June manufacturing and mining production confirm both sectors of the economy posted positive contributions to GDP growth in the second quarter (Q2). While mining production fell in June by 2.6% month-on-month and 0.8% year-on-year strong production in April and May helped overall output grow 2.6% quarter-on-quarter (q/q) annualised in Q2. Manufacturing output, while declining in June by 2.3% on the year, grew in Q2 by 6.1% q/q annualised following three consecutive quarters of contraction, helped by low statistical base factors. The Q2 manufacturing and mining production data are consistent with positive GDP growth in the quarter putting an end to the technical recession that ensued after two straight quarters of contraction in Q4 last year and Q1. Assuming 25% q/q annualised growth in agriculture in Q2 and flat output in the services sector GDP should grow by around 1.5% q/q annualised in Q2.
The South African Chamber of Commerce and Industry (SACCI) business confidence index increased in July for a fourth straight month rising to 95.3 from 94.9 in June. The business confidence index is at its highest since February and above its 2016 year-end level of 93.8. The main contributors to July’s improvement came from increased vehicle sales, more building plans passed, lower inflation, and higher share prices. The largest detractors were lower export and import volumes and the rand exchange rate. The SACCI report cites the World Economic Forum’s 2016-2017 Global Competitiveness Report. Although falling to 47th position overall, South Africa ranked 10th in the world for the efficiency of its legal framework for challenging regulations, 16th for judicial independence and 14th for the strength of investor protection. South Africa ranked second in the world for the soundness of its banks.
Escalating tensions between North Korea and the US and uncertainty surrounding the motion of no confidence caused foreign investors to retreat from the South African bond market in the past week. Foreign investors sold a net R2.83 billion of domestic bonds in the week ended 13th August partly reversing the R8.10 billion inflow during July. For the year-to-date net bond inflows total R35.06 billion. By contrast foreign investors have been net sellers of domestic equities since the start of the year amounting to R61.41 billion, building on the total net outflow of R124.83 billion in 2016. However, there is an indication that the trend may be turning. Although foreign investors sold a net R86 million of equities in the past week net inflows of R10.77 billion were recorded in July.
SOUTH AFRICA POLITICAL REVIEW
Despite raised hopes stemming from the decision to hold a secret ballot President Zuma survived the motion of no confidence. However, the margin was by far the narrowest of the eight motions of no confidence Zuma has faced since 2009. The motion was rejected by 198 votes to 177 indicating that around 20-30 ANC members of parliament voted for the motion while the estimated 9 ANC abstentions added to the growing voice of dissatisfaction within the ruling party. The motion of no confidence outcome was better than the opposition parties were hoping for and raises the likelihood that Zuma will be removed as head of state soon after the ANC elective conference in December.
SOUTH AFRICA: THE WEEK AHEAD
Retail sales: Due Wednesday 16th August. Retail sales are expected to maintain their positive upturn in June with year-on-year growth of 2.4% according to consensus forecast up from 1.7% in May, helped by low statistical base factors. Retail sales will have shown positive year-on-year growth in each month of the second quarter (Q2) contributing positively to the quarter’s GDP growth, in sharp contrast to Q1 when retail sales contracted by 3.5% quarter-on-quarter annualised. The outlook for retail sales is helped by falling inflation and the prospect for further interest rate cuts.
Escalating tensions between North Korea and the US caused global investors to switch out of so-called risk assets including equities, commodities and emerging market currencies into safe-haven assets such as gold, the Japanese yen and Swiss franc. European stocks fell almost 3% over the past week its worst performance of the year while the S&P 500 index was down almost 2%. The CBOE Volatility Index surged by 44% over the week to its highest level since 8th November with the volume of put and call options rising to a record high. Surprisingly, despite the sharp rise in global risk aversion inflows into emerging market equity and bond funds was positive for the week, indicating the underlying strength of demand for the asset class.
