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Overberg Asset Management publishes quarterly performance fact sheets for both local and global portfolios
In this week's bottom line - 23 November 2021
Last week, on 18 November 2021, the South African Reserve Bank raised the repo interest rate by 25 basis points to 3.75%. The prime interest rate will rise to 7.25%. We look at how interest rates are affected by our inflation rate.
Contributed by Werner Erasmus
Consumer price inflation, as measured by the consumer price index (CPI) was at 5% year-on-year in October, unchanged from September. This was in line with the consensus and marks the sixth consecutive month that inflation is above 4.5% (the midpoint of the SARB’s target). The biggest contributor to the October print was transport inflation which rose from 10.1% year-on-year in September to 10.9% in October, largely on the back of higher oil prices pushing up petrol inflation. Fuel prices increased by 23.1% year-on-year in October. Core inflation, which excludes volatile food and non-alcoholic beverages, fuel and energy and is a signal of underlying consumer demand, remained flat at 3.2% year-on-year. Looking ahead, the SARB expects headline consumer price inflation to be 4.5% for 2021 (from 4.4%), 4.3% for 2022 (from 4.2%), and 4.6% in 2023 (from 4.5%). The risks to inflation have increased in the short term. Concerning factors include persistent global supply chain disruptions and port congestion which have resulted in increased shipping costs. Global oil prices have increased and remain elevated. These factors have significantly increased producer price inflation. The expectation is that the headline rate will creep a bit higher over the coming months before falling back in early 2022.
The South African Reserve Bank (SARB) Monetary Policy Committee (MPC) increased the Repo rate by 25 basis points to 3.75%. The MPC cited inflation risk as an important factor but emphasised that the current trajectory of interest rates remains supportive of the economic recovery. The committee was split in its decision with two members voting to hold rates and three members voting to increase rates. The latest repo rate hike brings the prime lending rate up to 7.25%. Future rate increases of 25 basis points are expected in each quarter of 2022, 2023, and 2024, as indicated by the bank’s Quarterly Projection Model (QPM). This aggressive interest rates hiking cycle trajectory is however not shared by some local banks and research houses that expect fewer hikes over the projected period. The South Africa GDP growth rate has also been revised slightly downwards by the SARB, citing a larger negative impact from the July riots (and other factors). Growth for 2021 is forecast at 5.2% (previously 5.3%), reflecting a healthy rebound from the economic effects of the COVID-19 pandemic. GDP growth forecasts for 2022 and 2023 remain unchanged at 1.7% and 1.8%, respectively. The MPC assessed the risks to the growth outlook to the downside, driven by a possible slowdown in commodity prices, the longer-term damage caused by the pandemic and July’s unrests, ongoing electricity supply constraints, weak job creation, and subdued investment. Progress in the COVID-19 vaccine roll-out is however a potential source of upside to the outlook. Furthermore, the SARB’s implied starting point for the rand forecast is R15.1 to the US dollar, compared with R14.47 at the time of the previous meeting in September.
Retail activity made a welcome comeback in September, rebounding much faster than anticipated. Stores less severely hit by the social unrest in July performed strongly, providing the much-needed boost to the sector’s recovery. Retail sales for September significantly exceeded expectations increasing by 2.1% year-on-year. Most of this improvement was due to an 11.3% year-on-year surge in the sales of textiles, clothing, footwear, and leather goods. On a monthly basis, seasonally adjusted retail sales increased by 5.1%. Despite September’s performance, seasonally adjusted retail sales for the three months to September, which covers the third quarter of 2021, decreased by 5.4% compared with the second quarter of 2021, according to Stats SA. This suggests that the effect of the riots on the sector might be bigger than initially thought. Looking ahead, low-interest rates, increased vaccination uptake, Christmas shopping, and improved job security and prospects will probably continue to support the recovery. However, downside risks emanate from supply chain disruptions, unreliable energy supply, further Covid waves, and associated lockdowns. Furthermore, the effects of businesses harshly impacted by the looting will linger until operations are restored to full capacity.
SOUTH AFRICA: THE WEEK AHEAD
Contributed by Ingrid Breed
Leading Business Cycle Indicator, due Tuesday 23 November. The SARB’s composite leading business cycle indicator, which provides an insight into expected future economic and business conditions, is forecast to have increased 1.2% in September, up from the above-expectations improvement of 0.7% in October.
Producer Price Index, due Wednesday 25 November. Producer price inflation is expected to remain at elevated levels with the consensus expecting a slight increase to 8% year-on-year and 0.6% month-on-month in October from 7.8% and 0.9% in September. Rising food and fuel prices and persistent supply-chain constraints remain the key drivers.
