MARKET REVIEW… The temporary perfect storm – Equities, Bonds and Property rise in tandem
• South African markets were largely guided by global drivers over this first quarter of 2015; namely: (1) Europe’s QE (Quantitative Easing) stimulus and signs of economic recovery across the euro area, (2) initiation of US rate hikes being pushed out, and (3) ongoing falls in Oil and other commodity prices. Overlain upon these market moving drivers talk of “Grexit” (Greek exit from the Eurozone) grabbed many a headline with a drawn-out negotiation process still in play.
• The JSE All Share touched a record peak at 53,374.8 on February 24th, before entering a choppier period for the remainder of the quarter. March in particular saw the Rand as well as Resources and Industrials pressured whilst Financials and Property stocks carried their winning streak.
• Looking across the asset spectrum in Rand terms: SA listed Property once again trumped returns with a 13.7% rise over the quarter, followed by Global Property returning 9.7%, Global Equity 7.7%, then Local Equity at 5.9%, both Local and Global Bonds gave you a 3% return. Sitting in cash proved unfruitful with SA Cash yielding 1.5% and Global Cash lost you 4% in Rand terms. Local headline inflation for February was 3.9%.
• The Rand began the year on slightly firmer footing at 11.57 to the USD and steadied for the first two months. However the strong dollar across the globe, saw our local currency suffer a volatile March and gave back all its earlier gains. The Rand ended the quarter 4.9% weaker against the USD at 12.13 but healthy against the Euro at 13.02 and Sterling at 17.98. Encouraging is the 7% appreciation of the Rand against the Euro over the quarter, SA’s major trading partner.
Data sourced from Bloombergs, total return calculated on Gross Dividends reinvested
- Global Equity = MSCI AC World, Global Bonds = JPM GBI, Global Cash = JPM Cash, Global Property = MSCI World Real Estate Index
SA EQUITIES – Bolt out of the starting blocks, stall in March on Resource downgrades
• Considering the JSE All Share index rose 11.1% in the year of 2014, the first quarter’s performance appears more than satisfactory at 5.9% with a peak record high of 53 374.8 on February 24th.
• From a broad Sector basis, Financials carried the baton, leading returns for the quarter with an increase of 11.2%, Industrials rose 5.6% and Resources just 0.1%.
- Household Goods +28% for the quarter, thanks to Steinhoff’s 28% rally. Steinhoff’s large Euro area exposure attracts investors locally and abroad.
- Technology +25.9% with EOH touching record highs +46.6% and Datatec also putting in a good performance.
- Media +23.3% as JSE top weighted stock, Naspers, now constituting almost 10% of the All Share, rallied over the quarter as its 34%-held Chinese gaming subsidiary, Tencent, jumps to become one of the largest Internet companies in the world, its market capitalisation at over $200bn now larger than Amazon, IBM and Oracle.
- General Retail +15.3% as Foschini Group +35.5% and Truworths +17.4%
- Industrial Metals -27.8% as commodity prices continued their slide (Iron ore tumbled 27.9%, Copper -4.8%, Aluminium -2.5% and Nickel -18%). Kumba Iron Ore -32.3% and Arcelormittal -28.5%.
- Construction -25.9% as PPC slides 31.4% after merger talks with AfriSam were terminated.
- Platinum -14.8% with all Platinum shares tumbling in response to the platinum price declines (falling 5.5%) as well as poor operational performances. Lonmin -33.1% (Glencore announces plans to unbundle its 23.9% stake in LON), Implats -22.4% and Amplats -12.8%. The exception Northam Platinum rallies 25.6% as the company begins wielding its cash pile by acquiring Everest Mine and talk of a take-out of Aquarius is bandied about.
- Oil & Gas -9.2%. Spot Brent fell further, trading below $50/barrel for the first time since April 2009, taking Sasol down 4.4%. Sasol also announces plans to change its dividend policy as part of plans to conserve cash amid the fall in oil.
• Year-to-date SA equities have attracted foreign inflows of R9.6bn, with outflows of R0.5bn from SA bonds.
• SA Equities have risen by an annualised 18% over the last 10 years whilst SA Bonds have given you 8.9%. Over this period Industrials outperformed, rising 23.2% versus Financials 17.8% and Resources 9.5%. On a 2 year view, Industrials and Financials have given roughly a similar range of returns of around 25-26% with Resources losing over 4%.