July inflation numbers were weaker than expected for a fifth consecutive month. Headline consumer price inflation (CPI) increased 0.1% month-on-month and 1.7% year-on-year versus respective consensus forecasts of 0.2% and 1.8%. Core inflation excluding food and energy prices, which are traditionally volatile, remained unchanged at 1.7% on the year. While the softening in some CPI components is likely to be temporary the low inflation readings in core services may be longer lasting making it harder for inflation to pick-up, especially once low statistical base effects have dissipated. Following the release of the CPI numbers the probability of a Fed interest rate hike in December fell to 40.6%. Post the data release Dallas Fed President Robert Kaplan said that while he was a strong advocate of the two recent rate hikes: “I at this stage want to see continued evidence, or more evidence, that we’re making progress on reaching our inflation target…. I’m willing to be patient.” St. Louis Fed President warned against the risk of the Fed being too aggressive in raising interest rates.
US non-farm productivity, which measures the hourly output per worker, increased in the second quarter (Q2) by 0.9% quarter-on-quarter annualised up from 0.1% in Q1. Output increased by a solid 3.4% while hours worked increased by 2.5%. Unit labour costs, measuring how much faster compensation is growing relative to output, increased by just 0.6% after surging 5.3% in Q1. Despite the recent uptick productivity gains have been disappointing during the current economic cycle with an average annual productivity increase of 1.2% over the past ten years compared with an average of 2.1% over the past 70 years. With the economy at full employment an acceleration in GDP growth depends on a pick-up in productivity. Part of the blame for low productivity gains lies with low capital expenditure which is holding down the capital-to-labour ratio. New York Fed President William Dudley attributes subdued inflation to weak productivity growth which he says is behind persistently modest wage increases.
The Job Openings and Labour Turnover Survey (JOLTS) reported total job openings, a measure of labour demand, increased in June by a massive 461,000 to a seasonally adjusted 6.2 million. The monthly increase was the largest since July 2015 taking the total to its highest since the data series began in December 2000. There is a growing divergence between job openings and actual hiring indicating a skills shortage. The ratio of job openings to unemployment hit a 16-year high. Companies are running out of skilled workers, putting a constraint on potential GDP growth.
US consumer credit, excluding home loans, decreased from $18.3 billion in May to $12.4 billion in June well below the $15.3 billion consensus forecast. The decline is attributed to weaker vehicle sales and a decrease in student loans. While the main components of consumer credit, including revolving and non-revolving loans showed steady year-on-year growth of 4.9% and 3.5%, the monthly decline unless it is temporary, may signal a slowdown in consumer spending in the months ahead. Consumer spending contributes over two-thirds of US GDP.
Consumer price inflation (CPI) eased from 1.5% year-on-year in June to 1.4% in July well below the authorities’ 3% target for 2017. While largely attributed to food prices which fell 1.1% on the year inflation of non-food items fell to a 7-month low of 2.0% indicating broad-based disinflation. The downward inflation trend may prompt the Peoples’ Bank of China (PBOC) to pause in its current monetary tightening cycle forcing the government to seek other macro-prudential tools to reduce the economy’s excessive debt levels.
China’s trade volumes eased in July with both exports and imports increasing less than expected by 7.2% and 11% year-on-year respectively, down sharply from 11.3% and 17.2% in June and well below the 10.9% and 16.6% consensus forecasts. Exports slowed to their lowest pace of growth since exiting contraction in March. Exports to all trading regions slowed markedly except for Japan which picked up from 5.5% to 6.6%. While raising concerns that global demand is starting to cool part of the blame for the trade slowdown is attributed to negative price effects stemming from weakening producer price inflation.
China’s economic activity data slowed more than expected in July with all key indicators weaker than the average second quarter (Q2) readings. Industrial output growth slowed from 7.6% year-on-year in June to 6.4%, retail sales slowed from 11% to 10.4% and year-to-date growth in fixed asset investment slowed from 8.6% to 8.3%. The overall economic activity data are at their weakest since the start of the year attributed to the effect of policy measures aimed at curbing property speculation, excess borrowing and industrial overcapacity. Lower spending levels combined with slower factory activity will likely weigh on GDP growth in the second half of the year.
Japan’s GDP growth surged in the second quarter (Q2) to 1.0% quarter-on-quarter and 4.0% annualised. This exceeded expectations of 0.6% and 2.5% respectively and marked the first consecutive run of six quarters of growth since 2006. Encouragingly the growth drivers moved from exports to domestic demand making the economic expansion less dependent on the global economy and yen depreciation. Due to a surge in imports net trade subtracted 0.3 percentage points from GDP growth. Domestic demand and fixed capital formation were the biggest growth drivers contributing 1.7 percentage points to the quarterly growth rate. Private consumption increased a solid 0.9% on the quarter and business spending by a substantial 2.4%. Despite the impressive GDP data, the Bank of Japan is likely to maintain its programme of quantitative and qualitative easing to ensure inflation meets its target of 2% by 2018.
