The US market continued to gain with the S&P 500 Index adding 4% at the time of writing. While green shoots are now visible across the broader market, the leaderboard was once again driven by the “magnificent seven” (i.e., Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla) as the artificial intelligence (AI) theme continued to drive investor enthusiasm. Nvidia was at the helm of the advance on the back of a blockbuster fourth quarter result underpinned by relentless demand for AI-enabling processing units. The group’s success serves as a barometer for the strength of the AI boom, as it fulfils a fundamental role in supporting big tech firms including Microsoft (ChatGPT), Google (Bard now Gemini), and Apple (Siri 2.0) in their ambitious AI endeavours. Recent commentary from US Fed members has resulted in market participants trimming back the number of rate cuts expected for the year, with the start of these cuts also being pushed out to later in the year. The market shifted rate cut expectations to July – closer to the Fed’s own expectations – after having kicked off the year on an overly optimistic note, with cuts having been priced in for the first half of the year already.
The European Central Bank (ECB) maintained its “data-dependant” approach to monetary policy – ECB Vice President, Luis de Guindos, noted that the recent inflation outlook is very positive, however, any changes to monetary policy will be dependent on whether upcoming economic data confirms this. Market participants downwardly revised expectations for aggressive rate cuts, with recent forecasts pricing in less than four 25 basis-point cuts for 2024. The odds of a first rate cut in April are now being placed at only 30%, with the new target being June. The Euro Stoxx 600 Index was up 2.7% for the month.
The local bourse was unable to maintain upward momentum, bucking the positive trend seen offshore, with the All-Share Index trading down around 2.6% towards month end (USD terms: -4.2%). The Budget Speech garnered attention and was decent from a market perspective – decidedly bond-friendly and on balance more equity-friendly than what was expected prior to its tabling. Again, execution risk remains both on sticking to the budget and government executing vital reforms to ensure an uplift in growth longer term. While investors cheered the exclusion of SOE bailouts from the budget initially, it has been touted as a potential issue if more money is required to support key network industries. It also appears that market participants (particularly offshore investors) have adopted a highly cautious stance ahead of the 2024 general election –likely a key factor contributing to the underperformance of the local market.
Economic Data Review
Market participants now expect the US Fed to start cutting rates later in the year
Flash estimates showed that the S&P Global Composite PMI for the US declined to 51.4 in February from 52 in the previous month, below expectations. Output increased slightly, but a softer uptick in services activity hindered overall expansion. Retail sales in January increased 0.6% y/y - this was lower than expectations. In December 2023, the deficit was little changed at $62.2 billion from a downwardly revised $61.9 billion in November 2023, and matching forecasts, as exports increased 1.5% and imports rose 1.3%. The unemployment rate in the US was 3.7% in January, unchanged from December, and slightly below consensus of 3.8%. The annual inflation rate in the US fell back to 3.1% in January following a brief increase to 3.4% in December but was higher than forecasts of 2.9%. Fed policymakers confirmed the policy rate was likely at its peak but noted that it would not be appropriate to reduce rates until they had gained greater confidence that inflation was moving firmly toward 2%, minutes from the January FOMC meeting showed.
ECB’s inflation outlook remains positive, but policy action remains data dependant
On a preliminary basis, the HCOB Eurozone Composite PMI rose to 48.9 in February, up from 47.9 in January and above the market consensus of 48.5, a preliminary estimate showed. The latest reading signalled a ninth consecutive month of falling output, although the contraction was the weakest since last June, as a stabilisation in the service sector offset a deeper downturn in manufacturing. Retail sales fell 0.8% y/y in December, a touch better than market expectations of a 0.9% decline, marking the 15th consecutive month of contraction in retail trade. A trade surplus of €16.8 billion was recorded in December against market expectations of a €21.5 billion surplus. The unemployment rate was unchanged at 6.4% in December, aligning with the market forecasts and remaining historically low. Inflation for December came in at 2.8%, matching consensus. At its most recent meeting, ECB officials agreed that it was too early to discuss interest rate cuts, despite recent indications of cooling inflationary pressures across the Eurozone. They expressed concerns that such a move may be premature and could potentially hinder or delay the timely return of inflation to target levels. In January, the ECB kept interest rates unchanged, as expected, at record-high levels 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.
