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Contributed by Werner Erasmus
Absa’s purchasing managers index (PMI) rose to 57.1 index points in January from 54.1 in the previous month. The current level is in line with November’s reading, but above the average recorded in the fourth quarter of 2021 and reflects a strong start to the year for the manufacturing sector. The improvement is largely due to a rebound in business activity. The forward-looking index (expected business conditions in six months’ time) painted an even more optimistic picture, rising to an almost four-year high of 71.3 points. The improved reading comes as restrictions aimed at slowing the spread of the pandemic were eased further in December and several trading partners lifted travel bans on South Africa after it exited the fourth wave of Covid-19 infections that ensued following the onset of the Omicron strain. All the major subcomponents of the index excluding supplier performance rose in January. The new sales orders sub-index climbed to 55.5 from 51.7, while the sub-index measuring business activity climbed by almost eight points. While it is difficult to pinpoint the reasons for the stark improvement, the most likely is that future virus surges may not come with the strict restrictions on activity that limit output growth.
New vehicles sales increased by 19.5% year-on-year in January. Sales of passenger cars increased by a notable 26.6% on the year. The vehicle rental industry was responsible for 12.3% of total vehicle sales last month. This is another sign that the tourism sector is recovering, albeit tentatively. Less promising was the 9.3% year-on-year decline in vehicle exports during January. This is, however, expected to pick up through 2022 as major producers plan to introduce new models for the export market. NAAMSA noted in its press report that the new vehicle market is expected to continue its gradual recovery to pre-COVID-19 levels in line with the moderate economic growth forecast for South Africa for 2022, but at a slower pace. The South African Reserve Bank increased its benchmark repo rate by 25 basis points to 4% at its January 2022 meeting due to increased inflation risks. Inflation has been fuelled, amongst others, by record-high fuel prices, rising food and energy costs as well as a depreciating rand exchange rate. Consumer and business sentiment will therefore remain under pressure over the short to medium term while supply chain disruptions, such as the global shortage of semi-conductors, will also continue to hamper new vehicle sales and production during the year. On the positive side, NAAMSA expects the new vehicle market trend over the next three years to be upwards, in close correlation with National Treasury’s projected domestic economic growth outlook, averaging 1.7% for 2022, 2023 and 2024.
SOUTH AFRICA: THE WEEK AHEAD
Contributed by Werner Erasmus
Mining production: Due Wednesday, 9 February 2022. Mining production is expected to ease to 3.5% growth year-on-year in December, according to the Bloomberg forecast, from 5.2% in the prior month. December typically sees a seasonal drop in production. Moreover, the rise in Covid-19 cases globally and lockdown restrictions likely weighed on export demand.
Manufacturing production: Due Wednesday, 9 February 2022. Manufacturing is expected to dip 1.8% year-on-year in December, from a 0.7% fall in the prior month, according to the Bloomberg consensus. Omicron and global supply chain disruptions weighed on the sector in the last month of 2021.
State of the Nations Address (SONA): Due Thursday, 10 February 2022. President Cyril Ramaphosa will deliver the state of the nation address on Thursday and is expected to detail progress by the government in its plans to attract foreign investment and help kick-start an economy still battling to recover from Covid-19. Ramaphosa is also expected to provide some hints of what to expect in the upcoming budget, in particular regarding government’s plans to extend income support to the unemployed.
Contributed by Nick Downing
The oil price continued to surge despite the OPEC + group agreeing to its 8th consecutive monthly increase in production. The price surpassed the 2014 peak of $90 per barrel. While production quotas increased by another 400,000 per day, the cartel is unable to keep up with production. According to an OPEC report, production was lagging by 824,000 barrels per day. The shortfall is blamed on years of under-investment, exacerbated by the growing appetite for renewable energy. The Ukraine crisis is also adding to the oil price rally, especially with oil inventory levels at multi-year lows. The oil price, which has gained by 60% over the past 12 months is one of the main culprits in the world’s inflationary surge, and has the potential to dampen consumer spending, which contributes around two-thirds of GDP in the developed world. Fortunately, oil prices are expected to peak in the second quarter, according to the consensus analyst forecast, with US production set to increase. The view is borne out by the shape of oil price futures, which are heavily in backwardation meaning current prices are higher than contracts maturing months ahead. Meanwhile, there is some respite on the Ukraine front, following President Macron’s diplomatic visit to Moscow. He said Russia’s aggression is about wresting a better deal with NATO rather than invading Ukraine. Forthcoming US and NATO compromises are likely to de-escalate the geopolitical risk premium embedded in the oil price.
