The last twelve months have tested our psyche in numerous ways with fear of uncertainty being the overwhelming challenge. This has been the ingredient that has driven extraordinary investment market volatility and massive sector divergence. The pandemic is not over, and we do not know how the world will operate in the future. However, there does appear to be light at the end of the tunnel as vaccine programs are implemented and a better understanding of COVID 19 is being achieved.
Global economies are in recession, but investment markets are up!
The global and SA economies slumped into recession in 2020, declining 3.3% and 7% respectively. The IMF predicts the global economy to recover to pre-pandemic (2019) economic levels by 2023 and the SA Treasury predicts SA to get there in 2023.
However, from just before the pandemic lockdown (Feb 2020) to end March 2021, equity markets have produced a very mixed return. The JSE is up 17.4% (including a 35% crash) and the world MSCI Index is up 11.5% (in US Dollars). The Rand / Dollar is flat.
Why the disconnect between economic recession and equity market strength? It is due to the enormous monetary stimulus ($20T) injected from developed country central banks. This massive new money supply has gone directly to consumers and capital markets through bond buying and lowering of interest rates, all of which had to find a home, pushing up investment markets. The JSE’s offshore shares benefitted from the stimulus, with Resources, Naspers and Richemont soaring 42% and +30% respectively, driving the JSE up 17.4% from Feb 2020 to March 2021. However, local sectors such as Banks, Retailers and Property have all declined 20%.
When will the pandemic be over?
COVID 19 fears have subsided significantly as the world’s understanding of the virus has soared and many creditable vaccines are being administered. Therefore, it appears the end is near, and could be reached in 2022. But there are still many unknowns, which will continue to stoke fear and are likely to stretch out a “back to pre-pandemic life” return, with many physical and psychological scars to mend. The effects of this virus may stay with us for some time to come.
SA is still in a precarious position
SA’s pandemic recovery to drag out longer
Following the second wave, SA’s daily 7-day average infections are down to a 10-month low just above 1000 a day. Although we always question the stats, this is very positive and points to a much hoped for high herd immunity (+50%) developing. However, a 3rd wave is predicted this winter, for which we must be prepared.
SA’s government vaccine rollout that started slowly last month has great plans to inoculate all adults by early 2022. We are always hopeful of success, but government’s implementation to date is very poor, and we are doubtful that the government’s targets can be achieved without a meaningful change in strategy for assistance from the private sector.
Consequently, we believe that SA is likely to limp along to a partial recovery into 2022, with the risk that much needed foreign travel remains restricted, as we fall behind accepted global vaccination standards.
A slow economic recovery is expected
SA GDP declined 7% in 2020 and the Treasury forecasts GDP growth of 3.8%, 2.4% and 2.5% for 2021 to 2023, respectively, returning SA’s economy to pre-pandemic levels in 2023. This is an anaemic outlook, given that SA’s average GDP growth for the 10 years to 2019 was only 1.7%.
Global GDP forecast per the IMF (International Monetary Fund) for 2021 and 2022 is 6% and 4.1% respectively. This is after an estimated contraction of 3.3% in 2020.
SA’s large debt (85% of GDP) is a major concern
Averting a debt crisis remains a major risk. The current account (government revenue less expenditure) is in deficit at -15.9% of GDP. The government is currently borrowing R500bn a year and 21% of expenditure is to pay interest on debt.
The recent austerity measures, such as capping the government wage bill, is only a short-term solution. Economic growth (+3% to +5%) is the only sustainable solution, which requires direct local and foreign investment. This will only take place with an improved confidence in the country, which needs government policy changes to create a more competitive business environment. These are labour rule changes and structural reforms.
ANC’s support swings to Ramaphosa
With the likely suspension of Ace Magashule from the ANC and the noose tightening around Zuma, Ramaphosa’s majority support in the ANC will be a welcome relief. But will this change the ANC’s agenda to govern more effectively and implement positive reforms for the country?
Casting out Magashule and Zuma will be a much-needed victory for the ANC, which will be well celebrated throughout the country. However, this is just the tip of the iceberg. Although rooting out corruption is important, it will take at least a generation to overcome.
The Rand is benefiting from strong commodity prices
After the Rand spiked to 19 to the US Dollar in March 2020, it has had a remarkable recovery to 14.5 despite little change to the country’s weak economic outlook post-pandemic. The key driver of the stronger Rand has been an abnormally high trade surplus (exports exceed imports) due to a spike in commodity prices (exports) and weak economic demand (imports). This positive flow of funds into the country has produced a lot of demand for the Rand.
The trade balance is very volatile as shown in the graph below and an eventual negative swing is likely to turn the tide on the Rand.
Strong commodity prices have historically supported the Rand as shown by the graph below, which is likely to add support to the Rand for the rest of the year. However, fundamentally, we believe the Rand is overvalued, with a fair value of 17.8 (see our article Forecasting Volatile Rand).
Inflation remains the biggest risk to investment markets
When inflation goes up above targeted levels (SA 3% to 6%, US average 2%) central banks raise interest rates to subdue a continued rise. Higher future interest rates reduce the present value of an asset, which is negative for investment markets.
Currently global equity markets are pricing in minor inflation into the future. The market view holds, that although global growth will rebound sharply in 2021 (6% per the IMF) and the world economy will only return to pre-pandemic (2019) economic levels in 2023, this growth will be accompanied by excess supply and hence muted pricing power. Hence, little inflation pressure.
What markets are tussling with is the effect of the unprecedented monetary stimulus from central banks in developed markets. A parallel is being drawn with the injection of stimulus in 2009 to rescue global banks that did not boost inflation. This time the stimulus is three times bigger, and a large portion has flowed to consumers. It would be unusual for this extreme excess money supply not to push up inflation, which the market is not pricing in.
A further risk is the US Federal Reserve is positioning itself to be behind the curve with its two major policy changes of targeting average inflation of 2% and not applying data forecasts to decision making. This highlights the massive economic uncertainty still existing and makes the global economy vulnerable to potential sharper interest rate adjustments that will be negative for markets.
Last week, the Chinese PPI (producer price index) surged 4.4%, up from 1.7% in February, mainly due to higher commodity and energy prices.
Although the SA economic outlook remains weak, local equity valuations are attractive and are not pricing in much recovery. With the low interest rate environment, most of the SA’s negativity is priced into local shares.
The Rand has been supported by an abnormally high trade surplus. Although the Rand may not weaken materially (+10%) this year, we still believe that with the weak fiscal and economic outlook, that the R/$ fundamental value is 17.80. See our Rand report.
Offshore markets require selective positioning, favouring emerging markets and more value as opposed to growth sectors.
With low SA interest rates likely for the next two years, interest bearing (Money Market and Bonds) returns will be low. Therefore, more measured risk is necessary in the form of selective equities. More undervalued local, emerging market and value orientated equities are imperative to higher returns.
A balanced (local /offshore) and diversified positioning is important to mitigate the risks of rising offshore interest rates and their negative effects on high valuation sectors (technology, etc).
It’s critical to ensure that your investment portfolio is properly balanced and adjusted to suit your personal risk profile to achieve your goals.