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In this week's bottom line - 6 July 2021

Vaccination is proceeding rapidly, especially across developed economies. Most countries in the West are already 50% vaccinated, which is coinciding with a relaxation of lockdown restrictions and a powerful economic recovery.

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south african markets
SOUTH AFRICA: ECONOMIC REVIEW
Contributed by Werner Erasmus

Private sector credit extension (PSCE) contracted 0.4% year-on-year in May, markedly lower than the 1.8% year-on-year contraction in April. Credit extension to households rose by 5.6% year-on-year, faster than the 4.7% growth recorded in April. The ongoing uptrend in household credit is particularly encouraging as it should, along with a recovery in the labour market, help to support a recovery in consumer spending despite the dip in fiscal relief to households from 2021Q2. In contrast, loans and advances to the corporate sector fell for a third straight month (-3.9% year-on-year), albeit coming from a higher base than household credit extension. The divergent trends are part explained by the contrasting approaches to credit uptake by corporates and households in response to the pandemic. Looking ahead, an improvement in corporate credit uptake is expected as the influence of base effects starts fading in the coming months. Nevertheless, corporates may still be careful with debt accumulation amid the prevailing Covid-19 third wave. The slight improvement in household credit uptake is promising and should be somewhat supportive of household spending. Nevertheless, souring consumer sentiment and the slow recovery in the labour market could weigh on future consumption expenditure.

The trade balance surprised to the upside increasing to R55 billion in May up from R51 billion in April. The latest reading was the widest monthly trade surplus since January 2010. The trade balance was supported by a 1.5% month-on-month increase in exports to R163.51 billion. This once again owed to booming commodity prices and stronger export demand from major trading partners (USA, China, Germany, UK, and Japan). Imports however, contracted 0.9% month-on-month, to R108.91 billion. Year-to-date, the cumulative trade surplus measured R202.6 billion compared to just R10.6 billion in the corresponding period last year. The cumulative figures showed that the value of exports surged by about 54% year-on-year in the first five months of the year, while the value of imports was up by around 14%. Looking ahead, a continued improvement in global economic growth and demand accompanied by strong commodity prices are expected to maintain support for exports going forward. As for imports, domestic consumption and investment activity remain relatively subdued. Positively, the sustained trade surplus and the generally positive outlook on the current account fundamentally provide support for the rand. Sustained higher commodity prices and emerging market inflows should also be rand positive, limiting the inflationary impact of higher imported oil prices.

The Absa Purchasing Managers’ Index (PMI) declined to 57.4 in June from 57.8 the month before. Encouragingly, all five of the headline PMI’s major sub-indices were above the neutral 50-mark, which separates expansion from contraction. The PMI figure is a leading indicator and provides insight into the business conditions in the manufacturing sector. The PMI sub-indices include business activity, new orders, employment, supplier deliveries and inventories. The sub-index measuring manufacturers’ expectations in six months fell by 4.2 points to 59.3. This is amid concerns about the magnitude of the third wave of COVID-19 infections and South Africa already moving from level 2 to level 3 in mid-June. On the positive side, the outlook for manufacturers targeting the European and US export markets remains very bright, with recent international PMI readings remaining at or near record-high levels. The June PMI results suggest that while growth in new sales orders and business activity slowed somewhat, both remained very strong. Another positive development was the recovery in the employment index to back above the neutral 50-mark. The recent level 4 lockdown will have a limited direct effect on the manufacturing sector although alcohol beverage producers will be negatively impacted by the ban on alcohol. Further ahead, the recovery still faces several headwinds, including a slow vaccination roll-out, unstable power supply, and the dampening effect of fiscal austerity on demand.