RMB/BER Business Confidence Index, due Friday 26 November. No improvement is expected in business confidence from the third quarter’s sharp decline to 43 index points. The index is anticipated to remain unchanged at 43 due to the long-lasting negative impact from July’s unrest, the implementation of load-shedding, and the possibility of a fourth wave of Covid-19.
Private Sector Credit Extension, due Monday 29 November. The credit extended by the SARB to domestic borrowers is likely to have improved from its 1.6% growth recorded in September. The consensus forecast expects an expansion of 2.1% in October with credit extended to households remaining the key driver.
GLOBAL
Contributed by Nick Downing
Analysts are busy debating the implications of COP 26 on future investment returns. Moody’s has warned that the carbon transition will lift credit risk in the giant fossil fuel industry. Goldman Sachs believes the industry’s investment drought will cause oil and carbon prices to rise to unprecedented levels, with dire implications for inflation. The majority of investors feel companies will fail to meet their “net zero” commitments. There is a feeling that stakeholders, including companies and governments are merely paying “lip service” to carbon transition targets. Budgets are considered insufficient and ultimately global warming limits are unlikely to be met. This means “impact management” will become critical for investors as extreme weather will increasingly affect economic output and profit growth. While there is general disappointment over COP 26 commitments, the investment world will be fed with a growing stream of investable energy transition and environmental impact opportunities. Decarbonisation is expected to be a dominant secular growth theme for investors over the coming decade.
NORTH AMERICA
Contributed by Nick Downing
President Biden is expected to announce this week whether he wants Federal Reserve Chairman Jay Powell to be reappointed in February for a second four-year term or for Fed governor Lael Brainard to take the position. Democrat progressives prefer Brainard as she would be tougher on climate change and bank regulation, but Powell would offer continuity and greater comfort for financial markets. The decision is especially sensitive due to the surge in inflation over the past 6 months. Consumer price inflation has been above 5% on a year-on-year basis for 5 straight months, accelerating in October to 6.2% its highest since 1990. Core CPI, excluding food and energy prices, also accelerated from 4% to 4.6%, its highest since 1991. Biden is keenly aware that if inflation gets out of hand and entrenched at higher levels, he could lose his job to Donald Trump. Bond market yields indicate that inflation will eventually moderate back towards the Fed’s 2% average inflation target, as supply chain bottlenecks are resolved, and the world moves past peak energy prices and massive fiscal transfers. However, this view is becoming increasingly questioned. Some Fed policy makers are even starting to lose their resolve that the current inflation spike is transitory. Fed vice-chair Richard Clarida recently stated that the Fed could discuss at its upcoming December policy meeting a faster withdrawal in asset purchases, so that the programme expires before next June. This would pave the way for an earlier start to the interest rate hiking cycle. The Fed has confirmed that the asset purchase programme needs to end before interest rates can be lifted from their zero bound.
CHINA
Contributed by Nick Downing
Economic data was stronger than expected in October. Despite energy outages and a new wave of Covid cases, there was an improvement in both manufacturing and retail sales growth, confounding the consensus forecast for a further slowdown in activity. Year-on-year growth in manufacturing improved from 3.1% to 3.5% and retail sales growth picked-up from 4.4% to 4.9%, helped by increased online sales. Consumer activity was also boosted by steady jobs growth. However, regulatory curbs and fallout from the Evergrande debacle continued to weigh on the property sector. The year-on-year fall in new construction starts accelerated from 4.5% in the January-to-September period to 7.7% in the January-to-October period. New home prices fell for a rare second straight month, falling in October by 0.25% month-on-month, the biggest monthly decline since February 2015. The property market slowdown impacted fixed asset investment, with growth slowing from 7.3% on the year to 6.1% in the January-to-October period. Despite a stabilisation in manufacturing and retail activity, there are growing expectations that the government and People’s Bank of China (PBOC) will resort to policy stimulus to boost activity, notwithstanding elevated inflation readings. Although producer price inflation (PPI) surged in October from an already elevated 10.7% year-on-year to 13.5%, its highest since 1995, this is likely to mark the peak. Commodity and energy prices, blamed for the sharp PPI increase, have already started to stabilise. Meanwhile there is little pass-through to consumer price inflation, which remained moderate in October at just 1.5%, low enough to embolden the PBOC to enhance its policy stimulus.
