Market Overview (as of 29 January 2024)
The new year kicked off on a relatively positive note as investors returned from the festive period with growing expectations for central banks to implement aggressive rate cuts (as early as 1Q24). This is the opposite of how 2023 started, with the headlines at the time being dominated by a slew of interest rate hikes and rampant inflation. In terms of performance, gains on the MSCI World Index (+2.2%) were driven by developed markets which offset a weak performance from emerging markets (MSCI Emerging Markets Index: -3.2%). China (MSCI China Index: -6.9%) was one of the biggest laggards as ongoing growth concerns continued to dampen sentiment, however, there was some reprieve towards month end following news that Chinese authorities are planning to provide stimulus to support the stock market.
US markets continued to drive growth in the equity space, with the S&P 500 adding 2.6% at the time of writing, amid another round of solid gains from large tech companies. Recent data continues to show that the economy remains steadfast, with GDP growth over 4Q23 coming in significantly ahead of expectations. This data, in conjunction with better-than-expected Personal Consumption Expenditure (PCE), the Fed's preferred inflation gauge, showed that inflation continued to slow, and that restrictive monetary policy has not had a profoundly negative impact on the US economy thus far. This should strengthen arguments that a “soft landing” or “no landing” could be on the cards for the US economy but will temper expectations of aggressive rate cuts by the Fed this year, unless inflation follows a sharper path downwards and/or the economy stutters. Currently, Fed officials anticipate 0.75 percentage points worth of cuts in 2024 which will be implemented through three, quarter-point cuts.
In Europe, the European Central Bank (ECB) kept interest rates unchanged (at record-high levels) at its first meeting of 2024 and noted that they will maintain rates at restrictive levels for as long as necessary to bring inflation back to its 2% target. The monetary policy committee believes that the European economy likely stalled in 4Q23. ECB President, Christine Lagarde, told reporters that officials unanimously concurred that it was premature to discuss interest rate cuts but stood by her previous comments that a rate cut could be on the cards mid-year. Economists are currently forecasting an interest rate cut as soon as April. The Euro Stoxx 600 Index managed to edge approximately 1.3% higher for the month.
On the local front, the All Share Index contracted by 3.2% in January (USD terms: -6.1%) with the rand coming under pressure once again amid dollar strength. Meanwhile, as expected, the South African Reserve Bank (SARB) unanimously decided to keep its key repo rate at 8.25% at its January meeting – keeping borrowing costs at their highest since 2009. The bank highlighted the persistence of inflation risks while emphasising a balanced evaluation of risks to medium-term growth. The inflation forecast was kept at 5% for 2024 and was slightly revised upward to 4.6% for 2025 (4.5% in November 2023). The SARB maintained its growth projections at 1.2% for 2024 and 1.3% for 2025.
Economic Data Review
The US Federal Reserve expects to cut interest rates by 75bps this year
Flash estimates showed that the S&P Global Composite PMI for the US surged to 52.3 in January 2024, beating expectations, and marking a notable increase from December's 50.9 and indicating the most rapid rise in business activity since June 2023. Service sector activity expanded the most in seven months, while manufacturing firms continued to experience a moderate drop in output. Retail sales in December increased 5.6% y/y - better than expected. The US trade deficit narrowed to $63.2 billion in November 2023 from $64.5 billion in October and below forecasts of a $65 billion gap, as exports and imports each fell 1.9%. The unemployment rate held at 3.7% in December 2023, unchanged from the previous month and slightly below the market consensus of 3.8%. The annual headline inflation rate in the US went up to 3.4% in December 2023 from a five-month low of 3.1% in November, higher than market forecasts of 3.2%. The Federal Reserve kept the fed funds rate steady, as expected, for a third consecutive meeting in December, in line with expectations but indicated 75bps cuts in 2024. Policymakers said that recent indicators suggest that economic growth has slowed, and job gains have moderated but remain strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated.
The ECB kept rates on hold at its first meeting for the year, despite concerns of a possible recession
On a preliminary basis, the HCOB Eurozone Composite PMI was slightly up at 47.9 in January from 47.6 in December, falling short of market expectations of 48. The latest reading suggests that business activity in the bloc fell for an eighth consecutive month, but at the slowest rate since last July, as manufacturing production contraction eased to the softest since last April, and services activity declined the most since October. Retail sales fell by 1.1% y/y in November, below market expectations of a 1.5% decline, but accelerating from the 0.8% drop in October. A trade surplus of €20.3 billion was recorded in November 2023, switching from a €13.8 billion gap in the same month of the previous year. This was above forecasts of a €11.2 billion trade surplus. The unemployment rate hit 6.4% in November 2023, aligning with June's historic low and slightly surpassing the market forecast of 6.5%. The inflation rate for December came in at 2.9%, matching consensus expectations. The ECB kept interest rates unchanged (as expected) at record-high levels during its first meeting of 2024 and pledged to maintain them at sufficiently restrictive levels for as long as necessary to bring inflation back to its target in a timely manner, despite concerns about a looming recession and a gradual easing in inflationary pressures. During the central bank's press conference, President Lagarde told reporters that officials unanimously concurred that it was premature to engage in discussions regarding interest rate cuts. The ECB concluded its rapid rate-hiking cycle in September, but it has maintained a somewhat hawkish stance due to persistent underlying price pressures within the Eurozone and uncertainties stemming from geopolitical tensions, including the Red Sea blockade.