Total new vehicle sales increased in May by 197.8% on the year to 38 337 units, up significantly from the 12 874 vehicles sold during May 2020. Export sales also recorded a gain of 196.8%, to 35 326 units compared to 11 901 vehicles exported in May 2020. The significant increases are mainly attributed to base effects resulting from the low number of vehicles sold in May last year because of the Covid-19 lockdowns. All three new vehicle categories, namely passenger vehicles, light commercial vehicles and medium and heavy truck segments recorded significant year-on-year increases. In the year-to-date, aggregate new vehicle sales were 44.9% above the same period last year, although the base effect creates a significant statistical distortion. Further ahead, new vehicle sales are anticipated to recover in line with the economy. However, Naamsa notes in its report that structural constraints in the economy, coupled with the lack of stable electricity supply and growing household debt, will continue to curb a quick economic recovery.

The IHS Markit South Africa PMI fell to 51 in June from 53.2 the previous month. The IHS PMI is a composite single-figure indicator of private sector business performance. Any figure above the neutral 50 mark indicates an overall improvement in the sector. The May figure concludes a second consecutive monthly decline signalling a loss of momentum in the rate of improvement in operating conditions across the private sector economy. On a more positive note, the latest reading pointed to the ninth straight month of expansion in South Africa’s private sector activity although at the softest pace since March. Output fell for the first time this year and growth in new orders stalled, as the reintroduction of stricter lockdown measures during June hit consumer demand. Also, there was a renewed drop in export sales. Meanwhile, raw material shortages led to a solid increase in backlogs, which prompted firms to raise employment at the quickest rate since November 2012. On the price front, input prices rose at a marked pace in June, although the overall rate of inflation eased slightly from May’s recent high. Output charges continued to rise sharply as firms often passed these costs onto their customers. Finally, business confidence eased for the second straight month as concerns grew that COVID-19 restrictions would harm economic activity in the near future.

south african markets
SOUTH AFRICA: THE WEEK AHEAD
Contributed by Ingrid Breed

Manufacturing Production, due Monday 12 July. Following the record 87.9% year-on-year surge in April of 2021, manufacturing production is expected to have recorded another yearly increase in May, flattered by last year’s production standstill. However, month-on-month figures are expected to have declined in May as the underlying structural constraints, resumption of load-shedding and elevated input costs continue to pose downside risks to the sector’s recovery.

global trade
GLOBAL
Contributed by Nick Downing

Commodity prices are booming. The S&P GSCI composite commodity index has almost doubled over the past 12 months, powered by increases across oil, metals and agricultural commodities. The price gains are attributed to the reopening of economies and pent-up demand, fuelled further by massive fiscal stimulus. Investors are also drawn to commodities due to their natural hedge against rising inflation risks and to their hedge against the potential for US dollar weakness. Copper has captured the attention of the investment community over the past week after breaking above its previous all-time high recorded in 2011 during the commodity “super-cycle”, which was led by China’s rapid industrialisation. While copper and other metal prices are showing the characteristics of another super-cycle, most economists are sceptical as China is transforming from an investment-led to a consumer-led economy. However, other economies are taking up the baton helped by extravagant infrastructure spending plans and the race towards a net zero carbon footprint within the next 30 years. The mass adoption of renewable energy and electric vehicles will lead to a step change in demand for copper and other key “green” metals. Meanwhile, the hangover from the last super-cycle means mining companies have been reluctant to develop new capacity. Due to the extended period taken to develop new mines, the existing supply constraints may last several years and potentially squeeze commodity prices even higher. Ivan Glasenburg, CEO of Glencore said the copper price needs to rise another 50% from current levels to unleash the new capacity required to meet burgeoning demand forecasts.

 

north america
NORTH AMERICA
Contributed by Nick Downing

The Congressional Budget Office substantially lifted its economic forecasts for the US economy. In the fourth quarter, the CBO forecasts year-on-year GDP growth of 7.4% compared with its forecast of 3.7% made in February. The uplift is attributed to the subsequent $1.9 trillion pandemic relief package, a quicker than expected reopening in economic activity and the increased pool of household savings. The CBO also raised its inflation forecast. The personal consumption expenditures price index, the Federal Reserve’s preferred inflation measure, is expected to register an annual rate of 2.8% in Q4, up from the earlier forecast of 1.7%. However, the same update indicates inflation will then subside to 2% in 2022, mirroring the Fed’s prediction that the current inflation spike will be transitory. The outlook reflects what many analysts call a Goldilocks scenario, with the economy running strongly alongside manageable inflation and the continuation of easy monetary policy. The danger is that market complacency often sets in when the outlook is as good as it can get. A potential concern is the weakening trade deficit and its effect on US dollar stability. The deficit is ballooning due to the sharp increase in domestic demand. Fast rising imports are not being matched by export growth. In May the trade deficit widened by a further 3.1% month-on-month to $71.2 billion.

