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In this week's bottom line - 14 December 2021
Looking into the crystal ball
In recent weeks analysts and economists have been making predictions on what will move markets and drive economic growth in the coming year. Markets are forward looking and as the year draws to a close, we look at the most important themes that will shape the year ahead.
Contributed by Werner Erasmus
Inflation accelerated at its fastest pace in more than a year but remains within the Reserve Bank’s 3%-6% target band. Consumer prices rose 4.4% in April, slightly faster than economists expected and the most since February 2020. The key driver of the year-on-year CPI jump was of course fuel prices, and food and non-alcoholic beverages. On a month-on-month basis, the rate of change was 0.7%, compared to a 0.5% drop in the same period in 2020, the first full month of the lockdown. The SARB in its latest MPC statement expects the headline consumer price inflation forecast for 2021 to be slightly lower at 4.2% (down from 4.3%) and for 2022 and 2023 unchanged at 4.4% and 4.5%, respectively. Higher electricity and fuel prices have recently put upward pressure on inflation expectations, although going forward a stronger exchange rate, ongoing moderation in unit labour costs, and sustained economic slack are expected to offset higher electricity and food price inflation, keeping the headline inflation forecast relatively stable. Overall, the SARB expects inflation for the year to remain stable despite overall inflation risk increasing, before rising to around the midpoint (4.5%) of the inflation target range in 2022 and 2023.
The South African Reserve Bank kept its repo rate unchanged for a fifth straight meeting. The Monetary Policy Committee (MPC) kept the repurchase rate at 3.5% (prime rate at 7%), the lowest level since it was introduced in 1998. The bank’s growth forecasts were lifted slightly, largely in response to stronger support from the elevated terms of trade as a result of higher commodity prices. The SARB expects Gross Domestic Product (GDP) to grow by 4.2% in 2021 up from 3.8%. Getting back to pre-pandemic output levels, however, will take time with SARB expecting GDP to grow by 2.3% in 2022 and 2.4% in 2023, little changed since the March meeting. The bank’s Quarterly Projection Model (QPM) still indicates an increase of 25 basis points in each of the second and fourth quarters of 2021 although the overall tone of the MPC statement gives the impression that the bank will keep rates lower for longer. The SARB noted important macroeconomic gains would be realised by achieving a stable public debt level, increasing the supply of energy, moderating administered price inflation, and keeping wage inflation low into the recovery.
Real retail sales declined by 2.5% year-on-year March, following a downwardly revised 2.2% rise in February and surprising markets that expected a 1.9% gain. The biggest drag came from general dealers declining 9.3% year-on-year. However, despite falling by 3.7% month-on-month, sales volumes still rose by 1.5% quarter-on-quarter in the first quarter of 2021. This was on the back of a solid 6.9% month-on-month gain recorded in February. Looking ahead household balance sheets are likely to remain under pressure for some time as high unemployment persists and debt as a percentage of disposable income remains elevated. Only a modest lift in household consumption expenditure is expected in the near term with tighter restrictions remaining a risk to economic recovery although the vaccination roll-out, which commenced on 17th May, should boost consumer confidence somewhat.
Both S&P Global and Fitch Ratings left their long-term sovereign credit ratings for South Africa unchanged at BB-, which is three levels below investment grade, retaining their stable and negative outlooks, respectively. While expected, the confirmation will come as somewhat of a relief for the National Treasury, which is trying to make headway in getting the country out of ‘junk’ status. S&P Global Ratings warned that while the South African economy should rebound from 2020’s steep contraction, growth prospects are clouded by downside risks. They noted that structural constraints, a weak pace of economic reforms, and low vaccination rates will continue to constrain medium-term economic growth and limit the government’s ability to contain the debt-to-GDP ratio. Earlier last week, Moody’s had commented in its annual report (not a rating review) that South Africa faces the risk of even more tense socioeconomic relations amid slow economic growth, too little job creation, and rising public debt. On a more positive note, the rating agencies also listed South Africa’s strengths including a credible central bank, a flexible exchange rate, an actively traded currency, deep capital markets as well as a favourable debt structure [low share of foreign currency debt] with long maturities, which should help counterbalance low economic growth and fiscal pressures.
SOUTH AFRICA: THE WEEK AHEAD
Contributed by Ingrid Breed
Composite Leading Business Cycle Indicator, due Tuesday 25 May. No radical change is expected in the South African Reserve Bank’s (SARB) composite leading business cycle indicator for March. The consensus forecast is for a 1.8% increase, a slight decrease from the 2% growth recorded in February.