• Over the first quarter the JSE All Share earnings were downgraded by 6.5% largely in response to the fall in oil and commodity prices severely impacting Resource earnings, which were cut on average by 15.6%. Financials saw small upgrades of approximately 1.7% whilst Industrials were trimmed 1.7%.
• Platinum stocks were revised lower by a massive 27.7%, followed by Industrial Metals, General Miners and Construction companies.
• Upward revisions were most notable amongst Non-life Insurers, Banks and Fixed Line Telecoms.
• On 2015 earnings estimates, the All Share forward PE re-rated to 16.4x at the end of March from 15.5x at the end of December. The forward PE on Industrials remains hefty at 19.7x (largely thanks to Naspers’s forward PE over 60x), followed by Financials at 14.6x and Resources at 14.2x.
Global Market Returns Compared:
EMERGING MARKETS ONLY MARGINALLY UNDERPERFORM DEVELOPED MARKETS…
• In US dollar terms MSCI Emerging Markets rose 2.3%, marginally underperforming MSCI Developed Markets +2.5%.
• Within Emerging Markets – Asian markets rallied, up 5.3% whilst EMEA added 2% and LatAM tumbled 9.5%.
• Top performing Emerging Markets included: Russia rebounding off 2014 lows +18.6%, Hungary +14%, Philippines +10.2%, China +8.1%, India +5.4%.
• Worst performing Emerging Markets were: Greece -29.3% on geopolitical / debt standoff concerns, Columbia -19.3%, Turkey -15.8% and Brazil -14.6%.
• MSCI South Africa fared relatively well, returning 3.3% in $-terms, outperforming EM’s +2.3% and DM +2.5%, despite rand depreciation of 4.9% against the strong dollar.
BOND MARKETS … experience a second wind as initiation of US rate hikes gets pushed out
• SA Bonds had their best monthly return in six years with a return of 6.5% in January. However during the rest of the quarter the index gave back some of those gains resulting in a return of 3% for the quarter. The SA benchmark 10 year yield was down 15bps over Q1. SA Inflation-Linked Bonds underperformed, returning just 0.27% over Q1.
• US 10 year benchmark Treasury yields fell to their lowest levels since May 2013 (1.64%) as the timing of US rate hikes was pushed out by Fed Chairwoman Janet Yellen following a bout of disappointing US economic data, in particular employment and Inflation data. Economists now expect the US to only initiate rates normalisation around September of this year.
• European bond markets rallied sharply since the ECB began its asset purchases of public-sector bonds on March 9th as part of its trillion-euro stimulus program, the German 10 year yield ending the quarter at 0.185%. In comparison the US 10 year ended Q1 at 1.93%. The German-US 30 year spread has moved to levels last seen in the 1980s.
US Fed Funds rate targets
IMPACT OF THE STRONG DOLLAR… Winners and Losers (report by Deutsche Bank)
➢ Graphs sourced from JPM
• Three months into 2015, the global economy appears on track to expand at about the same pace as in 2014 (consensus sitting at Global GDP growth of 3.4%), with advanced economies growing slightly faster and emerging economies growing somewhat slower than last year. Relative to expectations at the end of last year, however, the US is off to a slower start, while other advanced economies, especially the euro area, are doing better than anticipated. These surprises appear to have much to do with faster than expected moves in the dollar’s value against key foreign currencies.
• Since middle of 2014 the dollar has risen by about 25% against the euro, 20% against the yen, and 15% on a broad trade-weighted basis. These trends have good prospects for continuing in the same direction with the expectation of moving through parity against the euro later this year. The concomitant question becomes how will the global economies adjust to these currency swings and who will be the winners and losers thereof.
• TWI – Trade-weighted index = ave of the US$ against the currencies of its major trading partners weighted relative to reflect each trading partners importance to the US
OITP = Other important trading partners
• Dollar appreciation is a clear plus for the euro area and Japan, as currency depreciation is a key transmission channel of their recently adopted and expanded QE policies aimed at raising domestic inflation from uncomfortably low levels. So far these policies and the induced currency moves seem to be generating the desired effect of lifting inflation expectations and boosting sluggish economies via increases in net exports.