Bank of England (BoE) sees inflation below 2% in a few months, supporting rate cut expectations
Initial reports showed that the S&P Global UK Composite PMI for February increased to 53.3 from 52.9 in January, surpassing the expected 52.9. Retail sales rebounded by 0.7% y/y in January, following a sharp fall of 2.4% in December and surpassing market expectations of a 1.4% decline. The UK’s trade deficit narrowed to £2.6 billion in December, from a revised £3.7 billion in November, as imports fell 3.4% and exports declined 2.0% - this was softer than expectations of a deficit of £1.9 billion. The unemployment rate declined to 3.8% in 4Q23, down from 4.0% in 3Q23 and slightly below the market consensus of 4.0%. The BoE maintained its benchmark interest rate at a 15-year high of 5.25% for the fourth consecutive time during its first meeting of 2024, in line with market expectations. The central bank said monetary policy will need to remain restrictive to return inflation to target sustainably, but dropped a reference to further tightening and acknowledged that the risks to inflation are more balanced. Still, key indicators of inflation persistence remain elevated although services inflation and wage growth have fallen by more than expected. Policymakers expect GDP growth to pick up gradually during the forecast period, in large part reflecting a waning drag on the rate of growth from past rate increases.
Additional stimulus plans from Chinese officials bolstered sentiment
The Caixin China General Composite PMI was at 52.5 in January this year, edging lower from December's seven-month high of 52.6, while marking the 13th straight month of growth in private sector activity. Retail sales increased by 7.4% y/y in December, missing market consensus of 8.0% and slowing from a 10.1% jump in November. China's trade surplus increased to $75.3 billion in December, surpassing market forecasts of $74.8 billion. The surveyed urban unemployment rate increased to 5.2% in January from 5.1% in the previous month. Consumer prices fell by 0.8% y/y in January 2024, the most in more than 14 years and worse than market forecasts of a 0.5% fall. It was the fourth straight month of decline in CPI, marking the longest streak of drops since 2009. The reference for mortgages, the five-year loan prime rate, was slashed by 25bps to 3.95%, more than market forecasts of a reduction of 15bps. It was the first rate reduction since June 2023 and the largest since that rate was introduced in 2019, as the board ramped up efforts to spur credit demand and reverse a property downturn. Meanwhile, the one-year rate was kept at 3.45%, defying consensus of a drop of 15bps. Both key lending rates are at record lows. Earlier in the month, the central bank unleashed CNY 1 trillion of liquidity into the banking system by trimming the reserve requirement ration for commercial banks by 50bps and reducing interest rates on re-lending funds aimed at promoting loans to agricultural and small firms.
Bank of Japan (BoJ) officials grow increasingly confident about imminent exit from negative rates
Early estimates showed that the Jibun Bank Composite PMI fell to 50.3 in February from a final 51.5 in January, which was the highest figure in four months. Retail sales rose 2.1% y/y in December, slowing from a 5.4% gain in November and missing market expectations for 4.7% growth. Japan’s trade deficit narrowed sharply to ¥1.8 trillion in January from ¥3.5 trillion in the same period last year and compared with market consensus of a gap of ¥1.9 trillion. The unemployment rate fell to 2.4% in December from 2.5% in the previous two months, which was also the consensus forecast. The annual inflation rate dropped to 2.2% (higher than forecasts) in January from 2.6% in December, the lowest figure since March 2022. At its January meeting, the BoJ kept its key short-term interest rate unchanged, in line with market expectations. 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 the confidence in achieving the BoJ's projections has steadily grown.
Local Budget Speech appeared to be market friendly as heightened political risk remains a concern
In December 2023, the leading business cycle indicator contracted 0.8% m/m (following a decrease of 0.4% a month prior), marking a second consecutive decline. In contrast, the SACCI Business Confidence Index recovered to a reading of 112.1 (from 108.6 in November) and improved further in January to a reading of 112.3. Sentiment was driven by increased merchandise exports, higher new-vehicle sales, a rise in tourism, as well as an uptick in retail sales (+2.7% in December). The trade balance in December amounted to a surplus of ~R14 billion (slightly below expectations of ~R15 billion) as exports decreased 11.5%.