Producer Price Inflation, due Thursday 27 May. The consensus forecast is that April PPI increased 6.7% month-on-month and 1.6% year-on-year, up from 5.2% and 1.3%, respectively in March. The expected jump is attributed to the base effect of last year’s low readings, along with continued high fuel and transport prices, higher intermediate input prices and supply chain difficulties caused by the Covid-19 pandemic.
Balance of Trade, due Monday 31 May. After recording the largest ever monthly trade surplus of R52.77 billion in March South Africa’s trade surplus is expected to narrow to R25 billion in April. The trade surplus is nonetheless expected to come in strong as a result of the increase in export commodity prices albeit smaller than the previous month.
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.
Contributed by Nick Downing
The monthly increase in nonfarm payrolls slowed dramatically in April to just 266,000 well below the consensus forecast of 1 million new jobs and the downwardly revised figure of 770,000 in March. The unemployment rate inched higher from 6.0% to 6.1% as more people entered the labour market. Total employment is still down by 8.2 million compared with February 2020. The employment data surprise is attributed to enhanced unemployment benefits of $300 a week which run until September, creating a disincentive to work in lower paying jobs. Home child-care and continued fear of the Covid virus are also keeping people from joining the labour market, contributing to the unusual combination of labour shortages and high unemployment. Average hourly earnings unexpectedly increased in April by 0.7% month-on-month, supporting the anecdotal evidence of rising labour shortages in certain sectors. Despite the extenuating circumstances, the subdued labour data should help ease fears of an over-heating economy and its inflationary risks and anxiety over the Federal Reserve lifting its accommodative monetary policy settings earlier than expected. The jobs data should also add extra impetus to Joe Biden’s proposed infrastructure spending plans.
In its semi-annual Financial Stability Report, the Federal Reserve stated that Covid 19 was the biggest threat to financial stability but also 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. According to the report, “Should risk appetite decline from elevated levels, a range of asset prices could be vulnerable to large and sudden declines, which can lead to broader stress to the financial system.” The listing boom in special-purpose acquisition vehicles (SPACS) was cited as evidence of unusually high investor risk appetite. The Fed’s report also highlighted difficulty in monitoring hedge fund leverage and associated risks, citing the collapse of Archegos Capital Management. Although the collapse caused several billion dollars of bank losses, the Fed was comforted by the general health of bank balance sheets and household finances. Moreover, the Fed advised that businesses were well positioned to service their debt with help from strong earnings growth and low interest rates.
Treasury Secretary Janet Yellen spooked financial markets which are anxious that the Federal Reserve sticks to its accommodative monetary policy guidance, when she said, “It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat”. As it stands, the Fed expects the fed funds rate will remain at its current setting of 0-0.25% until 2024. Political appointees do not usually interfere with Fed policy and given the statement’s impact on financial markets she quickly offered further explanation later the same day, mirroring Fed chair Jay Powell’s view that inflationary pressures would not be persistent. She also added that Joe Biden’s $4 trillion infrastructure and social development spending plans would not lead to an over-heating of the economy as spending would be spread out over 8-10 years. Moreover, the planned expenditure would enhance productivity, thereby constraining inflation.
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 Consumer Confidence Index declined in April, falling by 1.4 points to 34.7 and breaking the upward trend that started in February. Consumer optimism was down across all sentiment sectors – Overall Livelihood (-1.1), Income Growth (-0.6), Employment (-1.9) and Willingness to buy durable goods (-1.9). The percentage of respondents expecting prices to rise in the year ahead increased by 4.7% points to 76%, marking the highest level since February 2020. Only 6.3% of respondents expect prices to go down, falling by 2.7% from March. The latest survey results points to ongoing pessimism amongst Japanese consumers. However, high savings ratios recorded last year, and the expectation of higher prices could become the catalyst for a consumer led recovery as the global economy starts to build momentum.
Japanese private service sector activity continued to stabilise in April according to the latest Jibun Bank Flash Japan Services PMI. The headline Services Business Activity Index, tracking the change in the volume of business activity from the month before, came in at 49.5 compared to 48.3 in March and just below the key 50-level separating expansion from contraction. Demand for services has stabilised and is back at levels last recoded at the start of 2020, before the covid-19 pandemic became widespread. It marks the lowest contraction in business activity in 15 months and reflects the lower restrictions on firms during April, partly offset by the reintroduction of certain restrictions at the end of the month. Encouragingly, employment levels improved for a third straight month and job creation was the strongest in two years. Costs were also notably higher, driven by higher staff costs and raw materials but were passed on to customers, leading to services price inflation for the first time since February 2020. Overall firms in the private service sector expect activity to keep expanding in the year ahead and remain confident that a successful vaccination program would support a further recovery in demand.
