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In this week's bottom line - 30 November 2021
Preference shares have provided excellent income returns for investors since they were first listed on the JSE in the mid-2000s. Although they count as equity they have debt like characteristics, paying a yield linked to the prime rate, and are ahead of ordinary shares in terms of seniority.
Contributed by Werner Erasmus
Annual producer price inflation was 8.1% in October, up from 7.8% in September. The latest reading is the highest level recorded since February 2016. The producer price index (PPI) increased by 0.7% month-on-month. The main contributors to the headline PPI annual inflation rate were coke, petroleum, chemical, rubber and plastic products (Up 17.5%); food products, beverages and tobacco products (Up 5.6%); and metals, machinery, equipment and computing equipment (Up 10.1%). Overall, much like the rest of the world, the PPI suggests that South Africa’s producers continue to face rising input costs. Rising energy prices globally and supply chain bottlenecks have stoked fears that this will continue to feed into rising consumer inflation, which has proved far less transitory than many monetary policy authorities first thought. While the pass-through to consumers of these price pressures has so far been restrained, it remains an upside risk to consumer inflation. South Africa’s producer inflation is in line with global trends and is expected to remain high into 2022. Supply chain disruptions, elevated shipping and container costs, and still-high oil prices are all expected to continue to put upward pressure on producer inflation. Locally the weaker currency will put further strain on producers. These mounting cost-push pressures may eventually be passed on to consumers especially if demand strengthens.
After falling from 50 to 43 in the third quarter, the RMB/BER Business Confidence Index (BCI) remained unchanged in the fourth quarter of 2021. The recent strike by workers in the metal and engineering industry and ongoing power cuts continued to weigh on a recovery in business confidence in the fourth quarter. Business confidence is an important ingredient for much-needed fixed investment, which helps spur job creation and economic growth. The index’s neutral mark is 50, with a reading below deemed to be negative. Looking ahead, various factors such as supply chain disruptions, insufficient stocks, load-shedding, and escalating cost increases are expected to continue, which will put further pressure on business, dimming hopes for an early recovery in business confidence.
SOUTH AFRICA: THE WEEK AHEAD
Contributed by Ingrid Breed
Private Sector Credit Extension, due Tuesday 30 November. The credit extended by the SARB to domestic borrowers is likely to have improved from the 1.6% growth recorded in September. The consensus forecast is that it expanded 1.75% in October with credit extended to households remaining the key driver.
Unemployment Rate, due Tuesday 30 November. The third quarter’s unemployment rate is anticipated to have increased to a new record level of 35.6% after recording the highest jobless rate on record of 34.4% in the second quarter. The continuing high unemployment rate is expected as a result of the worsening pandemic and as a long-term consequence of the looting and unrest during July.
Balance of Trade, due Tuesday 30 November. The October trade balance is likely to have continued being supported by the surge in commodity prices, sustaining the consistent trade surplus recorded since the second half of 2020. The consensus is that the trade surplus increased to R23 billion in October from R22.2 billion in September.
Absa Purchasing Managers’ Index, due Wednesday 1st December. November’s Absa manufacturing Purchasing Managers’ Index is expected to have eased marginally in November, albeit remaining in expansionary territory for a fourth consecutive month. The consensus forecast is that it will come in at 53.3 index points from 53.6 in October. The expected improvement is premised on the traditional seasonal lift ahead of the festive season. However, unstable electricity availability and global supply shortages continue to weigh on the manufacturing sector.
New Vehicle Sales, due Wednesday 30 December. New vehicle sales are likely to have increased slightly by 6.3% year-on-year in November from 6.1% in the preceding month, although load shedding may cause a negative surprise to the data.
IHS Purchasing Managers’ Index, due Friday 3 December. The IHS Markit South Africa Purchasing Managers’ Index, which covers the entire economy, is expected to have expanded in November to 50.3 index points after falling to a sub-50 contractionary reading of 48.6 index points in October. The improvement is premised on a traditional seasonal lift ahead of the festive season.