Job growth was stronger than expected in June. Following a disappointing increase in non- farm payrolls of just 278,000 in April and a lower than expected 583,000 in May, payrolls increased by a solid 850,000 in June. Restrictions on labour supply, such as Covid fears and the need for parents to provide child-care, appear to be easing. The disincentive to work created by the government’s $300 per week enhanced unemployment benefit is also dissipating. Most Republican-led states have already discontinued the payments, which in any event are due to expire in early September. With social activity resuming, the leisure and hospitality sector contributed most of the new jobs in June with 343,000. Retailers also contributed a sizeable 67,000 new jobs. Wages in these sectors have risen sharply due to labour shortages. Compared with February 2020, prior to the onset of the pandemic, leisure and hospitality wages and retail sector wages have increased by 7.9% and 8.6%, respectively. Wage growth, which on an overall basis increased in June by 0.3% month-on-month and 3.6% year-on-year, could ultimately lead to rising inflation expectations, potentially troubling the Federal Reserve. However, the Fed will also be mindful that compared with February 2020, there are still 6.8 million fewer jobs, the unemployment rate is 5.9% rather than 3.5% and the labour participation rate which measures the number who are either employed or actively looking for work is 61.6% rather than 63.3%. The economy is still a long way from full employment, which beside the 2% average inflation target is a prerequisite for the Fed to begin hiking interest rates.

The Case-Shiller national home price index accelerated in April by 14.6% year-on-year, up from 13.3% in March, and its fastest pace since the data series began in 1987. The surge in home prices was earlier confirmed by Federal Housing Finance Agency, which reported a 15.7% increase in home prices in April. There are many reports of buyers paying more than the asking price to secure home purchases. The market frenzy is attributed to strengthened household balance sheets, the ability to work from home and lower mortgage lending rates. Although the average 30-year fixed-rate mortgage has increased from its recent low of 2.65% to 3.05%, it is still well below the pre-pandemic rate of 3.50% in February 2020. The surge in home prices is benefitting household finances and in turn consumer demand, which comprises two-thirds of US GDP. However, the benign wealth effect could go rapidly into reverse if the housing market bubble bursts. Boston Federal Reserve Bank president Eric Rosengren has stated that “I’m not predicting that we’ll necessarily have a bust. But I do think it’s worth paying close attention to what’s happening in the housing market.”

china
CHINA
Contributed by Nick Downing

The National Bureau of Statistics purchasing managers’ index (PMI) surveys signal a slowdown in economic momentum, prompting some economists to lower their GDP forecasts for the year. The manufacturing PMI eased back in June to a four-month low of 50.9 from 51.0 in May. Although above the key 50-mark for a 16th consecutive month, a level which demarcates expansion from contraction, some of the PMI sub-indices are a concern. The forward-looking new export orders index fell again, from 48.3 to 48.1, pointing to contracting exports in the months ahead. The non-manufacturing PMI, measuring activity in services and construction, fell from 55.2 to 53.5 attributed to a fall in the services PMI from 54.3 to 52.3. Again, the forward-looking services new orders index was in contractionary territory, dropping from 52.0 to 49.5. The slowdown in the services sector will be especially disappointing for authorities who have been hoping for consumer demand to catch-up with the post-pandemic export- and industrial-led recovery. Consumer confidence is being held back by the recent flair-up in Covid cases and a relatively slow vaccination programme. Meanwhile, credit rating agencies Fitch and S&P Global Ratings are expressing concern over rising credit default risks in China’s less developed provinces, due to Beijing’s waning appetite for bailing out state-owned enterprises.

japanese markets
JAPAN
Contributed by Carel la Cock

Japan’s Consumer Confidence Index rose to 37.4 in June, up 3.3 points from May and breaking a two-month decline. Consumer optimism picked up across all sentiment sectors: – Overall Livelihood (+2.1), Income Growth (+1.6), Employment (+7.3) and Willingness to buy durable goods (+2.2). The percentage of respondents expecting prices to rise in the year ahead jumped by 5% points to 79.9% in June, while only 5.1% expect prices to go down, 2.2% points lower than in May.