The corporate goods price index (CGPI) increased in July by a solid 0.3% month-on-month up from 0.1% in June. On a year-on-year basis CGPI producer price inflation accelerated from 2.2% in June to 2.6% in July the seventh straight positive reading and its highest since reaching 2.6% in November 2014. While companies have so far been reluctant to pass on producer price increases to the end consumer the recent upswing in private consumption may prompt firms to gradually raise prices, which bodes well for a lift in consumer price inflation.
The Cabinet’s Economy Watchers Survey dropped from 50.0 in June to 49.7 in July its first decline since March. The forward-looking expectations index, forecasting conditions two to three months ahead, also fell for the first time in four months from 50.5 to 50.3 although remained above the expansionary 50-level indicating a perception that economic conditions are improving. While both current and expectations indices worsened over the month the declines were slight and the Cabinet Office maintained its assessment that the economy “continues to recover”.
Germany’s industrial production unexpectedly fell in June by 1.1% month-on-month reversing May’s 1.2% gain. The decline was broad-based with consumer goods, producer goods and capital goods production each falling by 1.7%, 1.2% and 1.9% respectively. While the data implies the economy may be losing a little steam the bigger picture remains positive. The German Economics Ministry noted that some payback was due after five straight months of increased production adding that: “Industrial orders and indicators for the business climate in Germany suggest that the upward trend in industrial production will continue.” Despite the setback in June industrial output in the second quarter grew by a solid 1.8% quarter-on-quarter.
Eurozone industrial production fell in June by 0.6% month-on-month its first decline since February when output fell 0.2%. The monthly decline was led by drops in capital goods and durable consumer goods production of 1.9% and 1.2% while output of intermediate goods and non-durable consumer goods fell by a milder 0.3% and 0.4% respectively. Energy production increased 1.8%, the only component to show growth over the month. Among individual countries industrial output fell most in Ireland and Malta while the Eurozone’s two largest economies Germany and France also posted declines. While slightly disappointing, some payback in June had been expected following the massive 1.2% increase in Eurozone industrial production in May. The monthly decline is unlikely to mark a change in trend.
Industrial production increased in June by a surprisingly strong 0.5% month-on-month lifting year-on year growth to 0.3% an improvement on the 0.2% contraction in May. The major drivers were mining and quarrying, benefiting from an absence of maintenance which usually takes place in June. Encouragingly, growth in manufacturing output improved from 0.3% on the year to 0.6%. Capital Economics economist Paul Hollingsworth noted that: “Looking ahead, surveys suggest that the manufacturing sector should gain some momentum in the third quarter, while export growth should pick up further.” He continued: “As a result, we remain optimistic that growth should hold up fairly well in the second half of the year, rather than slow.”
FAR EAST AND EMERGING MARKETS
Singapore’s second quarter (Q2) GDP growth was revised sharply higher from 0.5% quarter-on-quarter annualised and 2.5% year-on-year to 2.2% and 2.9% respectively. Encouragingly the upward growth revision was driven by improved services growth. The Q2 GDP data numbers indicate Singapore’s economic recovery is broadening beyond its narrow reliance on semiconductor demand with evidence of improving labour market conditions, wage growth and rising inflation. The recovery in the service sector, which contributes 70% of Singapore’s GDP, signals a more stable economic expansion.
Malaysia’s industrial production increased in June by 4% year-on-year, which although a slowdown from growth of 4.6% in May and 4.1% in April defied expectations of a sharper slowdown and capped growth in the second quarter (Q2) of 4.3% on the year. Manufacturing output increased in June by a solid 4.7% on the year. The robust industrial production numbers have led economists to raise their Q2 GDP forecasts. CIMB Investment Bank raised its forecast from a previous 4.9% to 5.7%. Malaysia’s industrial production is expected to remain firm in the second half of the year helped by healthy export demand, strong domestic consumption and infrastructure spending. The IMF lifted its 2017 GDP growth forecast in July from a previous 4.5% to 4.8%.
