Weekly Market Report 31 August 2021 - Overberg Asset Management

Weekly market report

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In this week's bottom line - 31 August 2021

Contributed by Gielie Fourie

It was a week of contrasting economic data, both good and bad. We start with the good news. First, South Africa’s economy is 11% larger after a rebasing exercise. This will be pleasing to the rating agencies. Periodic revisions of gross domestic product (GDP) are very normal and highly recommended. Stats SA’s rebasing exercise shows that the GDP crash in 2020 was slightly less severe than estimated earlier. The revised estimate of nominal GDP in 2020 is R5.5 trillion, an increase of 11% compared with the previous estimate of R4.9 trillion. For 2015, the new base year, GDP was revised upwards by R371 billion (9.2%). The higher nominal GDP figures indicate that key economic and fiscal ratios will now be less onerous. More accurate data relating to the economy helps investors to better understand the environment they are investing in. Government policies will not likely be changed by the larger size of the economy. The detail of the data revisions shows that there was a less significant contraction in GDP in 2020 of -6.4% YoY instead of -7.0% YoY. GDP in Q1 2021 rises from 1.1% YoY growth to above 2.0% YoY growth. The Q2 2021 GDP outcome will likely get a boost as well, given the significant growth in commodity prices which will have benefited both exports and tax revenues.

There was also the usual bad news. The Reserve Bank’s composite leading business cycle indicator was a big disappointment. The indicator fell by 2.3% from a month earlier in June. This is the biggest monthly decline since April 2020, following a 2.3% rise in May. All nine of the available components decreased. The drop in the leading indicator indicates a move in the wrong direction. Economic activity is not expected to pick up soon. The drop in several economic metrics, like the SACCI business confidence index, the sharp drop in both Absa’s and Markit’s manufacturing PMI figures, the drop in manufacturing production, the drop in retail sales, the surge in unemployment figures, continuing riots, Covid-19 lockdowns, and the slow Covid-19 vaccination rollout, all contributed to a substantial drag on the economy.

Lastly, South Africa’s unemployment rate surged to 34.4% in Q2 2021, from 32.6% in the previous quarter. It was the highest jobless rate since comparable data began in 2008. The contributing factors included the worsening pandemic crisis and the unending unrest and looting. The number of unemployed persons jumped by 584,000 to 7.8 million, employment fell by 54,000 to 14.9 million and the labour force went up by 530,000 to 22.8 million. The expanded definition of unemployment, including people who have stopped looking for work, was at 44.4%, up from 43.2% in the prior period. The youth unemployment rate, measuring job seekers between 15 and 24 years old, hit a new record high of 64.4%. When will it dawn on the ANC that its socialist policies are the cause of our social unrest? Running out of other people’s money, the ANC is now resorting to crowdfunding to pay ANC staff salaries. Peak global unemployment during the Great Depression hit 24.9% in 1933. We are far above the rates recorded during the Great Depression. High unemployment is a fertile breeding ground for social unrest. We are at a tipping point.

SOUTH AFRICA: THE WEEK AHEAD

Contributed by Ingrid Breed

Private Sector Credit Extension. Due Tuesday 31 August. The private sector credit extension (PSCE), which is the credit extended by the SARB to domestic borrowers, including government and commercial banks, is expected to have declined for a fifth consecutive month by 0.7% year-on-year in July 2021. This follows the unexpected decline by 0.54% year-on-year in June and comes as a result of weak credit demand stemming from the Covid-19 lockdown and disruptions caused by the social unrest in Kwazulu-Natal and Gauteng.

Balance of Trade. Due Tuesday 31 August. The trade surplus is expected to have narrowed slightly in July to R46.2 billion after widening to a record high of R57.68 billion in June. A dip in the trade balance is expected due to the Transnet cyberattack and the unrest in Kwazulu-Natal and Gauteng.

Absa Manufacturing Purchasing Managers’ Index. Due Wednesday 1 September. After the unrest caused the Absa Manufacturing Purchasing Managers Index (PMI) to plummet in July, the PMI is anticipated to have picked up slightly in August but remaining below the neutral 50-mark, thus indicating a decrease in manufacturing activity. The PMI is expected to have increased slightly to 47 index points in August from 43.5 in July with manufacturers’ sentiment and activity likely to take time to recover.

New Vehicle Sales. Due Wednesday 1 September. New vehicle sales are expected to have recovered from the disruption in the July production and delivery of vehicles, caused by the unrest and cyberattacks. The consensus forecast is that new vehicle sales increased 12.6% year-on-year in August after a 1.7% year-on-year increase in July.

IHS Markit Purchasing Managers’ Index. Due Friday 3 September. The IHS Markit PMI is anticipated to have recovered slightly in August after recording the first contraction in South Africa’s private sector activity in ten months in July. Despite the recovery, the PMI is expected to have remained in sub-50 contractionary territory at 49 index points from 46.1 in July.

