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3rd Quarter 2021 Market Outlook

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As SA continues to battle with a third COVID 19 wave, we send our condolences to all who have suffered from this terrible pandemic.

Good 6 month returns, but with constant volatility

The JSE All Share Index (ALSI) returned 7.5% the last 6 months, although fluctuating by up to 5% per week, illustrating the continuing uncertainty in global markets, largely due to the difficulty in estimating and quelling the negative effects of COVID 19. Fortunately, SA has had some positive political gains – notwithstanding the past 72 hours – which is underpinning some renewed confidence (albeit off a low base). However, global economic forecast risks remain high in the short-term, which makes portfolio balancing and diversification critical.

Although we still believe global industries will return largely to how we knew it pre-pandemic, there are still many hurdles to jump, which may take a year or two longer than expected as the COVID 19 virus continues to present its multiple variants, and different global responses are undertaken.

Global markets remain a major driver of the JSE – ALSI. The main global investment issues are:

Inflation is considered the biggest risk

Potential high inflation will result in increased interest rates, which will slow economic growth and reduce asset valuations. Currently, this is the biggest market fear posing the question: is the current rise in inflation temporary (transitory) or a longer-term threat? Our view is that it is a longer-term threat, which we discuss in our market outlook section later.

US Inflation

CPI and core CPI

Dealing with abnormally high global debt

Global debt increased to $281T last year driven by government stimulus pumped into economies to support economic growth. The great debate is how all this debt will affect future economic growth and will the sudden increase drive higher inflation. Pure economic theory would say “yes” to both, but investment markets appear to be dismissing this whilst increased money flows have pushed up asset prices.

Global Dept in USD

Government stimulus after the last two crises

FISCAL Stimunlous (as pencentage of GDP)

Higher global economic growth forecasts

Forecast risks remain high as countries deal with the pandemic in different ways. Yet the outlook has improved with the 2021 global economic growth forecast at 6%, up from 4% at the beginning of the year. Pre-pandemic economic levels should be attained in 2023 with growth of 4.5% and 3% in 2022 and 2023, respectively. But 2023 economic activity is still forecast to be 4% lower than projected pre-pandemic.

Recent lower than expected economic growth indicators have reversed fearful rising global bond yields, casting more uncertainty on the rate of global recovery.

China’s recovery remains a big risk

A material contributor to global growth is China’s recovery, which is looking lower than expected and is being supported by renewed stimulus released from their banking sector as domestic demand wanes. China is forecast to grow 8.5% and 5.5% in 2021 and 2022, respectively.

Social media regulations

The monopolisation of giant media firms (Facebook, Google, Tencent, etc) has been flagged as a major concern by various governments. China has been more proactive by implementing anti-competitive restrictions, which has started to weigh on growth outlooks. Given the dizzying high valuations of the sector, investment risks are heightened.

The growth to value rotation

A general view is that value shares (boring stalwart companies) have outperformed growth shares (new industry companies) over time. But, per the graph below, the value sector has significantly underperformed the growth sector over the last 15 years. This is partly due to an abnormally low interest rate environment that has bolstered growth-orientated valuations. With the interest rate cycle starting to increase, the rotation from growth to value appears to be starting.

The growth to value rotation

SA shows signs of political positives, but implementation is a major concern

Positive SA political wins

  • Zuma jailed – a significant win in support of our judiciary and constitution. Reflects important majority support for Ramaphosa in the ANC and lifts hopes that corruption will be dealt with. The suspension of Ace Magashule and Zweli Mkhize supports this new course.
  • Government wage increases – restricted to a 4.8% increase, albeit above the budgeted 2.1% in February, it reflects Government’s win against the Unions. Although this is only a one-year deal, which garnered support from the negative effects of the pandemic, it’s a victory. But, a bigger battle is brewing next year.
  • Disposal of state assets – the 51% sale of SAA – Without knowing the finer details of the deal, this appears to be a positive shift in state ownership, albeit with very little other choices. A proposal to privatise our ports is a major plus for this critical economic gateway. The sanctioning of private electricity generation to 100MW from 1MW will also boost valuable electricity resources and introduce vital competition.

SA COVID 19 response still a disappointment and a major concern

The spread of the new Delta variant has driven the 3rd wave, which appears to be peaking in certain areas with the assistance of the extended adjusted level 4 lockdown. Sadly, the official seven-day average death toll of 363 has surpassed the first wave’s 294, with total deaths now at 64500. However, according to a recent Discovery report, they estimate deaths to be far higher at around 150000 to 160000.

Government’s reactive, as opposed to a responsive approach to the 3rd wave with blanket restrictions and poor enforcement highlights the poor management of the pandemic. But the bigger concern is the slow rollout of vaccines, highlighting the government’s inabilities to implement successfully.

Vaccinations per 100 people 

Vaccinations per 1000 people

The SA economic recovery is improving, off a low base

Despite a disappointing slow vaccine rollout, SA 2021 GDP forecasts have increased to 4.6% from 3.5% at the beginning of the year. This is largely from higher commodity prices, which have provided a welcome boost to revenues of R50bn to R70bn. However, the outlook for 2022 and 2023 still looks dismally low at 2.4% and 2.5% respectively.

The Rand’s strength is driven by strong commodity prices

Rand/Dollar vs Commodity prices

Rand v Dollar vs Commodity prices

Commodity prices are reaching near all-time highs. Iron ore, copper and platinum group metals are triple their average prices. These abnormally high prices are not sustainable and will revert to their means, barring platinum metals, in our opinion.

SA trade surplus / deficit

The graph below shows an abnormally high spike in the SA trade surplus driven by high exports (commodities) and low imports due to a weak demand economy. This inflow of funds has been the major driver of the strong Rand this year.

SA Trade Surplus

 

The Rand is fundamentally overvalued

We believe the Rand’s fundamental value is R17.60 to the US Dollar, derived from a purchasing power parity (PPP) of 14.1 plus a 25% risk premium, which is representative of SA’s weak economic position (a 3-year forecast debt/GDP of 100%) and lack of growth implementation skills.

PPP Model USD vs ZAR Exchange Rate

Market Outlook

Global developed equity markets are trading at all-time highs and at historical high forward P/E multiples.

These markets are forecasting low inflation and low interest rates for an extended period, which we believe is unlikely. A conservative investment approach is recommended, incorporating more value-based sectors and emerging market countries.

SA equities are fundamentally cheap despite the woes of the country

SA Equity and MSCI World Forward P/E

SA Equity and MSCI World Forward P E

Near all-time low SA interest rates are a major boost for the economy and valuations, which, in our opinion, are not priced into SA equities.

Conclusion – Balance and diversification are critical

The path to a full global economic recovery remains uncertain, which is reflected in continued market volatility. Serious risks, such as higher inflation should be considered by diversifying into more value-based sectors.

Emerging markets and South African equities offer more attractive returns in the medium term and should be balanced in a global investment portfolio.

The Rand remains vulnerable to global money flows and commodity prices, which makes it very difficult to forecast in the short term. But fundamentally, it should be weaker, and we expect the Rand to weaken materially in the medium to long-term.

SA interest rates are expected to remain low for the next two years, which is positive for equities, but negative for interest earners. Including a measured portion of equity risk into your portfolio is essential to achieve after-tax returns above inflation.

It’s critical to ensure that your investment portfolio is properly balanced and adjusted to suit your personal risk profile to achieve your goals.

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