JAPAN
Contributed by Carel la Cock
Japan’s economy contracted in the second quarter of the year and underperformed expectations as supply chain disruption and a resurgence in covid-19 cases tightened consumer spending and business investment while also throttling exports. The quarter-on-quarter contraction of 0.8%, or 3.0% annualised, was below the 0.8% annualised contraction expected by analysts. Private consumption fell by 1.1% quarter on quarter more than offsetting the 0.9% growth in the first quarter while exports were down 2.1% compared to the previous quarter, caused by production restrictions at automakers because of semiconductor shortages. Business and private investment were both key drivers to the poor performance, declining by 3.8% and 2.6% respectively compared to the previous quarter. While most central banks expect supply chain woes to continue into next year, some economists believe that we are past the worse and that global trade will pick up from here which will benefit exporting economies like Japan. Furthermore, Japan is now one of the most vaccinated nations in the world and with daily new covid-19 cases declining, consumer spending is expected to rebound in the fourth quarter boosting the economic recovery. In addition, newly appointed prime minister, Fumio Kishida, has announced a stimulus package containing cash handouts and subsidies for struggling households and small businesses to the tune of ¥43.7tn ($383bn) that will further boost a recovery in private consumption. The stimulus package is in contrast with other advanced economies that have since recovered from the pandemic and are more worried about inflation. The stimulus brings the total fiscal support since the start of the pandemic to ¥471tn or nearly 25% of GDP. It is believed the measures will lift the economy by 5.6%.
EUROPE
Contributed by Carel la Cock
The eurozone’s economy gained momentum in the third quarter and has nearly recovered to pre-pandemic levels. Quarter-on-quarter growth of 2.2% has also narrowed the recovery gap with the US and China but deteriorating supply chain bottlenecks and rising energy prices pose major headwinds in the last quarter of the year. Quarterly growth was mixed for the four largest nations in the bloc with France (+3%) and Italy (+2.6%) beating expectations, while Germany (+1.8%) and Spain (+2%) disappointed and both were still well below pre-pandemic levels by 1.1% and 6.6% respectively. Overall, the eurozone is 0.5% smaller than the fourth quarter of 2019. The German government has lowered its end of year growth predictions to 2.6% for 2021 from a previous 3.5% but increased its growth forecast for 2022 from 3.6% to 4.1% with a view that the current supply shortages will subside by the summer. Encouragingly, third quarter growth was mainly driven by higher household consumption in Germany and France while Spain saw a rebound in its key tourism sector which led to gains in retail, transport and hospitality. France also reported better than expected export growth of 2.3% and Italy is expecting growth of more than 6% for the year, which will be its fastest growth in nearly half a century. Employment increased 0.9% compared to the previous quarter following the 0.7% increase in the second quarter. According to the latest IHS Markit Europe Business Outlook the private sector remains positive in its outlook for the coming year and pins its hopes on a continuation of higher demand and sales as economies emerge from this year’s lockdowns. Corporate earnings are expected to improve despite rising costs which will likely impact manufacturers more than service providers.
UNITED KINGDOM
Contributed by Carel la Cock
The UK’s economy grew by 1.3% quarter-on-quarter in the third quarter, slowing down from second quarter growth of 5.5% and was below expectations of 1.5% as persistent supply chain bottlenecks cause disruptions in manufacturing. The main drivers of growth in terms of output for the third quarter were hospitality, arts and recreation as restrictions were finally lifted and the economy reopened while household consumption made the largest contribution to expenditure. Despite the growth in the last two quarters, the economy remains 2.1% smaller than pre-pandemic levels making it one of the worst performing developed economies. Temporary boosts to the economy came from the healthcare sector where visits to general practitioners were up following the end of covid-19 restrictions as well as an increase in conveyancing as homebuyers pushed through sales before the stamp duty holiday ended. In contrast, motor vehicle production fell by an eye popping 8.2% and car sales were also down as the global shortage in semiconductors impacted the industry. Overall, manufacturing is still down from pre-pandemic levels while business investment remains 12.4% below the end of 2019, indicative that there remains uncertainty about the UK’s recovery from the pandemic as well as its place in Europe since Brexit.
FAR EAST AND EMERGING MARKETS
Contributed by Carel la Cock
The latest IHS Markit India Business Outlook showed that private sector companies have become more optimistic since the June survey with a net balance of +14% forecasting output growth in the year ahead. Although sentiment has improved it is still below historic levels and below the emerging markets average of +23%. Companies are banking on a rebound in market conditions and a return to stronger demand as the pandemic fades. Survey participants saw growth opportunities in product expansions and new service offerings while expecting capital expenditure and spending on research and development to increase. Headwinds include further rises is staff costs and other input costs, but participants seem confident that these costs will be passed on to consumers. A rise in covid-19 cases and further lockdowns remain downside risks. Service providers expect to increase staff compliments in contrast to manufacturers that foresee job shedding in the year ahead. Finally, private sector companies expect earnings to improve in the year ahead, a turnaround from the June survey. The net balance of responses of +7% improved from -5% in June but still some way off the global average of +12% while Indian manufacturers were more optimistic than their service provider counterparts.