Meanwhile, Japanese manufacturing expanded in April and showed the strongest improvement in operating conditions since 2018. The Jibun Bank Manufacturing PMI reading at 53.6 in April was 0.9 points higher than March and the highest since April 2018. Production volumes improved and output saw a third monthly improvement and at the fastest pace in three years. An uptick in demand has been singled out as the main driver and anecdotal evidence points to an increase in client confidence in both domestic and international markets as the global economic recovery gets underway. Employment levels also expanded as firms anticipates higher order volumes although the rate of new positions created was only marginally higher overall. Upward pressure on input prices continued in April leading to the rate of inflation rising to the highest since November 2018. Firms passed on the increased costs to clients marking the fifth consecutive month of higher output prices. Looking ahead, manufacturers reported increased confidence about business conditions in the next twelve months based on the belief that a broad economic recovery will be realised once the pandemic is over.
Contributed by Carel La Cock
The eurozone’s economy contracted for a second consecutive quarter at the start of the year, leading the single currency block to slide into a technical recession for a second time in the past year. The economy contracted by 0.6% quarter-on-quarter following the 0.7% fall in the last quarter of 2020 and came off the back of a resurgence in covid-19 cases at the start of the year with more stringent lockdown measures to prevent a third wave of infections. Germany, the largest economy in the eurozone, reported a 1.7% quarter-on-quarter contraction with higher manufacturing exports more than offset by lower consumer spending. In Spain, household consumption and subdued manufacturing, and in Italy, lower services sector activity, caused both economies to suffered similar fates, contracting 0.5% and 0.4% respectively. Portugal fared even worse, contracting 3.3% following the spike in covid-19 cases in the first quarter. France managed to buck the trend, reporting growth of 0.4% and helped by improved consumer spending and a recovery in construction. Expectations for a swift recovery in the second half of the year remain intact and supported by the latest PMI survey results. The Eurozone Composite Output Index was stable at 53.8 in April while the Eurozone Services Business Activity Index showed an expansion in April, rising from 49.6 in March to 50.5. Economists expect a consumer driven recovery this year, predicting that consumers will unleash an additional €170bn in spending as they whittle down their excess savings from last year. The recovery expectation is underpinned by increased vaccinations which will lead to further relaxing of restrictions. The European Central Bank (ECB) expects the economy to expand by 4% and 4.1% in the next two years, returning to pre-pandemic levels by 2022.
Contributed by Carel La Cock
Economic growth in the UK is expected to be better than previously expected according to the latest meeting notes from the Monetary Policy Committee (MPC). Andrew Bailey, Bank of England (BoE) governor, said that the central bank expects gross domestic product to grow by 7.25% this year, improving from the expected 5% growth predicted only three months ago. The faster recovery will be driven by a recovery in consumer spending while unemployment will ease from a previously expected peak of 7.75% to a new expected peak of 5.5%. Inflation is expected to rise from the current 0.7% hitting the 2% target later this year and is likely to then recede. However, the BoE has indicated that it will wait for signs of sustained inflationary pressure before thinking about hiking rates. Consequently, the Monetary Policy Committee (MPC) voted to keep the benchmark interest rate at 0.1%. Markets are pricing in a rate hike by next year only, expecting rates to remain at historic lows for the remainder of the year.
PMI and job survey data released last week have corroborated the view of the MPC. The KPMG and REC UK Report on Jobs showed that permanent placements have improved at the fastest pace since 1997 and that the availability of candidates has dropped causing wages to rise. The improved employment conditions were due to further easing in lockdown restrictions and improved business confidence following the successful rollout of vaccinations. The UK services sector improved again in April, according to the CIPS UK Services PMI which reported a Business Activity Index reading of 61.0, up from 56.3 in March and the highest reading since October 2013. Private sector service firms confirmed the flow of pent-up demand and expect demand to improve as the successful vaccine roll-out keeps supporting consumer confidence. Signs of inflationary pressures remain a concern as many firms indicated that higher staff costs and increased raw material prices have added to their business costs rising at the fastest pace since February 2017. Manufacturing continued to expand in April, although the rate of expansion has fallen below that of the services sector. Similarly, input price inflation in the manufacturing sector, has seen average costs rising at the fastest pace since November 2017. The outlook for both services and manufacturing were the strongest since 2012.
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.