The Bank of Japan’s (BoJ) Tankan Survey for all industries and all enterprises marched higher in the second quarter to +14 from +5 in the first quarter. A reading above zero indicates favourable business conditions. Although the reading for the services sector disappointed by edging higher only slightly from -1 to +1, economists are positive about growth in the second half of the year and expect the economy to be at pre-pandemic levels by the end of 2021. The manufacturing sector showed promise as large companies indicated that current conditions improved to above their long-term average. Production machinery, one of Japan’s key export sectors, recorded a reading of +26 while electrical machinery was at +28. However, the survey also highlighted the effect of the recent resurgence in covid-19 infections and the accompanied regional lockdown measures. The index for hotels and restaurants was at -74 while transportation was at -10. Nearly 1% of the population is vaccinated daily and a further opening of the economy will see a rebound in the services sector that has been lagging to date.

euro european markets
EUROPE
Contributed by Carel la Cock

Europe’s inflation figures for June retreated from a two year high in May, giving some reprieve to central bankers who have been adamant that the recent inflation spike was temporary. The June annual inflation figure of 1.9% was down from 2.0% in May falling below the European Central Bank’s target, but economists have warned that it is likely to increase again towards the end of the year before subsiding by next year. Lower growth in energy and services prices were the main drivers of the lower headline inflation, however core inflation which excludes energy, food, alcohol, and tobacco prices, also fell from 1.0% in May to 0.9% in June. The ECB in its latest forecast predicted that inflation will be back down to 1.4% by the end of 2023. One of the reasons for lower inflation in the outer years is that economists believe that the eurozone labour market will remain weak once furlough schemes end. However, the latest unemployment figures paint a brighter picture. In May 382,000 fewer people were unemployed than the month before and survey results suggest manufacturers are hiring staff at the fastest rate in two decades. Eurozone unemployment has fallen from its peak in August last year of 8.5%, down to 7.9% in May. Despite the improving labour market, wage pressure has remained subdued thus far, but interest rate setters will keep a close eye on any changes.

uk markets
UNITED KINGDOM
Contributed by Carel la Cock

In a parting shot outgoing Bank of England (BoE) chief economist Andy Haldane warned that complacency from committee members could be disastrous and that “if this risk were to be realised, everyone would lose”. Mr Haldane has voted against other rate-setters in the BoE’s last two meetings, contending for reduced quantitative easing. He argues that there are three factors driving the economic recovery at present, which include the opening of the economy from covid-19 lockdown measures and surge in household spending as consumers unwind savings accumulated during lockdowns and satisfy pent-up demand. The third is the strong fiscal and monetary response which he says was “adding significant further momentum to an already rapidly bouncing economy”. He fears that the economy could overheat and that it will lead to rapidly rising interest rates to higher levels than if the central bank acted now. However, governor of the BoE, Andrew Bailey allayed fears in response and reiterated that the recent jump in prices was temporary and that the BoE was not being complacent. He added that the BoE must not overact by hiking rates too soon and stunt the recovery of the economy. While Mr Haldane expects 4% inflation by year end, Mr Bailey expects inflation to peak at 3% but acknowledges that there might be “bottlenecks” in certain areas where demand will temporarily outstrip supply. He sees this being caused by the unusual situation of supply and demand returning to normal at the same time, but that it will normalise in the months ahead. He further added that spending was likely to be directed to areas of the economy with spare capacity as demand further normalises. Inflation remains a hot topic of discussion and as more evidence of inflation emerges from data releases, pressure on central banks to stark hiking rates will increase. However, higher inflation will help governments reduce the real value of their debt piles, which have grown considerably during the pandemic, and overshooting inflation targets for a short period would not be detrimental.