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

Contributed by Nick Downing

Federal Reserve chairman Jay Powell’s much anticipated speech at the annual Jackson Hole central bankers’ conference pacified financial markets, which had grown anxious that he would announce an imminent taper of the central bank’s $120 billion per month asset purchase programme. After the speech, the S&P 500 index clocked up yet another record high, while the yield on the 10-year Treasury bond dropped from 1.34% to 1.31%, considerably below the March high of 1.74%. The shorter-dated 5-year yield fell sharply from 0.84% to 0.79%, indicating little concern over taper tantrums, let alone an imminent start to Fed interest rate hikes. Powell stated that economic progress warranted a start to the taper process by year-end but remained vague on the exact start date, which suggests it is unlikely to begin before the November policy meeting. The market’s consensus view is that the timetable will be formally set at the 2-3 November meeting with asset purchases staring to be reduced at the final policy meeting of the year on 14-15 December. Now that the market is settled on the taper starting date, attention will turn to the likely pace of purchase withdrawals and the taper end date, which in turn will inevitably lead to speculation over interest rate hikes. However, Powell was at pains to stress that the quantitative easing taper has no bearing on when interest rates might be lifted. The decoupling of the processes lessens the risk of a 2013-style taper tantrum, when the market had linked the two events and panicked due to premature interest rate fears. According to his speech, the Fed has set a “different and substantially more stringent test” for lifting interest rates than for reducing asset purchases. He spent the bulk of his speech arguing that inflationary pressures are transitory, that long-term disinflationary forces such as globalisation and technology will reassert themselves once the once-off effects of the pandemic settle.

There are indications that the Delta variant is affecting economic activity, impacting consumer and business demand as well as supply chains, with the net result that both demand and supply are being undermined. The IHS Markit manufacturing and services purchasing managers’ indices (PMIs) both dropped sharply in August: The manufacturing PMI from 63.4 to 61.2, a 4-month low and the services PMI from 59.9 to 55.2, an 8-month low. Consumers pulled back, driving retail sales down in July by 1.1% month-on-month. Overall consumer spending, which drives over two-thirds of US GDP, slowed to 0.3% growth, down sharply from June’s 1.1% month-on-month growth. Yet household income surged by 1.1% on the month indicating that consumers resorted once again to accumulating precautionary savings. Durable goods orders also eased, falling in July by 0.1% on the month, but the blame rests on supply chain disruptions and shortages of materials and labour rather than any cutback in demand. Amid depleted inventories, durable goods orders increased by a healthy 0.8% on the month. While the Delta variant is undoubtedly affecting the economy, the impact is mild compared to the first wave when the economy was put under full lockdown. Delta cases appear to have passed their peak and vaccination is picking-up pace. Meanwhile, consumers are sitting on a huge hoard of excess savings (estimated at around $2 trillion) and businesses are eager to replenish inventories. Economists are predicting a solid rebound in economic activity in the latter part of the year and into 2022.

CHINA

Contributed by Nick Downing

China’s regulatory crackdown has been unrelenting. Investor nerves have been rattled further since president Xi Jinping announced on the 17th August in his “common prosperity for all” speech the need to “regulate excessively high incomes and encourage high-income groups and enterprises to return more to society.” The day afterwards, Tencent pledged the equivalent of $7.7 billion to state-led charitable causes aimed at greater income equality and better social safety nets. Government has also made the “996” policy illegal. Adopted by the private sector, especially by technology firms, the policy requires staff to work from 9 in the morning to 9 at night, six days a week. The crackdown has also extended in the past week to online gaming restrictions. Under 18s will only be allowed to game for 3 hours a week, from 8-9 on Fridays, Saturdays and Sundays. This will impact gaming providers such as Tencent, although the company claims that the age segment accounts for less than 3% of its gaming revenue. While some investors are understandably panicked by the rise in government control over the private sector, there is a silver lining. The drive for greater income equality will increase the size of the middle class and benefit aggregated consumer demand, although demand for luxury goods products will more likely be a victim than a beneficiary. The state’s increased control will impact some sectors but at the same time other sectors’ fortunes will be bolstered, for instance technology hardware, semiconductors, robotics, electric vehicles and other beneficiaries of the “decarbonisation” trend. Even the mega-cap technology and e-commerce shares such as Alibaba and Tencent will recover. While ant-trust and anti-monopolistic policies will promote greater competition from within China it is highly unlikely that the door will be freely opened to their foreign competitors such as the FAANG (Facebook, Amazon, Apple, Netflix, Google) cohort. In conclusion, the net effect of rising central control is not all-bad for China’s equity market, especially as Beijing’s biggest target is the frothy residential property market. Residential property is the biggest competing asset class to equities for China’s retail investors