Contributed by Nick Downing
The US economy added a much stronger than expected 467,000 new jobs in January, well above the consensus forecast of 150,000. The November and December nonfarm payroll number was also revised higher by an aggregate 709,000. Hourly wages increased in January by a solid 5.7% year-on-year and 0.7% month-on-month. The data, which indicates an increasingly tight labour market and rising wage pressure, prompted a further increase in the 10-year Treasury bond yield as the market digested prospects for more aggressive rate increases from the Federal Reserve. After the data release the interest rate futures market priced in more than five 25 basis point interest rate hikes in 2022. Some analysts are even predicting the inaugural rate hike at the Fed’s policy meeting on 15-16th March could be as much as 50 basis points. The labour participation rate, which measures the number of people who are either working or actively looking for work, nudged higher from 61.9% to 62.2%, although the gain is attributed to an increase in population estimates at the start of the year.
Labour participation remains hamstrung by Covid effects, although as these ease and households run down the savings they accumulated from pandemic relief programmes, the labour participation rate is expected to recover. Elevated wages will also incentivise people to return to the labour market. The response from the bond market and interest rate futures market to the stronger than expected jobs data may be overdone. Besides the anticipated improvement in labour participation, employment data tends to be a lagging indicator, which means jobs growth will continue rising even as the pace of growth in consumer demand begins to slow. While the former will boost wage growth, which is inflationary and a source of concern for the Fed, the expected slowdown in consumer demand, which is already underway due to the fading impact of stimulus payments and a weaker equity market performance, should reduce inflationary pressure to a greater extent.
Consumer spending contributes over two-thirds of US GDP. In this context, it is a potential concern that US consumer confidence fell in January below the low point at the start of the pandemic in 2020 hitting its lowest level since November 2011. The University of Michigan Consumer Sentiment Index fell to 67.2 from 70.6 in December, compared with 79.0 in January 2021. The steep decline over the month is due mainly to the Omicron impact, which peaked on 10th January. However, other factors also contributed, including rising inflation and falling real incomes, and the expiry of pandemic relief. Among the survey respondents, 75% cited inflation rather than employment as the most serious problem facing the economy and 58% anticipated a renewed recession. According to Richard Curtin, chief survey economist, “The Fed is about to raise interest rates to tame inflation…. The danger is that consumers may overreact to these tiny nudges, especially given the uncertainties about the coronavirus and other heightened geopolitical risks.” The potential impact of rising interest rates on the equity market and residential property market, significant sources of wealth for US households, could add further pressure on consumer confidence.
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 fell 2.4 points in January to 36.7 marking the lowest reading in five months. Consumer optimism was softer across all sentiment sectors – Overall Livelihood (-1.8), Income Growth (-1.0), Employment (-4.8) and Willingness to buy durable goods (-2.2). The percentage of respondents expecting prices to rise in the year ahead jumped by 1.2% points to 89.7% in January, while only 2.7% expect prices to go down. Japanese consumers have been tightening their belts since the start of the pandemic reflected in the high savings ratios recorded. In the third quarter of last year, savings edged up to 10.3% from 9.6% in the second quarter. Expectations of higher inflation might prompt consumers to tap into their savings which will help a consumer led recovery. Interest rates remains at historic lows and the Bank of Japan is one of the most dovish central banks in the world, which should bode well for consumer confidence once the pandemic peters out.