FAR EAST AND EMERGING MARKETS
Contributed by Carel La Cock

Asian countries are seeing a broad-based economic expansion according to the latest IHS Markit Asia Sector PMI figures. Of the 18 sectors being tracked, no less than 16 increased output in April and 13 indicated higher employment levels. Automobiles and Auto parts saw the quickest growth and maintained the momentum gathered in the last three quarters. Other manufacturing sectors such as chemicals, technology equipment, machinery and equipment and household and personal use chemicals all showed promising growth, outpacing the gains made in March. The April reading of the IHS Markit ASEAN Manufacturing PMI figures also showed a steep rise in output and new orders. Vietnam reported the best growth of the ASEAN nations with their PMI hitting a two and a half year high followed by Indonesia which hit a record high. Business confidence across the region was the strongest in over a year. Service sectors also improved especially in healthcare, transportation, and industrial services, but their recovery is still lagging manufacturing. As the global economy continues to gather pace, the region is well placed to benefit from higher global demand and trade.

markets
Y to D %
Market Indicators
Indicator

JSE All Share

JSE Fini 15 

JSE Indi 25

JSE Resi 20

R/$

R/€

R/£              

Dow Jones

Nikkei

Hang Seng

FTSE 100

Gold

Platinum

Brent oil

Y to D %

+ 11.38

+ 8.36

+ 9.15

+ 13.40

+ 3.01

+ 6.09

+ 1.69

+ 13.66

+ 4.20

+ 3.35

+ 10.90

– 5.95

+ 1.66

+ 49.7

Level

66066

13068

85031

65292

14.26

16.92

19.75

34786

28598

28143

7164

1776

1087

77.3

THE BOTTOM LINE
Contributed by Nick Downing

Vaccination is proceeding rapidly, especially across developed economies. Most countries in the West are already 50% vaccinated, which is coinciding with a relaxation of lockdown restrictions and a powerful economic recovery. The OECD upgraded its forecasts for global GDP growth in 2021 from 5.6% to 5.8% and in 2022 from 4% to 4.4%, bringing most of the world to pre-pandemic GDP levels by the end of 2022. The US is expected to grow by 7% this year, according to the Federal Reserve, up from its earlier forecast of 6.5%. Countries which are reopening tend to have the fastest growth projections. UK GDP for example grew in April by a massive 2.3% month-on-month. The OECD increased its forecast for UK growth in 2021 from 5.1% in March to 7.2%, making it the fastest growth rate among developed economies.

Forward-looking survey data and company earnings upgrades indicate a continuation of the V-shaped recovery into year-end. Purchasing managers’ indices (PMIs) are surging to record highs, levels not reached in decades. According to PMI research company IHS Markit, “The US economy saw a spectacular acceleration in growth in May, the rate of expansion of business activity soaring well above anything previously recorded in recent history as the economy continued to reopen from Covid 19 restrictions.” Company earnings forecasts continue to be upgraded, most impressively in economies just starting to reopen. UK companies are expected to report earnings growth of over 75% in 2021, with a similar outlook across Europe.

With all this good news and growth recovery prospects brightening by the day, what could possibly go wrong? Most of the expected growth has already been discounted in equity prices. Zero interest rates, central bank liquidity injections and unprecedented fiscal relief have fuelled a surge in investment activity and speculation, lifting prices in some cases way above their fundamental value. In its semi-annual Financial Stability Report in May, the Fed warned against high asset valuations and the risk of significant declines. The Fed had issued a warning over inflated asset prices in its last report in November. Prices have moved even higher since then and again since May. The listing boom in special-purpose acquisition vehicles (SPACS) was cited as evidence of unusually high investor risk appetite.