The Bank of England (BoE) maintained a restrictive stance; however, investors expect a rate cut later this year
Initial reports showed that the S&P Global UK Composite PMI rose to 52.5 in January 2024, up from 52.1 in December and slightly above the market consensus of 52.2. Retail sales fell by 2.4% y/y in December 2023, following a revised 0.2% increase in November and missing expectations of 1.1% growth. The UK’s trade deficit narrowed sharply to £1.41 billion in November 2023, compared to expectations of a £4 billion deficit, from a revised £3.2 billion in October, as imports fell by 2.3% and exports edged up by 0.1%. In line with market expectations, the unemployment rate was unchanged at 4.2%. Annual inflation in the UK unexpectedly rose to 4% in December 2023 from a nearly two-year low of 3.9% in November, and above forecasts of 3.8%. The BoE maintained its benchmark interest rate at a 15-year high of 5.25% (as expected) for the third consecutive time during its December meeting, aligning with policymakers' efforts to combat inflation, even in the face of indications pointing to a deteriorating economic landscape. The remaining three members advocated for a 25bps rate hike, citing the relatively tight labour market and evidence of persistent inflationary pressures. The central bank has emphasised the probable necessity for an extended period of restrictive monetary policy to curb inflation, while also highlighting the potential requirement for further tightening should persistent inflationary pressures persist. Despite these statements, investor forecasts anticipate a decline in UK interest rates this year. However, they have adjusted their bets on the extent of rate cuts, with the first fully priced in for June instead of May.
Recent stimulus plans for China provides some relief
The Caixin China General Composite PMI rose to 52.6 in December 2023 from 51.6 in the prior month. This was the 12th straight month of growth in private sector activity and the steepest pace since May, as factory activity increased the most in four months and the service sector expanded at the fastest rate since July. Retail sales increased by 7.4% y/y in December 2023, missing market consensus of 8.0% and slowing from a 10.1% jump in November. China's trade surplus increased to $75.34 billion in December 2023 from $70.65 billion in the previous year, surpassing market forecasts of $74.75 billion. The surveyed urban unemployment rate inched up to 5.1% in December 2023 from 5% in the previous three months, which was the lowest jobless rate since November 2021. China's consumer prices fell by 0.3% y/y in December 2023, marking the third straight month of decline, which was the longest streak of drops since October 2009. Figures came in less than market forecasts of a 0.4% fall. The People's Bank of China (PBoC) maintained lending rates at the January fixing, as was widely expected, as the central bank continued its attempt to support an economic revival. The decision came after the central bank ramped up its liquidity injection through medium-term policy last week while surprising markets by keeping the interest rate unchanged.
The Bank of Japan (BoJ) debated phasing out stimulus, and will look at the appropriate pace of future interest rate hikes
Early estimates showed that the Jibun Bank Composite PMI rose to 51.1 in January 2024 from a final 50.0 in December. It was the highest reading since September, with services activity continuing to lead the way as the expansion strengthened to a four-month high. Retail sales rose 5.3% y/y in November 2023, accelerating for the first time in three months following a downwardly revised 4.1% gain in October and exceeding market forecasts for a 5% growth. Japan’s trade balance unexpectedly shifted to a surplus of ¥62.10 billion in December 2023 from a deficit of ¥1.5 billion in the same period of the prior year, beating market estimates of a shortfall of ¥122.1 billion. The unemployment rate stood at 2.5% in November 2023, unchanged from the previous month and matching market forecasts. The annual inflation rate fell to 2.6% (in line with forecasts) in December 2023 from 2.8% in the prior month, pointing to the lowest figure since July 2022. The BoJ kept its key short-term interest rate unchanged, in line with market expectations, at its January meeting. After the decision, BoJ Governor Ueda commented that any potential rate hike would initially seek to maintain BOJ policy in support of the economy and would strive to minimise disruptions. Expanding on the newly incorporated language in the central bank's quarterly outlook report, the governor noted that confidence in achieving the BOJ's projections has steadily grown.
Local inflation eased in November with expectations of interest rates remaining on hold
In November 2023, the leading business cycle indicator contracted 0.4% (after an increase of 0.5% a month before), marking the first decline in over five months. Retail sales were down 0.9% y/y (in line with expectations) amid a further slowdown in retail activity within the hardware, textiles and clothing sectors. Nevertheless, the SACCI Business Confidence Index for November increased to a nine-month high of 111.5 (compared to a reading of 108.6 in the previous month), with sentiment driven by a more positive outlook on tourism and foreign trade relations (including merchandise volumes). The trade balance amounted to a surplus of about R21 billion (ahead of expectations of about R5.8 billion) as exports surged 9.2% while imports dropped 10%.