Contributed by Nick Downing
In a coordinated move, a group of countries including the US, UK, China, Japan, South Korea and India, agreed to release between 65-70 million barrels of oil from their national strategic reserves, over coming months. The Brent oil price jumped over 3% on the news to over $82 per barrel as markets had expected a larger release. However, the oil price slumped later in the week with news of the Covid Omicron variant, dropping by 12% last Friday to under $73 per barrel. The US will release 50 million barrels from its 600-million-barrel Strategic Petroleum Reserve, but the move is largely symbolic as it comprises only 2.5 days’ worth of US consumption. President Biden’s popularity has slumped to a post-election low, attributed to rising inflation. He wants to be seen to be doing something about inflation, which is largely rooted in surging fuel prices. Fuel prices have gained by over 70% over the past 12 months. Biden’s pleas to the OPEC + oil cartel to raise production, have fallen on deaf ears. OPEC + started at the beginning of the year to raise production by 400,000 barrels per day every month until it reaches pre-pandemic output levels. This may be considered too slow given the speed of global economic recovery, but the cartel is concerned that any bumps along the way could drive the oil price sharply lower if production is levelled too high. Oil producers are scarred by their experience in April 2020 when oil prices fell at the outset of the pandemic into unchartered negative territory. The sudden arrival of Omicron may even prompt OPEC + at its upcoming monthly meeting on 2nd December to pause its monthly production increases, much to the frustration of the White House and consumers generally.
Contributed by Nick Downing
Minutes from the Federal Reserve’s policy meeting on 2-3rd November reveal substantial and growing debate over the inflation outlook, with some members of the Federal Open Market Committee calling for the withdrawal of monthly asset purchases to be accelerated. As it stands, the $120 billion per month Treasury and mortgage bond asset purchase programme will be tapered by $15 billion per month so that the programme expires by June next year. According to the Fed minutes, some officials “preferred a somewhat faster pace of reductions that would result in an earlier conclusion to net purchases.” An earlier conclusion would pave the way for an earlier start to interest rate hikes. However, the debate at the Fed appears evenly balanced with other officials arguing for a “patient attitude toward incoming data” due to continued uncertainty over the course of the pandemic and supply chain logjams. Upon the release of the Fed minutes interest rate futures attributed a greater than 50% probability to the first increase occurring by May but since the news of the Omicron Covid variant, the expected interest rate trajectory has dropped back to a post June rate hike. Having successfully navigated the pandemic with unprecedented monetary stimulus, the Fed is now under pressure to navigate the highest inflation since 1990. Consumer price inflation is at 6.2% and the Fed’s preferred inflation measure, the personal consumption expenditures index also accelerated in October from 3.7% to 4.1% at the core level, excluding food and oil prices. Perhaps for this reason, President Biden chose last week to reappoint Jay Powell to a second four-year term, when his tenure expires in February. Powell provides continuity. Lael Brainard, a Democrat who had been tipped to replace Powell was chosen for the Fed vice-chair. The appointments will be ratified by the Senate.
The economy showed signs of strengthening momentum in the fourth quarter (Q4), making up for the Delta-variant induced soft patch in Q3. Household spending which contributes three-quarters of US GDP, grew in October by a solid 1.3% month-on-month. Businesses also ramped up spending. New orders for non-defence capital goods excluding aircraft, a proxy for business investment, increased in October by 0.6% on the month. A tightening labour market is prompting businesses to increase spending on new machinery and technology. The trend is expected to continue into 2022 amid buoyant business confidence. Meanwhile, initial jobless claims fell sharply in the past week, dropping on a seasonally adjusted basis from 260,000 to 199,000 the lowest since November 1969, indicating an extremely tight labour market despite there being 4 million fewer employed than immediately prior to the pandemic. A tight labour market, record high job openings and strong wage growth contributed to a healthy 0.5% month-on-month increase in personal incomes in October. Household spending and business investment are likely to continue driving above-trend GDP growth into 2022.
Contributed by Nick Downing
China posted upbeat economic data over the past week. Trade volumes continued to surge, with exports rising in April by 32.3% year-on-year up from 30.6% in March. Exports to Southeast Asian countries were especially strong, rising by 40% on the year. China’s imports also gained by a solid 43.1% on the year, attributed to surging commodity prices but also recovering domestic demand. Consumer spending, the relative laggard in China’s post pandemic recovery, appears to be making a comeback with anecdotal evidence of significant growth in tourism travel and box office expenditure in May’s Labour Day holidays. The Caixin/ISM service sector purchasing managers’ index (PMI) also surged higher in April from 54.3 to 56.3 its highest in five months, indicating increased expenditure on consumer services. In contrast with last year, consumer spending is likely to take over from manufacturing as the main driver of China’s economy in 2021. Nonetheless, the manufacturing Caixin PMI also gained in April from 50.6 to 51.9, contributing to an increase in the composite PMI from 53.1 to 54.7, well above the neutral 50-level which demarcates expansion from contraction. However, Wang Zhe, senior economist at Caixin cautioned against rising inflationary pressures, “In the coming months, rising raw material prices and imported inflation are expected to limit policy choices and become a major obstacle to the sustained economic recovery.”