• A second set of winners is emerging market countries that are energy and commodity importers and whose currencies have not been tied closely to the dollar. The rise in the dollar has tended to be associated with declines in the price of oil and other commodities, favouring consumers over producers. India is a prime example of a winner, and is projected to take the mantle of fastest growing major emerging economy this year.
• There are four sets of losers. First, the US. The dollar appreciation has already helped push US inflation to lower than desired levels, and economists estimate that it will depress US GDP growth by ½ to ¾ percentage points per year over the next year or two. These effects were no doubt important in the Fed’s recent decision to signal a later, rather than sooner, start date for embarking on policy normalisation.
• The second set of losers are countries whose currencies are closely tied to the dollar, ie China. However, despite recent currency appreciation, loss in price competiveness has not yet shown through to China’s external performance. The third set of losers is commodity exporters, including dollar bloc countries, Brazil, Russia and oil exporters.
• The final set of potential losers is countries than have bulked up on dollar-denominated debt. But such vulnerability appears low relative to history, especially at the sovereign level. The build-up of Emerging Market external debt has been mostly an Asian phenomenon, driven primarily by China, whose external debt burden remains low relative to GDP. And while dollar-denominated debt has risen for EM corporates, they generally appear well-positioned to withstand further dollar appreciation without leading to systemic events.
EUROPE: QE and growth versus political risk…
• As expected, the ECB initiated a large-scale, broad-based asset purchase programme encompassing government bonds. Despite being particularly controversial in the euro area, the ECB still managed to design a QE programme that exceeded market expectations.
• The ECB intends purchasing EUR60bn of assets per month for 18 months from March 2015 to September 2016. The pace of purchases was above market expectations, the total implies a balance sheet expansion in excess of EUR 1 trillion and possibly more so. The ability to find EUR60bn of assets every month for 18 months will depend in part on the strength of the economic recovery.
• The euro area in general remains behind the curve on structural reforms, but the lower oil price and euro depreciation together have pushed 2015 and 2016 GDP growth expectations up to 1.4% and 1.6% respectively with upside risks, particularly if other QE channels work.
• Politics remain the main risk. Populism is on the rise and the risks have materialised in Greece. Best case is a balanced compromise to be agreed and Greece to remain a euro area member, but the risk of a political accident is high. Even in Spain government instability is a significant concern. Elsewhere in the periphery policy continuity is expected despite anti-austerity rhetoric.
• Grexit is a downside tail-risk. On 20 February Greece agreed to extend the current loan programme despite having earlier said that it would not. Most economists believe that an exit is in no one’s interest, least of all Greece. Although there has been little progress since 20 Feb.
• There is EUR7.2bn of aid available in the current loan programme, but Greece will have to demonstrate its commitment to fiscal adjustment and reform before the EU will release funds. Time is running out. The risk of Greece failing to compromise is high. As the government’s limited cash resources get used up, depositor nervousness is rising again. If the ECB imposes a hard cap on Emergency Liquidity Assistance, it could force Greece into capital controls, and propel Greece into making concessions. Alternatively it could be the staging post for the exit from the euro.
• Political fragmentation could also be the theme in the UK election on 7 May 2015. The result is the most uncertain in a generation. There are few market-friendly outcomes. The Conservatives would offer a referendum on the EU. Labour’s loose fiscal stance could speed up the pace of monetary tightening. Consensus sees the BoE on hold until May 2016.
• Prospects across EEMEA (Emerging Europe Middle East and Africa) are subdued. This is largely due to Russia and masks modest upward revisions elsewhere in the region on the back of a decent end to 2014 and an improved backdrop in Western Europe, itself due to lower oil.
• The outlook for Russia has become more challenging. Although economic activity held up relatively well last year with GDP growth at 0.6%, the combination of ongoing sanctions and sharply lower oil prices is starting to weigh heavily and the Russian economy could contract as much as 5.2% this year.