JAPAN

Contributed by Carel la Cock

Business conditions in Japan rebounded in June after dipping in May, according to the latest Business Conditions Indices. The Cabinet Office kept its assessment of the coincident index, a measure of current business conditions, as “Improving” indicating favourable business conditions for the fourth consecutive month. All three composite indices; Leading (+1.5), Coincident (+2.4) and Lagging (+1.1) improved, whilst the diffusion indices, a measure of the proportion of indicators improving, showed that Leading (80.0), Coincident (66.7) and Lagging (50) were all above the key 50-level. Higher new job offers, and a stronger consumer confidence index contributed to the overall improvement in the leading indicator while better industrial production, higher producers’ shipments and increased labour input pushed the coincident index higher. Although June figures point to ongoing improvement, more recent survey results have shown a slight decline in business activity, which is likely to be reflected in disappointing third quarter economic growth.

EUROPE

Contributed by Carel la Cock

Consumers are spending and driving the Eurozone economy back to pre-pandemic levels as a semblance of normality returns to life in the single currency bloc. High frequency data, which is less comprehensive and reliable than official economic releases, but benefits from being much timelier, shows that the fourth wave of covid-19 infections has had little effect on the economy. Data showing visits to shops, restaurants and leisure venues as well as travel and staff hiring, all support the idea that momentum gained in the second quarter has been sustained into the third quarter. Early forecasts by investment bank Jefferies predict a quarterly growth rate of 3%, outstripping the 2% growth in the second quarter. The Eurozone’s consumer driven sectors have caught up with manufacturers as chronic supply chain disruptions are starting to weigh heavily on the sector. Private consumption has picked up the slack from manufacturers and Google mobility data has shown that the Delta variant has had little impact on the movement of consumers. Tourism has also resumed in the Mediterranean and reports from Spain show that hotel occupancy is at 50%, the highest since the start of the pandemic. It is hoped that tourism in the Mediterranean will experience at least half of a normal season which will boost employment in the tourism industry with early indications that vacancies are on the up. It is encouraging to see that consumers have not altered their spending habits and there is hope for other nations once vaccinations have been rolled out.

UNITED KINGDOM

Contributed by Carel la Cock

UK inflation is being driven from an industry that is not usually associated with appreciation, but rather depreciation. In July one of the key drivers of inflation came from surging prices in the second-hand car market. The average price of used cars has soared 15% year on year in what some describe as a “freak of circumstances”. Potential buyers have been saving up during the pandemic and have postponed big ticket purchases until certainty around the effectiveness of vaccinations and an end to lockdown measures. Pre-pandemic commuters are also increasingly favouring working from home, but on days they go into the office they prefer to drive to avoid congested public transport. This has led to an increase in demand for vehicles at a time when a shortage in semiconductors has crippled the supply of new cars. Consumers have turned to the second-hand car market and dealerships are experiencing a boom. Car rental companies, that have a high turnover of new cars, have also been holding on to their stock this year, as few miles were clocked last year during the pandemic, which has exacerbated the steady supply of cars to the second-hand market. It is expected that the UK will register 600 000 fewer new cars this year and the Society of Motor Manufacturers and Traders reported the worst July for car production for nearly 70 years. The boom in the second-hand car market has also been witnessed in other countries for the same reasons and analysts expect price pressure on used cars to last well into the next two years or at least until the shortage of semiconductors and the production of new cars normalise.

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.

Y to D %

Market Indicators

Indicator

JSE All Share

JSE Fini 15

JSE Indi 25

JSE Resi 20

R/$

R/€

R/£

S&P 500

Nikkei

Hang Seng

Shanghai

FTSE 100

Gold

Platinum

Brent oil

Y to D %

+ 12.89

+ 18.20

+ 5.30

+ 17.43

– 0.24

– 3.62

+ 0.55

+ 20.57

+ 2.07

– 7.55

+ 0.82

+ 10.64

– 4.39

– 5.96

+ 41.08

Level

67064

14254

82030

67611

14.66

17.32

20.20

4528

28011

25174

3501

7148

1815

1008

73.08

THE BOTTOM LINE

Contributed by Nick Downing

Much has been written about the stretched valuations of US equity markets. By some measures they are more expensive than preceded the Dot.com Bust in 2001 and the 2008/09 Global Financial Crisis. Other markets are cheap and offer opportunities for outperformance. The attraction of ex-US markets is amplified by prospects of protracted US dollar weakness. The dollar, hampered by surging government debt, current account deficits, dwindling global influence and an overvalued starting point, is set for a multi-year period of depreciation. The dollar has tended to suffer cyclical underperformance every two decades or so, during which the currency drops against a trade weighted basket by 30-40% over 8-10 years. Some economists believe the latest cycle began last year and has some way to go.