Contributed by Carel la Cock
Japan’s private sector business activity sped up its recovery in November with the Flash Composite Output Index up 1.4 points to 52.1, marking its quickest rise in more than three years. Service sector activity improved with the Flash Services Business Activity Index rising to 52.1 from 50.7 in October, the quickest rise in over two years, helped by new business inflows. However, employment levels declined while input price inflation rose for a third consecutive month, reaching highs last seen in 2008. Despite input inflation and lower staff levels, service providers showed record levels of optimism for activity in the year ahead. The Jibun Bank Flash Japan Manufacturing Purchasing Managers’ Index, which measures the overall health of private sector manufacturing, improved to 54.2 in November from 53.2 last month. The Flash Manufacturing Output Index gained 2.9 points in November to 53.5 and manufacturers highlighted higher new order growth despite continued inflationary pressure due to ongoing supply shortages. Input price inflation was the highest since August 2008. Positive sentiment remained in the sector despite a slight decline from last month. Usamah Bhatti, economist at IHS Markit warns, “Firms across the Japanese private sector reported intensifying price pressures. Input prices across the private sector rose at the fastest pace for over 13 years with businesses attributing the rise to higher raw material, freight and staff costs amid shortages and deteriorating supplier performance.”
Contributed by Carel la Cock
Germany’s provisional inflation number recorded its highest level in nearly two decades, but economists argue that inflation in Europe’s largest economy has peaked and is likely to recede from the current level. The consumer price index rose by 5.2% compared to a year earlier, quickening from the 4.1% and 4.5% yearly growth recorded in the last two months. Surging energy prices, which were 22.1% higher than a year ago, contributed significantly to goods inflation which rose from 4.5% last month to 5.2%. Food prices were only marginally higher at 4.5% yearly growth compared to 4.4% in October. Services inflation rose to 2.8% from 2.4% the month before while rents were 1.4% higher than a year ago, the same rate as last month. A European Central Bank (ECB) executive board member said in an interview that “November will prove to be the peak” and economists have highlighted factors such as the effect of last year’s sales tax cut, that will soon drop out of the inflation numbers. Restrictions to curb rising covid-19 cases are likely to weaken consumer demand and dampen price pressures. Other European nations have also reported record high inflation. Among them Spain and Belgium both at 5.6% while the inflation figure for the single currency bloc is expected to come in at 4.4% for November, more than double the ECB’s target of 2%. ECB president, Christine Lagarde, maintained last week that evidence points to inflation fading by next year and that it would be wrong to hike rates now only for the effect to be felt in 18 months when inflation would already have subsided. The latest covid-19 variant has roiled markets and is likely to exacerbate supply shortages while negatively impacting services and consumer demand, strengthening the case to keep interest rates lower for longer.
Contributed by Carel la Cock
The UK private sector output growth largely maintained its momentum in November while purchasing managers reported the fastest rise in average cost inflation since records began in 1998, driven by higher energy costs, raw materials and wages. The IHS Markit/CIPS Flash UK Composite Output Index for November at 57.7 was in line with October’s 57.8 and growth in the services sector which comprises nearly 80% of the UK economy, outpaced growth in manufacturing despite the latter experiencing the strongest expansion in three months. Output growth was attributed to rising client demand and confidence from improving economic conditions which also boosted new orders. Export growth was driven by the service sector which reported the strongest rise in new business from abroad in over three years, in contrast to manufacturers who saw a third consecutive monthly drop in exports. Staff levels increased off the back of robust customer demand, rising for a ninth consecutive month with employers noting that recruitment difficulties and market churn have resulted in constrained growth. Chief business economist at IHS Markit, Chris Williamson, notes “For policymakers concerned about the health of the labour market after the end of the furlough scheme, the buoyant jobs growth signalled should bring some reassuring comfort.” He adds, “The latest survey results will none the less likely shorten the odds of an interest rate hike at the Bank of England’s December meeting.” His comment echoes those made by the Bank of England’s new chief economist, Huw Pill, when he said on Friday that economic conditions now existed for him to be swayed to vote in favour of a rate hike. This despite the latest news of the covid-19 variant that spooked markets on Friday. The monetary policy committee will vote on a rate hike in just over two weeks, enough time to get a better understanding of the impact of the latest virus variant.