The floodgates of monetary and fiscal stimulus were opened in an unprecedented emergency response to the pandemic. It is only reasonable to expect that these floodgates will be closed once the pandemic is in retreat. There is a non-trivial risk that the elixir which has pushed investor confidence to record highs, will soon be taken away. Stimulus payments from Joe Biden’s $1.9 trillion American Recovery Plan will soon run dry. The $300 per week enhanced unemployment benefits expire in September. His proposed $2.3 trillion American Jobs Plan, largely geared towards infrastructure, has been watered down substantially to less than $1 trillion and his $1.8 trillion American Families Plan will have to wait until next year and with its bias towards social spending will meet far more political resistance, even from within the Democrat party. There are already early signs that the Fed’s liquidity expansion is tailing off. The Fed had already reversed course and begun draining liquidity out of the US monetary system prior to its historic policy meeting on 15-16th June, when it brought forward the expected start of its rate hiking cycle from 2024 to 2023.

Although Fed chair Jay Powell stated that any withdrawal or “taper” of asset purchases would be “orderly, methodical and transparent”, tapering is now firmly on the central bank’s agenda. The market consensus expects the Fed to formally start taper discussions at the upcoming Jackson Hole central bankers’ symposium in August, and actual tapering to begin in early 2022. The Fed will be anxious to avoid the “taper tantrum” experienced in 2013 when the 10-year US Treasury bond yield spiked higher by 100 basis points in just two months, pricing in an additional 100 basis points of Fed interest rate hikes. However, market pricing suggests a similar outcome could be imminent. The difference between the negative real 10-year bond yield (after taking inflation into account) and the market’s expected inflation rate over the period (calculated from Treasury Inflation Protected Securities), is at abnormally wide levels. It is at the same level of 3.5% that preceded the 2013 taper tantrum. Bond yields will need to rise considerably to reduce this figure and redress the imbalance.

A sharp increase in bond yields would disrupt investor confidence, particularly in highly overvalued growth stocks. The earnings of secular growth stocks are discounted many years in advance as they tend to be less cyclical, but this makes them more susceptible to any increase in the discount rate (the 10-year bond yield). On the other hand, the performance of cyclical/value stocks such as financial, commodity, energy and industrial shares tend to correlate with rising and steepening bond yield curves. In general equity markets are over-valued but there are pockets of value in cyclical sectors of the market. In the US, the valuation gap between growth and value stocks is considerable. Growth stocks trade at an estimated forward price-earnings multiple of 32 versus 17 for value equities, a 90% premium compared with the long-term average of 40%.

Regions which are closely tied to the global economic and trade cycle, such as Japan, Europe, the UK and emerging markets, are offering more value compared with the richly priced US market and likely to outperform as their economies reopen. Earnings in these regions will be growing off a lower base. Emerging markets will enjoy an extra boost as they catch-up with their vaccination programmes. While fiscal stimulus expectations in the US are being dialled back, they are being fanned in Europe with the implementation of the €750 billion Next Generation EU recovery fund. Fiscal policy is more difficult to predict than monetary policy due to its dependence on politics. However, in Germany, the largest economy in Europe, politics bode well in this regard with the Green Party emerging as the front-runner ahead of the 26 September elections. The Green Party is strongly in favour of infrastructure spending.

Investors worry more following periods of substantial market gains. As the saying goes, bull markets climb “a wall of worry”. The big worry is inflation and the effect this might have on monetary policy and bond yields. The debate over the inflation threat is still wide open. We will probably only know the answer in 2022 after the once-off effects have had time to fade out of the equation. Until then, therefore, financial markets are likely to give the Fed and its belief that inflation is “transitory” the benefit of the doubt. Admittedly, a taper tantrum and accompanying spike in bond yields are potential short-term threats. The sectors most at risk from this eventuality are the richly priced growth shares, which after performing so well in 2020 are now over-valued. However, value sectors and regions which are packed with cyclical shares would do well in this environment. They are not as over-valued and will benefit from stronger upward earnings revisions. On balance, the MSCI global index will likely continue to climb its wall of worry, supported by robust upward earnings revisions.

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