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JSE Fini 15
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THE BOTTOM LINE
Contributed by Carel La Cock
Inflation: No discussion about the global economy will be complete without considering the impact inflation will have on the markets in the coming year. The latest inflation reading out of the US marked a three-decade high capping a year-on-year growth of 6.8%. Similarly, Germany reported its preferred harmonised index of consumer prices which shot up by 6% last month, a figure not printed since reunification. Fiscal and monetary stimulus by the developed world aided economies to bounce back from one of the worst recessions in modern history. Households satisfied pent up demand for goods after a period of unprecedented high savings and suppliers could not keep up. Inflation has been building steadily during the year. Early evidence emerged from purchasing managers’ indexes (PMI’s) across the world where lead times on inputs deteriorated month after month, causing input costs to spike while manufacturers successfully passed the higher costs on to consumers.
The services sectors remained subdued due to restrictive measures following subsequent waves of covid-19 infections and only experienced price pressures toward the latter stage of the year as firms struggled to fill vacancies. A surge in energy prices in Europe and the United Kingdom have exacerbated the situation. As a result, industries and countries experienced an uneven recovery and central banks have been reluctant to start hiking interest rates in fear of stunting economic growth. Labour shortages remain a concern and the employment cost index in the US, a key metric for the US Federal Reserve, has hit a thirty-year high of 1.3% quarterly growth in the third quarter. Labour participation rates have also been falling and talk of “transitory” inflation has cooled. It is now widely expected that inflationary pressure will remain well into the new year and that we could see central banks hiking rates at a faster pace than initially communicated. The US and UK could see rates of 1% and 0.75% by the end of next year according to Investec Chief Economist, Philip Shaw.
Pandemic: The pandemic will continue its trajectory from a pandemic to an endemic disease according to journalists at The Economist. Early anecdotal evidence suggests that the latest variant, Omicron, are already showing signs that the virus is mutating towards becoming more transmittable but less deadly. Advances in vaccines and the introduction of pills, which significantly reduce the risk of hospitalisations, will continue to brighten the outlook for 2022. However, uneven distribution of vaccines to poorer countries creates a hot bed for future mutations and poses a significant threat to global health. There is no better time to heed the World Health Organisation’s mantra of “No one is safe until everyone is safe.”
Travel: Travel in 2022 will become more expensive and will impact on the tourism industry. During the lockdowns of the last two years, businesses have been lauded for the speed of their innovation and adoption of technology to overcome restrictions in travel. The pandemic has accelerated the migration of business into the digital sphere and as a result industry experts expect business travel to be less than half the level pre-pandemic. The tourism industry relies on expensive business travel to subsidise leisure travel and we could see holidays becoming significantly more expensive in the next few years.
Crypto and digital currencies and the future of finance: The recent rise and fall of the Squid Game meme coin has highlighted the need of regulation in an industry that has risen into mainstream finance. After being minted following the meteoric rise of the Netflix production, Squid Game, the meme coin followed a similar trajectory and rose 230 000% to $2,856 before plummeting to zero and leaving punters “rugged”. Tom Standage, deputy editor of The Economist compares crypto currencies to Napster, the illegal music sharing website of the nineties. The concept of a “jukebox in the sky” was appealing, but totally illegal and it took several years for the idea and the technology to be developed and turned into a successful and legal business model by Spotify. Similarly, he sees that regulation and the “domestication” of the crypto industry could shape the finance industry in the next few years. On top of that, central banks are also poised to issue digital currencies and China has made significant strides in that regard. Amongst some of the benefits is that it will allow central banks greater control of cutting rates below zero or to stimulate the economy more effectively.
Global Economic Growth: Developed economies have rebounded strongly and most will have recovered to pre-pandemic levels by the end of the year. The threat of persistent inflation and imminent rate hikes, pose significant headwinds to sustained growth and the risk of future covid-19 variants looms large. That said, economists are predicting economic momentum to carry into next year. Investec predicts that global economic output will be 5.5% larger this year, easing to 4.5% by the end of 2022. Capital Economics forecasts global growth to peak this year at 6% and then fading faster to 4% and 3.5% in the next two years. The Organisation for Economic Co-operation and Development have similar predictions, putting global growth for the year at 5.6% and moderating to 4.5% and 3.2% in subsequent years. Despite global economic growth easing in the next few years, financial markets will continue their steady march ahead. Earnings will continue to catch up with stretched valuations, allaying investors’ fears of an imminent bear market. According to Capital Economics, the S&P 500 will stagnate in the next few years and will end 2023 on the same level as this year. Germany’s DAX 30 is expected to perform well once supply bottlenecks clear, especially in semiconductors, boosting its auto industry. The UK, Japan and emerging markets will see stock markets improve more modestly.
The best weapon against uncertainty and volatility in the year ahead is diversification. The risk of persistent inflation, rising interest rates and covid-19 resurgence will no doubt cause short term volatility, but will present opportunities for the savvy investors that a have a well-diversified portfolio that can weather the storm.
*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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