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 %
JSE All Share
JSE Fini 15
JSE Indi 25
JSE Resi 20
Y to D %
THE BOTTOM LINE
Contributed by Nick Downing
In general, people take far too little risk in their investment careers, even when generating income. The conventional wisdom is that an income portfolio should lie at the low end of the risk spectrum. The starting point in structuring the portfolio is mistakenly risk rather than return. As a result, these portfolios gravitate towards ultra-low risk and ultra-low return instruments such as money-market funds, which currently yield a paltry 3.5%, even less than the rate of inflation. The nominal return is 3.5% but the real return after taking the 5.0% inflation rate into account is 5% less 3.5%, which equals -1.5%. Financial advisers and their clients tend to be too fixated on risk, which often results in too little spending power in the retirement years.
Preference shares have provided excellent income returns for investors since they were first listed on the JSE in the mid-2000s. Although they count as equity they have debt like characteristics, paying a yield linked to the prime rate, and are ahead of ordinary shares in terms of seniority. Preference shareholders must be paid out in full first before any dividends can be distributed to ordinary shareholders. Over the long-term, preference shares have outstripped both bonds and cash. A year ago, due to pandemic risk aversion, preference shares were trading at record low levels with pre-tax yields well above 10% in some cases. The valuation anomaly has since been corrected and prices have surged over the past 12 months. There has been a double whammy, both attractive dividend income as well as substantial capital growth. In some instances, prices have surged over 50%. Adding fuel to the rally, some of the preference shares have been redeemed by their issuers as they were considered too costly. The banks, in particular, are anxious to redeem what they now consider to be an expensive form of debt. Changes in banking regulations mean banks can no longer count preference shares as part of their primary capital. So far this year, preference shares have already been redeemed by PSG and Sasfin. Nedbank and Investec are in the process, with offers already posted to shareholders. The flipside of preference share capital being too costly for the issuer is that it provides excellent value and an important source of income for investors.
Other preference share issues will also be redeemed. This ought to create an additional uplift to preference share prices, but financial markets are forward looking and much of this upside has already been discounted. As prices have firmed so the yields have compressed, providing less value for investors. With the redemptions, the preference share universe is also shrinking, which is regrettable for investors.
The pre-tax yields on the bank preference shares have compressed significantly over the past 12 months. With the Nedbank preference shares, for instance, the yield has dropped from over 9% to just over 6%. Meanwhile, the ordinary shares trade on an estimated 12-month forward dividend yield of over 7%. The risk might be higher as ordinary shares are lower than preference shares on the pecking order of capital seniority, but unlike preference shares have the potential to grow the dividend over time in line with rising profits. At this point, it makes sense to switch the Nedbank preference shares for Nedbank ordinary shares.
There are many shares that pay ordinary dividend yields that beat the money market rate. Bank shares and commodity shares pay dividend yields of 5% or more. Real estate investment trusts (REITs) also pay attractive yields, which hold the potential of growing over time. REITs have suffered a tremendous knock as shopping malls and offices emptied over the pandemic and are still at depressed levels, but the cheap share prices provide upside in terms of both yield expansion and capital growth. Growthpoint, the country’s largest REIT with a market capitalisation of R45 billion, trades on an estimated 12-month forward yield of 10%. Even if the forward estimate is wildly optimistic, the yield would still in the worst-case scenario be comfortably above the money market yield and inflation rate.
Despite their dramatic re-rating, some of the non-bank preference shares still offer compelling value, with pre-tax yields of around 8% in the case of the Discovery, Grindrod and Netcare. With their yields linked to prime, income will increase in line with rising interest rates, unlike conventional bonds which pay a fixed coupon and therefore offer no protection against interest rate risk. Preference shares also hold tax advantages. Their yields incur a 20% dividend withholding tax rather than a maximum 45% interest income tax, which is the rate levied on bonds and REITs.
Nonetheless, investors can look confidently to the bond market as an alternative and complimentary source of superior income yields. South African government bonds pay amongst the most generous income yields in the world. The 10-year government bond pays a yield of 9.40%, a whole 4.4% above the inflation rate and almost 6% above the money market rate.
A long-term investment strategy is traditionally reserved for growth-oriented portfolios, but investors should adopt a similar time horizon when planning for their income needs. A share in profit growth (ordinary shares and REITs) is vital for keeping up with inflation. Where fixed yields are concerned, there are far superior alternatives (preference shares and bonds) to money markets. Money markets play an important role, for holding cash that is already budgeted, but should never play a pivotal role in a long-term portfolio. It is advisable to contact your personal advisor or asset manager before structuring a long-term growth-oriented income portfolio. Such a portfolio should be professionally structured and actively managed.
*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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