade on the back of Eskom bail out depressed the USD/ZAR performance, down 0.7% in July.

In summary

July was an eventful month, the SARB reduced the repo rate by 25bps in what the market viewed as a hawkish cut; a Special Appropriation Bill allowing for a R59bn bailout for Eskom was tabled in Parliament, drawing negative opinion pieces from both Fitch and Moody’s. We think that South African government should consider a more sustainable restructuring or turnaround plan for SOEs, stop the bailouts and redeploy our taxpayer`s money into productive sectors of the economy like infrastructure. On the Global front, the Fed had a 25bp rate cut and has raised the uncertainty over the possibility of future rate cuts. On a positive note, the seasonally adjusted Absa Purchasing Managers’ Index (PMI) measured 52.1 index points in July, up from 46.2 in June. This is the first reading above the neutral 50-point mark since December 2018.

[1] https://www.nedbank.co.za/content/dam/nedbank-crp/reports/MonthyInsights/2019/MonthlyInsights_190702.pdf

[2] https://www.nedbank.co.za/content/dam/nedbank-crp/reports/MonthyInsights/2019/MonthlyInsights_190802.pdf

[3] https://www.franklintempleton.lu/investor/commentary-details?contentPath=common-blogs/beyond-bulls-and-bears/why-we-think-US-Equity-market-could-keep-running-into-2019

[4]  https://www.franklintempleton.lu/investor/commentary-details?contentPath=common-blogs/beyond-bulls-and-bears/why-we-think-US-Equity-market-could-keep-running-into-2019

[5] https://www.investopedia.com/terms/d/debtgdpratio.asp

[6] https://www.nedbank.co.za/content/dam/nedbank/site-assets/AboutUs/Economics_Unit/Research/Weekly_Economic_Monitor/Monitor_22_Jul_2019.pdf

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