The month of October was good for most asset classes as expectations rose that the United States (US) and China were closer to signing a trade deal. Monetary easing from most central banks also offered some support to the markets.
In the US, most indicators were weaker compared to the previous month, confirming our view that the US is “catching down” to the rest of the world. Industrial output fell 0.4% from a month earlier in September, following an upwardly revised 0.8% gain in August. This was the sharpest decline since April as manufacturing production fell 0.5%. Housing starts fell from a 12-year high, recording a 9.4% drop from a month earlier, to a seasonally adjusted annual rate of 1 256 000 units in September. Starts for the volatile multi-family housing sector dropped 28.2%, while single-family homebuilding increased 0.3%. Retail sales posted its biggest drop in seven months, falling by 0.3% from a month earlier in September, after an upwardly revised 0.6% gain in August. It was the first decline in retail trade since February, mainly due to slower sales of motor vehicles. Consumer sentiment, as measured by the University of Michigan, was revised lower to 95.5 in October. Consumer expectations and current conditions came in weaker than initially thought. The annual consumer inflation rate was unchanged at 1.7% in September, as a pick-up in food was offset by a decline in energy prices. The IHS Manufacturing Purchasing Managers’ Index (PMI) was the main positive surprise for the month; it rose to 51.5 in October from 51.1 in the previous month. The Federal Reserve lowered the target range for the federal funds rate to 1.50% to 1.75% during its October meeting, the third rate cut so far this year, amid muted inflation pressures and concerns about the global economic outlook. But the central bank signalled a pause in the easing cycle as the reference that it “will act as appropriate” was removed from the statement. The US economy also grew by an annualised 1.9% in the third quarter of 2019, beating market expectations of 1.6%. Household consumption, government spending and exports were the main drivers, while business investment fell.
Data from the Eurozone was mixed. The trade surplus rose to €14.7 billion in August from €11.9 billion in the corresponding month of the previous year. Exports fell 2.2% and imports slumped 4.1%. Exports and imports fell to their lowest level since December 2018. The unemployment rate dropped to 7.4% in August, the lowest since May 2008 as the number of unemployed people continued to decline. The IHS Markit Manufacturing PMI was at 45.7 in October, unchanged from the previous month. Industrial production dropped by 2.8% from a year earlier in August, following an upwardly revised 2.1% fall in the previous month. This was the tenth consecutive month of contraction in the industry sector. The annual inflation rate dropped to 0.8% in September from 1% in the previous month. It was the lowest inflation rate since November 2016, as energy prices fell further. Core inflation, which excludes volatile prices of energy and food, was at 1%, after a 0.9% gain in August. The European Central Bank left its main refinancing rate as well as the deposit rate unchanged at zero percent and -0.5% respectively during Mr Mario Draghi’s final meeting in October. The bank added that it expects key rates to remain at their present or lower levels until it has seen the inflation outlook converge to a level sufficiently close to, but below, 2%.
In the United Kingdom (UK), the threat of a hard Brexit was avoided for the time being as the European Union (EU) extended the deadline to the end of January 2020. Inflation was at 1.7% in September, unchanged from the previous month. It remained the lowest rate since December 2016, amid a slowdown in the cost of transport, as fuel prices fell the most since August 2016. The unemployment rate unexpectedly rose to 3.9% in the three months to August from 3.8% in the previous period. Meanwhile, total pay growth rose by 3.8%, below market expectations of 4%. The trade deficit narrowed to £1.55 billion in August from a revised £1.68 billion in the previous month. Imports rose 0.6%, while exports increased by 0.9%. The gross domestic product (GDP) expanded 1.3% year-on-year in the second quarter of 2019, compared to a revised 2.1% growth in the previous period. Retail sales rose 3.1% in September versus 2.6% in August. The IHS Markit manufacturing PMI rose to 48.3 in September, from the previous month’s six-and-a-half year low of 47.4. However, the latest reading remained below the neutral 50-point mark for five successive months. The Bank of England’s Monetary Policy Committee voted unanimously to hold the bank rate steady at 0.75% during its September meeting, and reaffirmed its pledge to gradual and limited rate rises under the assumption of a smooth Brexit and some recovery in global growth. There was no October meeting.