Local mining production edged 0.6% higher in December (well below forecasts of 4.9% growth) due to significantly lower output of iron ore (-18%), manganese ore (-13.1%) and other metallic minerals (-16.9%). Manufacturing production increased 0.7% y/y, marking the slowest increase in three months due to weaker contributions from motor vehicle parts and accessories (-7.1%), other chemical products (-10.2%), as well as textiles, clothing, leather, and footwear (-4%). In January, composite PMI edged up to a reading of 49.2 (vs a reading of 49 a month before), as private sector activity remained soft. Manufacturing PMI, however, dropped to 43.6 (December 2023: 50.9), pointing to a renewed contraction in the manufacturing sector amid a sharp decline in new sales orders.
Consumer Price Inflation (CPI) rose to 5.3% in January (against expectations of 5.4%) amid a slight uptick in prices across restaurants & hotels, food & non-alcoholic beverages, health care as well as transportation. This is trending towards the top-end of the South African Reserve Bank’s (SARB) target range of 3% to 6%. Core inflation (which excludes the price of food, non-alcoholic beverages, fuel, and energy) increased to 4.6%, slightly above forecasts of 4.5%.
On 21 February, Finance Minister Enoch Godongwana delivered the 2024/25 Budget Speech. A few key highlights included:
- No major tax or VAT increases (apart from the usual increase in sin taxes). The budget, however, proposed a net tax revenue increase of ~R15 billion through non-inflationary adjustments to personal income tax brackets, rebates, and medical credits.
- National Treasury has planned R150 billion in transfers from the Gold and Foreign Exchange Contingency Reserve Account (GFECRA), which will be used to rein in debt, provide for public wage increases and maintain the budget deficit at 4.9% of GDP.
- As a result, gross government debt is anticipated to reach its peak at 75.3% of GDP in 2025/26. This projection is 2.4ppts lower than the 77.7% projected in the Medium-Term Budget Policy Statement (MTBPS) but still higher than the 73.6% peak that was projected at the 2023 Budget.
- The consolidated budget deficit is projected to narrow from 4.9% of GDP to 3.3% by the end of the 2024 Medium-Term Expenditure Framework (MTEF) period.
Outlook
Local
- The global economy is still expected to perform poorly relative to historic averages. This is even with the IMF’s most recent upward adjustment to the 2024 forecast, from 3.0% to 3.2%, that was primarily driven by starting point gains. This highlights headwinds from tighter monetary policy, fiscal policy neutralising, and continued geopolitical tensions.
- Meanwhile, South Africa’s economy is expected to slowly start recovering from a decade of materially weak growth and currently binding structural constraints. Downside surprises will be driven by political outcomes that allow rent-seekers to divert policy away from the structural reform agenda and adversely affect investments. We forecast growth of 0.6% in 2023, lifting to 1.2% in 2024, 1.6% in 2025, and 1.8% by 2026.
- Falling inflation remains a key feature of the outlook, globally and locally. This will allow a modest lowering of nominal interest rates and support a gradual recovery in household spending growth. Unfortunately, tensions in the Middle East pose significant upside risk to oil prices and logistics costs, and this could keep goods inflation sticky at a time when local services inflation is recovering from pre-pandemic lows.
- Should this affect the disinflation trend in the medium term, it would be troubling for the central bank – compounding the prevailing cost of funding risks. We currently project headline inflation to average 5.2% this year, before falling towards target in 2026. Such a profile is necessary to support a moderation in the nominal repo rate to 7% in 2026.
- Fiscal policy was more positive than feared before the 2024 Budget. Despite modest revenue increases and persistent spending pressures, Treasury expects the fiscal deficit to narrow over the period to 2026/27 and debt to stabilise at a lower level. This is a function of employing valuation gains from GFECRA to reduce the debt and interest cost profile, which should also be positive for the risk premium in the near term. This would ease funding cost pressures but given budget implementations risks, both monetary and fiscal policy should only aim at being neutral, rather than accommodative.
Global
- US growth has held up very well over the last few quarters despite a very aggressive interest rate hiking cycle. In the last Bank of America survey, participants stopped predicting a global recession for the first time since April 2022.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. Our house view is for US growth to underperform consensus in 2024.
- 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 now becomes the pace and quantum of these cuts. Markets are now pricing in about three-and-a-half interest rate cuts by the Fed for 2024 and is much closer aligned to the Fed, versus the six cuts priced into the market just one month ago. 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, commercial banks lowered their five-year loan prime rates to 3.95%, the biggest cut on record.
- Geopolitics are 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.