Contributed by Carel La Cock
Europe’s economy expanded by 0.3% in the final quarter of the year, putting the single currency bloc back on par with pre-pandemic levels of output. The final quarter of the year proved challenging as the Omicron variant forced governments to implement restrictive measures that hampered the recovery in the services sector and saw economic growth slow from the 2.3% pace achieved in the third quarter. Encouragingly, household spend remained firm, while businesses ramped up their efforts to restock inventories, boosting output for the quarter. Compared to the same quarter in 2020, the eurozone economy was 4.6% larger and grew by 5.2% year-on-year for 2021 according to preliminary estimates. Amongst individual countries, Spain (+2%) reported the highest quarter-on-quarter growth, followed by Portugal (+1.6%) and Sweden (+1.4%), offsetting declines for Austria (-2.2%), Germany (-0.7%) and Latvia (-0.1%). All member states reported positive year-on-year growth with France growing 7% year-on-year in 2021 being the standout. It was the fastest growth experienced by the French in more than half a century, driven largely by consumer spending. France was also less impacted by supply chain bottlenecks compared to its more industrial neighbour, Germany, which aided its outperformance. Spain also reported solid growth for the year at 5%, boosted by its tourism industry, but remains 4% below pre-pandemic levels. Economists expect growth in the eurozone to make a healthy recovery in the first quarter of the year as supply chains return to normal and restrictive measures start to ease, boosting both manufacturing and the services sector.
Contributed by Carel La Cock
UK households have been dealt a double blow; first by Ofgem lifting the price cap on energy bills and then by the Bank of England (BoE) hiking interest rates. The energy regulator announced a steep rise in the price cap on energy bills for households from the beginning of April, with average bills expected to be 54% higher. Ofgem proposed reviewing the price cap quarterly instead of the current twice yearly, which they say will reduce the volatility in energy prices consumers face this year. However, with tensions between Russia and the west rising around military action in Ukraine, natural gas supply from Russia could be curtailed which will see another big jump in consumer prices when Ofgem is expected to reset the cap in October. Since August last year, 28 energy companies have gone out of business, squeezed by soaring wholesale gas prices and low consumer price caps. Chancellor of the exchequer, Rishi Sunak, announced a £9bn relief package to alleviate the pressure of high energy bills on the most vulnerable. However, the Bank of England in the same week piled on the misery by hiking interest rates by 25-basis points, which will impact UK households’ disposable incomes by as much as 2% this year. Rates could have been even higher as the monetary policy committee (MPC) voted five to four against a 50-basis point hike. The MPC adjusted its inflation outlook with a view that inflation will peak at 7.25% in April but will remain above 5% until the end of the year. Arguing for a steeper hike in rates, the minority MPC members noted that the central bank has made repeated inflation forecasting errors in the past year. Furthermore, there were signs that companies are set to raise prices significantly in the coming months and that workers are successfully negotiating higher wages, all adding to inflationary pressure.
In addition, the BoE will reduce its balance sheet by not replacing maturing bonds it holds through its £875bn asset purchasing programme while actively selling £20bn corporate bonds by the end of 2023. The run-off will see £28bn in bonds maturing in March and another £70bn maturing over the next two years. It is expected that the impact from rising rates and tapering QE will slow economic growth in the UK to 1% per year while inflation will be brought back to within the target range of 2% in the next two years.
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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THE BOTTOM LINE: RUSSIA INVADES UKRAINE
Contributed by Nick Downing
The full-scale Russian invasion has taken most political analysts by surprise. The consensus view had been that Putin was all bluster to gain concessions from NATO. When the invasion began on 24th February, most analysts believed the war would be over very quickly. They were wrong again, and also wrong about the ferocity of sanctions and the amount of self-sanctioning by the private sector. Putin himself must have been surprised by the level of broad-based international opposition and disappointed by the slow progress of his military.
Who would have thought that Switzerland would give up its sacred neutrality to join the united front against Putin’s actions? In the face of the terrible humanitarian cost, the fightback against Putin’s regime is encouraging, but it also means the outlook becomes more uncertain and the less Putin gets his own way the more dangerous he becomes.
The humanitarian cost is enormous, especially for civilians. The direct economic cost, provided the war does not spread geographically, will be limited to Russia and Ukraine. The two economies are relatively small. Russia lies 13th in the world in terms of its GDP while Ukraine is in 57th position. Russia only accounts for 4% of the euro area’s exports and less than 1% and 0.5% of exports from the UK and US. Indirectly, the impact of state and self-sanctions is far greater due to surging oil, gas, industrial and agricultural commodity prices. Surging energy and commodity prices will cause inflation, already a problem for central banks, to climb even higher, curtailing household spending and lifting production costs for companies. Central banks, which had been on track to tighten monetary policy, will now be more reluctant to do so due to the war’s effect on economic growth.