In China, data improved for the month. The Caixin Manufacturing PMI rose unexpectedly to 51.4 in September from 50.4 in the previous month. Inflation rose to 3% in September from 2.8% in August. This was the highest rate since October 2013, mainly due to persistently high pork prices following the outbreak of African swine fever. Annual core inflation, which strips out volatile food and energy prices, was at 1.5% in September, the same as August. The trade surplus widened to $39.65 billion in September from $30.26 billion in the same month a year earlier. Exports declined 3.2%, while imports fell at a faster 8.5%. Industrial production increased by 5.8% year-on-year in September, after a 4.4% rise in the previous month. This was the largest gain since June, as production rose further for both manufacturing and mining. The economy grew 6% year-on-year in the September quarter, slowing from 6.2% in the previous quarter. It was the slowest growth rate since the first quarter of 1992, amid persistent trade tensions with the US and weakening global demand.
In Japan, the Manufacturing PMI dropped to 48.5 in October from a final 48.9 in September. This was the sixth consecutive month of contraction in factory activity and the steepest fall since June 2016, amid reports of weaker global trade conditions and softer growth at key export markets. The unemployment rate remained unchanged at 2.2% in August, the lowest since October 1992. Consumer price inflation fell to 0.2% year-on-year on-year in September from 0.3% in August, below expectations of 0.4%. It was the lowest inflation rate in seven months, mainly pushed down by lower gasoline prices. This number raises the chances of further stimulus after the Bank of Japan decided to leave policy unchanged during its September meeting but left the window open for easing, calling for a review of prices and the economy in October.
On the local front, inflation edged down to 4.1% in September from 4.3% in August, slightly below market expectations of 4.2% but also below the midpoint of the South African Reserve Bank’s (SARB) target range of 3% to 6%. Prices slowed mostly for housing and utilities and transport. The unemployment rate edged up to 29.1% in the third quarter of 2019, the highest level since comparable data began in 2008. The number of unemployed people rose by 78 000 to 6.73 million, while employment increased by 62 000 to 16.38 million. A trade surplus of R6.84 billion was recorded in August, compared to an upwardly revised R3.72 billion deficit in the previous month. Exports rose at 8.4%, while imports fell 1%. The Manufacturing PMI slumped to 41.6 in September from 45.7 in August. This is the second sharp decline and the largest since August 2009, amid continued weak demand conditions. Retail sales increased by 1.0% year-on-year in August, easing from a 2% rise in the prior month. The SARB unanimously kept its benchmark repo rate unchanged at 6.5% in September, as widely expected, after trimming it by 0.25% in the prior meeting. There was no October meeting. The widely anticipated Eskom special paper was also released during the month. The paper outlined more detail on how Eskom would be split into three separate entities, namely generation, transmission and distribution. The new CEO will only be announced early next month and more details around funding and balance sheet restructuring are still being finalised. The medium-term budget policy statement (MTBPS) was also presented at the end of the month and markets (especially the rand and bonds) sold off on the very poor road map projected and lack of fiscal consolidation. The main budget deficit is forecast to reach -6.8% of GDP by 2020/2021 and gross debt to GDP is projected to grow to 71.3% by 2022/2023.
While recent global indicators remained on the soft side (US and Germany in particular), leading indicators continue to point towards a bottoming of global economic growth followed by a gradual improvement towards the second quarter of 2020 and beyond. This presupposes no material deterioration on the trade war front. Easy monetary conditions were likely to prove supportive. While relatively high inventory levels and a slowdown in the US profit cycle represented downside risk, this gradual economic recovery thesis remained our base case with a 60% plus probability. The US “catch down to the rest of the world” expectation remained intact as did a weaker trade-weighted US dollar over the medium to longer term. The relatively faster pace of US economic softening was not anticipated to represent a material threat to global growth. A further 25 basis points cut in the US Fed Fund rate remained the base case view although it is acknowledged that there could well be an additional cut beyond this. The market is currently implying more than 50 basis points worth of cuts through to the end of 2020.Trade war risks remain, but increased tariffs are likely to be accompanied by greater Chinese stimulus. Inflation remains well contained globally. Bond yield forecasts are higher than spot rates across the board as we view the risk of a recession to be relatively low. Global equities have more investment merit than global bonds based on an elevated earnings yield versus bond yields.
Locally, evidence of reform will be necessary to boost policy confidence and yield higher private sector investment. Economic growth will likely be constrained to below 2% until then. While we anticipate better than money market returns from growth assets over the next 12 months, mostly on valuation grounds, muted business confidence remains a significant impediment. An improvement in confidence would be required to generate returns in the double-digit range. Concerns over the fiscal deficit have risen sharply over the last few months as the country is experiencing low nominal growth (due to lower tax collections) and further state-owned enterprise (especially Eskom) bailouts. Moody’s is expected to review South Africa on 1 November. There is a high possibility that Moody’s will change our outlook from “neutral” to “negative” at this meeting, however, we do not expect a downgrade to below investment grade this year.