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 %
+ 19.29
+ 16.85
+ 21.83
+ 13.91
+ 7.31
– 0.76
+ 5.41
+ 24.68
+ 8.49
– 9.30
+ 3.58
+ 12.30
– 4.74
– 4.57
+ 53.15
Level
70865
14092
94905
65585
15.85
17.82
21.24
4682
29774
24689
3597
7255
1808
1023
79.33
THE BOTTOM LINE
Contributed by Kirk Swart
The South African Reserve Bank (SARB) has followed some central banks across the globe in raising the repurchase rate (repo) last week by 0.25%. The repo rate was raised from 3.5% to 3.75%. Future interest rate increases are not unexpected as rates across the globe have been lowered to multi-decade lows to combat the financial effect of the Covid-19 pandemic. While a normalisation in rates is expected, the pace at which it has arrived may have surprised many. It is feared in some corners that the SARB will raise the repo rate by 0.25% at regular intervals until pre-pandemic levels are reached at around 6.5%. The raising of rates is ‘data dependent’ which is a fancy way of saying that the SARB will keep an eye on inflation.
The South African Consumer Price inflation (CPI) figure for October came in at 5%, which is still within the target range of 3-6%. The current yield on the 10-year South African Government Bond is 9.68% offering investors a real yield of 4.68%. The real yield refers to the yield offered above the inflation rate. In contrast, US inflation for October registered a reading of 6.22%, while the current yield on the US 10-year government bond is 1.57% offering investors a real yield of -4.65%. The US figures would have undoubtedly influenced the SARBs decision to increase the repo rate.
The US Federal Reserve (FED) kept rates steady at 0 – 0.25% in early November indicating that they will not increase rates before the economy is strong enough following the pandemic. However, the economic recovery from the Covid crisis has been quick and strong. While global GDP declined by just over 10% between the fourth quarter of 2019 and the second quarter of 2020, it rebounded to 2019 levels by the second quarter of 2021 and is currently more than 5% above the 2019 level. The incredible rebound was made possible by the sheer size of policy support. Fiscal support following the pandemic is registered at 12% of global GDP. To put it in context, the global fiscal support during the 2008/09 financial crisis was only 2% of global GDP.
The strong and quick rebound in global GDP has had the unfortunate consequence of global supply constraints. These constraints are not only in physical goods such as semiconductors, which are likely to ease over time (transitory) but also in the labour market. Labour market shortages are becoming more pronounced due to workers retiring early, work from home initiatives changed the working environment, and workers demanding more flexible working conditions. Stimulus cheques sent to households have also been a factor in workers not returning to their previous employment. Labour market shortages can prove sticky as higher wage demands and better working conditions become intrenched.
To date it has been communicated by central banks that the inflation created by massive fiscal support will be transitory in nature. If some of the underlying inflationary pressures prove to be more permanent, many central banks of developed economies will raise rates quicker than they initially intended to. South Africa, being a net importer of goods, will continue to see an increase in inflation which is most likely the reason why a rate increase was pre-empted.
South African banks offer investors a perfect hedge against rising interest rates. In decades past, the banking industry was often described as operating according to the 3-6-3 rule. Take deposits at 3%, lent them out at 6% and be on the golf course by 3 o`clock. In fairness, modern banking is a little bit more complex than that, but the underlying fact remains true. Rising interest rates are good for banking margins.
South African banks have re-rated following the April 2020 lows but are still trading below the levels they traded at three years ago. Capitec and Investec* are the exceptions. FirstRand (FSR)*, ABSA (ABG), Nedbank (NED) and Standard Bank (SBK) are all trading below levels traded three years ago. Price to book ratios for these banks are close to 1 whilst trading at attractive dividend yields north of 5%. These banks are all well capitalised and any prolonged uptick in the interest rate will have a net positive effect on earnings.
The FTSE/JSE Financial 15 Index delivered a return of -13.89% over the last three years compared to 28.36% for the FTSE/JSE Top 40. This is a divergence of 42.28%. Rising interest rates might just be what South African bankers needed to be back on the golf course by 3 o`clock. *Overberg holds FSR and Investec on behalf of clients.
*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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