As expected the Reserve Bank of New Zealand (RBNZ) left its benchmark interest rate unchanged at 1.75%. While the accompanying policy statement projected a pick-up in economic growth in coming months the RBNZ also lowered its inflation outlook forecasting that headline inflation will fall below 1% in 2018 due to currency strength. RBNZ Governor Graeme Wheeler maintained the central bank’s position that interest rates would start rising next year although there is a strong chance the tightening schedule will be pushed back if the New Zealand dollar keeps strengthening.
KEY MARKET INDICATORS (YEAR TO DATE %)
JSE All Share
JSE Fini 15
JSE Indi 25
JSE Resi 20
The rand is testing key resistance at R/$13.00, which if broken would target further gains to R/$12.50 and thereafter R/$12.00.
The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.
Following the announcement of the snap election the British pound has broken above key resistance at £/$1.30 which has now become a key support level and should promote further near-term currency gains.
The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
The US 10-year Treasury yield has failed to break below key resistance at 2.0% raising the probability that the multi-year bull trend in US bonds is over.
The benchmark R186 2025 SA Gilt yield is trading in a tight trading range of 8.5-9.0%. A break above 9.0% is required for the yield to move decisively higher towards the 10.5% target level.
Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdqaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
The Brent oil price has broken above key resistance at $50 and likely to remain in a trading range of $50-60 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $6000 per ton.
Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1400 target level.
The break above 54,200 on the JSE All Share index projects an upward move to 60,000 marking a new high for the JSE.
Emerging market currencies have rallied since the start of the year in line with a falling dollar and rising global risk appetite. Despite domestic political and policy uncertainty the rand is likely to correlate closely with the strengthening trend in emerging market currencies. Given the constructive environment for the rand equity investors should reduce the relative weighting of rand hedge shares in their portfolios in favour of domestically focussed shares. The bank sector is a compelling candidate.
Historically the bank sector has provided investors with market beating performance delivering superior earnings growth and a higher dividend yield over the long-term. Despite its excellent track record the bank sector trades at a substantial discount to the broader market on a price-earnings multiple of 11.27x versus 19.99x for the All Share Index. The dividend yield also compares favourably at 4.82% versus 2.75%.
South Africa’s banks, led by strong management teams, have successfully navigated through the turbulence of political and policy uncertainty and the rating downgrade to junk status. History has shown that emerging market bank shares have tended to produce strong returns following a credit rating downgrade. This stems from management anticipating and discounting negative outcomes before they occur.
South Africa’s banks have been virtually recession proof delivering robust earnings growth and return on equity despite the turbulent economic and political environment. Combined earnings grew in Financial Year 2016 by 8.4% year-on-year, helped by resilient growth in net interest income and non-interest revenue. The banks’ combined return on equity grew to a robust 18.6% well above the international norm.
Impressively, bank debts have trended lower despite the economic recession. Debt counselling by distressed consumers and orderly court-sanctioned re-negotiation of debt terms has contributed to significantly lower than usual bad debts in the current economic downturn.
Following the anaemic economic environment of the past two years’ bank clients are less indebted, making space for healthy credit growth in the next economic upswing.
Conservative provisioning and increased regulatory restrictions have led banks to build robust capital buffers. The total capital adequacy ratio of the major banks has strengthened to 16%, substantially above the South African regulatory minimum of 9.75%.
Bank penetration is still at low levels creating extremely favourable long-term growth prospects. An estimated 65% of transactions in South Africa are still cash-based, while only 58% of South Africans hold bank accounts and only 14% borrow from banking institutions.
The initiation of the interest rate cutting cycle in July and likely easing in political and policy uncertainty after the ANC’s elective conference in December should lead to an upswing in aggregate credit demand across household and business sectors, in turn boosting bank earnings. While the bank index has gained just under 11% over the past month it has only gained 1.4% since the start of the year and its returns over three years are modest at 15.5% suggesting substantial upside from current levels.
Overberg Asset Management specialises in the management of private share portfolios. Our philosophy ensures a secure long-term relationship with our valued clients, built on trust, service, value and performance. At the cutting edge of investing, Overberg has a proven track record in Global and Domestic South African markets.