PROSPECTS FOR SOUTH AFRICA …
• USD strength is pertinent for South Africa where the economy has historically benefitted from a weaker exchange rate, but the gain in price competitiveness has usually been eroded by domestic inflation pressure. In contrast, this cycle has been distinctly different from the past, thanks to subdued FX pass through to local inflation due to the lower oil price. In real trade weighted terms, the rand has depreciated by more than 20% over the last five years, notwithstanding recent strength, with the effects beginning to show up in some improvement in exports, especially manufactured goods.
• With growth prospects improving in Europe – SA’s major trading partner and a key destination for manufactured goods – the outlook for the export market is slightly more positive. Whether exchange rate pass-through remains subdued at current exchange rate levels remains to be seen.
• In terms of the monetary policy outlook, SA will be one of the few EM economies where rates may rise shortly after the Fed’s normalisation has started. Improving real rate differentials may actually stand the rand in good stead, especially if the Current Account deficit improves as is expected. Dollar strength will in all likelihood promote further rebalancing of the Current Account deficit, especially at levels above R12/$ which is close to the fundamental equilibrium exchange rate estimate needed to stabilize the Current Account deficit over time.
• Despite the view of a decline in general EM risk, there are a number of reasons to expect an increase in SA specific risk. Two critical factors come into play: (1) the cost of a downgrade on SA debt and (2) Electricity supply shocks and the result thereof. Both of these factors will most certainly shape and possibly unnerve markets in the coming months.
• And lastly, SA Equity Valuations are unequivocally stretched based on trend. One can argue that based on consensus numbers Resource counters may appear cheap, however one would have to caution that earnings on these counters still need some downgrades and that the current PEs are not a true reflection of value.
SA MACROECONOMIC RELEASES OVER Q1
• The SA GDP growth rate in 4Q14 was an improvement on the previous three quarters with an increase of 4.1%, although capping the year to just 1.5%. This was particularly disappointing when compared to the already muted growth of 2.2% in 2013.
• On the positive side, SA inflation decelerated to 3.9% in February, the lowest level since March 2011.
• Despite the lower levels of inflation, the MPC kept rates on hold at 5.75%, with a statement that was more hawkish overall than expected, arguing that the scope for pausing monetary policy normalisation had diminished. The current very drawn out period of policy tightening began with a 50 bps hike in 1Q14 followed by a further 25bps hike in July 2014. But the SARB has paused since then. Many economists propose that although not imminent a hike later in the year is likely.
• The SARB marked up its inflation projections materially to 4.8% in 2015 and 5.9% in 2016.
• At the same time, it left this year’s GDP growth outlook unaltered at 2.2% y/y, while marginally lowering next year’s forecast to 2.3% (from 2.4%).
• The sharp narrowing in the 4Q14 trade deficit to 0.9% of GDP, from 2% was unsustainable and reflected temporarily strong Chinese imports ahead of the Lunar New Year. The January record R24.2bn deficit showed these exports to China had collapsed by the amount of the late 2014 gain. February’s trade deficit of R8.5bn improved from January’s record as sales of vehicle and transport equipment jumped 74% as well as precious metals surging 30%. In contrast export of mineral products shrank 10.6%. The expectation for 1Q15 as a whole is approximately a 1.2% deficit of GDP.
• SA Purchasers Managers Index rose marginally to 47.9 in March from 47.6 in Feb. The slight improvement brought the average for Q1 to 49.9 points, just below the neutral 50-point mark. Sadly electricity load-shedding and general weak demand seems to have nipped the late 2014 recovery in the bud and looks likely to weigh on the economy this year.
GLOBAL MARKETS AND CHARTS SHAPING THE FUTURE … waiting for the Fed
• Over the last 12 months, equity and bond flows have been closely tied to market expectations of Fed rates. Falling expectations of Fed rates have seen outflows from equities and a strengthening of bond inflows; rising rate expectations the opposite.
• If US rates move up in 2015 as anticipated, expect reallocations of flows from bonds to equities to resume.
• Recent European equity outperformance is being driven by record inflows, both foreign and domestic which are following strong positive data surprises in Europe as US data has disappointed. European data surprises are running close to the top of their historical band while US data surprises are at the bottom of their historical band.
• These inflows into Europe has seen European equity relative valuations 10% above average, pricing in strong earnings growth in Europe of 15%, outpacing the US by 11 percentage points with a large relative currency benefit partially offset by slower underlying growth.