Local mining production improved 6.8% in November (beating forecasts of 3% growth) due to stronger output from the PGMs as well as the coal and iron ore miners. As expected, manufacturing production increased 1.9% y/y, marking the second consecutive month of growth in industrial activity, with a strong contribution from producers of wood and related products as well as motor vehicle parts and accessories. In December, composite PMI softened to 49 (compared to 50 a month before), signalling a fresh slowdown in private sector activity. Manufacturing PMI improved to 50.9 (November: 48.2) as many businesses benefitted from an extended period of no load-shedding.
Consumer Price Inflation (CPI) eased to 5.1% in December (against expectations of 5.2%) amid moderating transport (fuel) costs as well as food & non-alcoholic beverage prices. This is trending towards the midpoint of the SARB’s target range of 3% to 6%. Core inflation (which excludes the price of food, non-alcoholic beverages, fuel and energy) was unchanged at 4.5%. During its January meeting, the SARB left its benchmark interest rate unchanged at 8.25% (as was widely anticipated) and emphasised that inflation risks remain elevated even though the risks for medium-term domestic growth appear balanced. Reserve Bank Governor, Lesetja Kganyago, said that future interest rate decisions depend on economic data available during the MPC meetings.
Outlook
Local
- The SARB expects trading partner growth to narrow to 2.6% this year, from 2.7% last year and 3.8% in 2022. Nevertheless, growth in trading partner economies is forecast to improve to 3.1% in 2025 and 2026.
- In line with this, as well as the continued implementation of structural reforms, we see a lift in local growth over the forecast period. We forecast growth of 0.6% in 2023, lifting to 1.2% in 2024, 1.6% in 2025 and 1.8% by 2026.
- Also supportive of higher local growth will be falling inflation and a modest lowering of interest rates. This will reduce cost of living pressures and usher in a gradual recovery in household spending growth.
- Risks to the outlook include further escalations in geopolitical tensions, which may revive supply chain disruptions, constrain global trade, and keep inflation elevated.
- Sticky global inflation alongside a weak rand could spell trouble for expectations of slower goods inflation and given that we expect a post-pandemic uplift in services inflation, this would keep local headline inflation above target. Nevertheless, we are in line with market consensus in anticipating a further slowing in headline inflation towards 5% on average this year, before falling towards target in 2026. We project average annual headline inflation of 5.2% in the current year, from 6.0% last year, 4.8% in 2025 and 4.7% in 2026.
- Monetary policy remains restrictive. A negative current account and anticipated fiscal slippage, together with rising global real interest rates, supports the narrative of rising neutral interest rates. However, if the SARB’s inflation forecast prevails, policy is likely to become more restrictive over the course of the year, surpassing the estimate on neutral by over 1% by 4Q24. Such conditions provide headroom for nominal interest rate cuts, but the extent will be dictated by shifts in real interest rates, SA’s fiscal performance and risk premium, as well as inflation expectations. Ultimately, the environment will be neutral, not accommodative.
Global
- US growth has held up very well over the last few quarters despite a very aggressive interest rate hiking cycle. In the Bank of America survey 80% of participants suggested that the US will experience a ‘soft’ landing in 2024 versus only 17% calling for a harder landing. The long and variable lags of monetary policy are in progress, but thus far the impact has been relatively small (as most companies/individuals have locked-in low rates). We expect this soft vs hard landing rhetoric to continue throughout the year as new data becomes available.
- Inflation has peaked and is trending lower. We are now in the ‘last mile’ (to get inflation from 3% to 2%), and many economists expect this to take some time. However, shelter inflation should continue to trend lower, causing inflation to continue its downward trend.
- The Fed’s interest rate hiking cycle is over. The question for 2024 becomes the pace and quantum of these cuts. Markets are pricing in almost six interest rate cuts by the Fed for 2024. The Fed is indicating only three cuts in their latest economic projections released in December 2023. The ‘soft’ landing narrative is based on the Fed cutting rates fast enough, so real rates don’t become too restrictive on the economy.
- In emerging markets, it is certainly encouraging to see the PBoC maintaining loose monetary policy and further injecting liquidity into the banking system. However, the recovery will remain fragile in the absence of fiscal stimulus targeted at restoring confidence to the consumer and addressing the property sector issues. With low levels of inflation and notable excess savings combined with attractive valuation multiplies, we are of the belief that selected opportunities remain in the Chinese economy and will be on the lookout for more palatable policy responses from fiscal authorities. This month, the Reverse Repo Rate was cut by 0.5% and further stimulus measures were announced.
- Geopolitics is always important for asset markets, but the election calendar for 2024 is exceptionally busy. This year, 76 countries will be voting, representing more than half of the world’s population and over 65% of global GDP. This, together with two major ongoing wars, could exacerbate uncertainty and volatility over the next few months. The impact from these developments, especially on oil, should be monitored very closely.
- Given all the above uncertainties, we are closely aligned to our strategic asset allocation benchmarks, with a slight defensive twist. We slightly favour fixed income over equities.