How will the Russia-Ukraine war impact financial markets? The impact will vary by region. The Russian market will suffer the most, reflecting the ferocity of sanctions, which include exclusion from the SWIFT payment system and sanctioning of Russia’s central bank, which means it cannot access its foreign reserves. Central bank sanctions have hitherto only been directed at North Korea, Venezuela and Iran, and have never ended well. Russia has ordered its banks to prevent foreigners from transacting in Russian securities. Russia’s MOEX stock index has been closed since the invasion but the declines in Russian global depositary receipts indicate an 80% market slump since the invasion began. The market now trades on a trailing price-earnings multiple of less than 1x. However, depending on how the war ends, Russia may be ejected from world equity indices such as the MSCI World index and for ESG reasons, global investors will shun the market. As a result, investors should not assume that the index will recover sharply as it did in 2014 after the Crimea invasion.
US and Pacific-Asia equities will suffer the least direct impact from the crisis. Europe is the most at risk due to its dependence on Russian oil and gas. Around 25% of Europe’s oil and 40% of its gas needs are met by Russian supplies. Europe’s banks are also the most exposed to Russia. Due to its proximity, the UK is also affected although not as badly as the euro area.
Europe will incur the greatest cost from the flood of Ukrainian refugees, which according to United Nations estimates already number over 1.5 million, with most destined for European countries. However, for investors there is a silver lining to these elevated risks. The ECB will be more reluctant than other central banks in removing pandemic-era monetary stimulus. The region’s governments are also likely to resume pandemic-era fiscal stimulus to shore up the economic impact of the crisis.
In 2014, when Russia invaded Crimea, emerging markets were the worst affected. The outlook now is very different, especially for commodity dependent economies like South Africa. The national budget’s commodity windfall enjoyed in FY 2022 is on track to be repeated in the current financial year. Generally, emerging market currencies are undervalued. EM central banks are ahead of their developed market counterparts in lifting interest rates to address rising inflation and local currency emerging market bond yields already trade at wide spreads relative to US Treasury bonds, making them less prone to global risk aversion.
There is considerable uncertainty over the extent and duration of the military crisis in Ukraine. However, provided the conflict does not spread across Ukraine’s border, the impact on global financial markets is likely to be short-lived. Unfortunately, it is a fact of human life that wars and crises regularly occur. According to precedent, equity markets suffer in the first few weeks of a war but then gradually recover. Since WW2, the worst market setback caused by a military conflict was during the first gulf war in 1991. Global equity markets fell sharply by 15-20%. However, they quickly recovered. This time may be different, but investors should be wary of being too negative. A ceasefire or peace agreement could easily create a surge in equity markets.
Investors should not forget that before the war erupted, global economic momentum was extremely positive, helped by a retreat of the Covid pandemic, above average GDP and earnings growth, and healthy household and company balance sheets. Financial markets have not been complacent in pricing in the risks emanating from the Ukraine crisis, evidenced by sharp declines in equity prices over the past fortnight. The global market’s trailing price-earnings multiple has now declined to 16.5x compared with its peak last year of 20x. The less demanding valuation greatly improves long-term return prospects. While markets remain expensive in the US relative to their historic average, they currently offer compelling value across the UK, Europe, Japan, China and emerging markets. Meanwhile, corporate credit spreads, the proverbial “canary in the coal mine”, continue to be well behaved, reflecting an absence of global financial risk contagion.
Investors must avoid knee-jerk reactions to the current crisis. Portfolios should ideally have been structured ahead of time to mitigate the risk of worst-case scenarios, via diversification across asset classes, currencies, and geographic regions. Investors will be anxious to do something, but the trade that adds the most to portfolios over the long-term is to buy not sell, at current low levels. It is certainly too early, but the time will come once the rate of deterioration in the crisis begins to abate.
*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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