A broadening improvement in global trade, as currently being experienced, lends itself to fuller global equity market participation. Expect emerging markets to flourish in this environment. A weakening dollar will moreover support emerging market currencies, providing an additional tailwind to portfolio returns. The South African market is cheap. The All-Share Index is trading on a 14.2 price-earnings (PE) multiple. However, there are numerous risks. Without going into too much detail, these involve government policy paralysis and lack of business and consumer confidence. As a result, human and financial capital is fleeing. The economy is under siege from one of the highest unemployment rates in the world at 34.4%. Youth unemployment is 64.4%. Government debt to GDP is 83% and our sovereign bonds have been relegated to junk status.

The Far East contains many emerging market opportunities, which can be accessed by South African investors. Emerging Asian equity markets trade at a 20% discount to global emerging markets, despite enjoying political stability, more rapid economic growth and better earnings prospects. The starting point sets the stage for a period of prolonged and substantial outperformance. The emerging Asian region is already larger than the US in GDP terms and once Washington has spent its Covid relief stimulus, will be growing at a significantly faster pace.

Vietnam, with a young population of 100 million and a rapidly emerging middle-class, has been dubbed the “next Asian tiger”. Its economy is at a similar stage of development to Taiwan’s in the early 1980s. It’s equity market trades at a similar valuation to South Africa’s on a 16.5 PE but the comparisons end there. The unemployment rate is 2.6%, government debt to GDP is 46.7%, its economy is growing faster than China’s with growth of 6.5% expected this year and around 8% next year. The 10-year government bond yields 2.03% versus the RSA 10-year yield of 8.85%.

Vietnam was the only economy besides China to eke out economic growth in 2020, despite the Covid pandemic and absence of its tourism industry which normally contributes 8% of GDP. In 2020, GDP grew by a remarkable 2.9%. According to global market research company IPSOS, Vietnam ranked #1 in the world for the level of confidence in the government’s handling of Covid. Development over the past 30 years has been remarkable with economic and political reforms transforming one of the world’s poorest nations into a lower middle-income country. Between 2002 and 2018, GDP per capita increased by 2.7 times lifting more than 45 million people out of poverty.

The population is large, young and well educated with a strong work ethic and entrepreneurial spirit. Around 55% of the population is under the age of 35. Rapid urbanization and industrialization and an emerging middle class provide excellent growth and investment opportunities. The economy’s rapid growth is backed by a modernising infrastructure. Infrastructure spending amounts to a substantial 6% of GDP. The government will increase infrastructure spending by 38% over the next five years, focused on building metros and ring roads in the two largest cities, Ho Chi Minh City and Hanoi, and the 1,800 km North-South highway. Electricity generation and transmission capacity is set to increase by 8% per annum over the next 10 years.

There was a smooth political transition at the 5-yearly National Party Congress concluded in February, assuring investors of policy continuity. An ambitious privatisation programme has culled the number of state-owned enterprises from 15,000 to 2,000 over the past 20 years. State-owned enterprises account for only 20% of GDP. Despite Vietnam’s trade surplus with the US equating to a massive 20% of GDP (compared with 2% of GDP in China’s case), the US is willing to overlook this due to its desire to foster a close relationship with the country. The relationship will strengthen as US relations with China deteriorate. The quid pro quo is that Vietnam has pledged to allow its currency to appreciate, not a bad outcome for foreign investors, and a strengthening currency will force the economy to innovate to remain competitive. Nonetheless, factory wages are still 60% below China’s. A significant “reshoring” of manufacturing capacity from China to Vietnam is occurring, a trend that has been accelerated by Covid related supply chain disruptions.

The stock market is maturing. The number of companies with a market capitalisation exceeding $1 billion has increased in the past 6 years from 10 to just under 50. The market has risen sharply this year, driven by domestic retail investors. Yet only 3% of households have retail stock brokerage accounts. The government wants this to be 5% by 2025 and 10% by 2030, following the same model which made other Asian tiger households wealthy. The mutual fund industry and corporate pension plans are still in their infancy, pointing to a multi-year structural shift in demand for share ownership.

VinaCapital Vietnam Opportunity Fund Ltd. (VOF) is listed on the London Stock Exchange with a market capitalization of just under £1 billion, offering investors the opportunity to share in this exceptional country’s growth and innovation. VOF is managed from Ho Chi Minh City and offers a highly differentiated model with investments across listed securities, debt, convertible debt, private equity and pre-listed equity. Diversification across asset classes both tempers volatility and in the case of private equity and pre-listings provides returns in excess of listed shares. VOF’s performance has been exceptional, with a compounded annual increase in net asset value per share of 12.1% over 10 years and 17.2% over 5 years. Moreover, the share trades at an 18% discount to net asset value. The share is a long-term constituent of Overberg Asset Management’s global private share portfolios.

*All writers’ opinions are their own and do not constitute investment recommendations or financial advice. Speaking to a qualified wealth and investment professional is crucial before making financial decisions.

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