Monthly investment update

After making steady gains in the first two weeks of the month, global equity markets sold off towards the end of the month as investors measured the impact of numerous instances of the coronavirus in South Korea, Italy and Iran. The new coronavirus was first diagnosed in the Wuhan province in China.

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While it seems as if the infection rate in China has slowed and is expected to decline going into March, these further outbreaks have added a new dimension. One would expect that health ministries in these countries would have been prepared and that the effect would be less severe than in China. However, it could further curtail crossborder travel and other industries which may add to the short-term global growth shock expected in quarter one of 2020.

United States (US) data was mostly better than expected in February, with the exception of the IHS Markit Composite Purchasing Managers’ Index (PMI) which fell to 49.6 in February from 53.3 in January, signalling the first contraction in the private sector since October 2013. Services activity fell and manufacturing growth slowed.

Retail sales increased 0.3% month-on-month in January, in line with market expectations. Non-farm payrolls increased by
225 000 in January, ahead of market expectations of 160 000 with strong job gains in construction, healthcare, transportation and warehousing. The unemployment rate creeped up to 3.6% from 3.5% in December (expected 3.5%) as the labour force participation increased to 63.4% from 63.2%. Average hourly earnings increased 3.1% year-on-year (expected 3%). Industrial production fell 0.8% year-on-year in January, slightly better than an expected 0.9% decline. The trade deficit fell 1.7% for 2019 to $616.8 billion as imports fell 1.7% and exports declined 1.3%. This was mainly because the goods deficit with China fell 18%.
The trade gap widened 5% with the European Union (EU); by 26.2% with Mexico and by 42% with Canada. The personal consumption expenditure price index went up 1.6% year-on-year in December, after a downwardly revised 1.4% in November.

Economic indicators out of the eurozone were mixed. The IHS Markit Eurozone Composite PMI increased to 51.6 in February from 51.3 January, ahead of market consensus of 51. This was the strongest pace of expansion in the private sector since August last year, boosted by service sector growth, while manufacturing contracted the least in a year. Consumer confidence rose to
-6.6 in February from -8.1 in January, better than market expectations of -8.2. Meanwhile, industrial production fell 4.1% year-on-year in December, well below an expected 2.3% decline, and retail trade slumped 1.6% month-on-month in December following a 0.8% increase in November. Fourth quarter gross domestic product (GDP) was revised lower to 0.9%, the weakest rate since quarter four of 2013. Gross domestic product growth slowed in Germany (0.5% vs 0.6% in quarter three), France (0.8% vs 1.4%) and Spain (1.8% versus 1.9%), while Italy’s economy stagnated (0.5% in quarter 3). The inflation rate came in at 1.4% year-on-year in January, boosted by energy and unprocessed food. The core inflation rate came in at 1.1%, below
December’s 1.3%.

Data was better than expected out of the United Kingdom (UK) in February. Retail sales increased 0.8% year-on-year in January, beating market expectations of a 0.7% gain and consumer confidence rose two points to -9 in January. Mortgage approvals also picked up during the month. The unemployment rate held steady at 3.8% in quarter four of 2019, in line with market expectations. Inflation accelerated to 1.8% in January from 1.3% in December and above market expectations of 1.6%, driven by transport, housing and utilities. The IHS Markit/CIPS UK Composite PMI was unchanged at 53.3 in February, ahead of market expectations of 52.8. Manufacturing rose to 51.9 from 50, while services growth slowed slightly to 53.3 from 53.9. This came amid a reduction in political uncertainty since the general election, which continued to translate into higher business activity and greater willingness to spend. The trade surplus of £845 million in December was the UK’s highest surplus on record, as exports increased 17.4% year-on- year while imports fell 0.1%.

The Japanese economy contracted 6.3% year-on-year in the fourth quarter, compared to consensus of a 3.7% contraction as private consumption fell sharply after the implementation of a sales tax increase in October. The composite PMI dropped to 47.0 in January from 50.1 in December, amid fears over the impact of coronavirus outbreak in China. The services sector contracted the most in nearly six years (PMI at 46.7 versus 51 in December), while manufacturing activity shrank (PMI at 47.6 versus 48.8). The trade deficit narrowed to more than expected as exports fell 2.6% year-on-year due to lower shipments of cars and machines to the US and sales of car parts and electronics to China, and imports shrank 3.6%. Core machinery orders (excluding those of ships and electrical equipment) fell by a worse-than-expected 12.5% month-on-month and 3.5% year-on-year. Consumer price inflation fell to 0.7% year-on-year in January from 0.8% in December, in line with market expectations.

Private sector activity slowed in China in the first month of the year. The Caixin China General Composite PMI dropped to 51.9 in January from 52.6 in December as manufacturing growth slowed (51.1 versus 51.5 in December) and services sector output expanded less (51.8 versus 52.5). Sentiment nevertheless rebounded across both sectors, mainly as further policy support is expected in response to the coronavirus outbreak. The People’s Bank of China cut its benchmark one-year loan prime rate (LPR) by 10 basis points to 4.05%, amid efforts to support the economy as it deals with the coronavirus outbreak. The five-year LPR was cut by five basis points to 4.75%. The rate adjustment followed a similar move in the medium-term lending rate.

South Africa’s economic data releases remained mostly soft in February. Retail sales for December declined 0.4% year-on-year, from a 2.6% year-on-year increase in November and against market expectations of 2.1% year-on-year, as consumers shifted buying to November Black Friday deals away from the traditional December holiday shopping period. Manufacturing production in December plummeted by 5.9% year-on- year, below the -3.2% in November and below consensus of a 3.9% contraction.
The unemployment rate remained unchanged at 29.1% in quarter four of 2019. South Africa’s Consumer Price Index (CPI) jumped to 4.5% year-on-year in January 2020, from a modest 4% in December 2019, but lower than market expectations of a 4.6% year-on-year increase. While still in contractionary territory, the IHS Markit PMI increased to 48.3 in January from 47.6 in the previous month. Output and employment declined. New export orders increased and the outlook for activity among firms strengthened to a seven-month high due to plans to introduce new products and services. On the positive side, December mining production increased by 1.8% yearon- year, after an upwardly revised decline of 1% in November (previously -3.1%), well above the Bloomberg consensus of a 3.5% decrease, on the back of a large increase in output from the gold sector. The trade surplus of R14.8 billion for December 2019 was up from a downwardly revised R5.6 billion (previously R6.1 billion) in November 2019 as imports decreased by a higher proportion than exports.

Following similar moves by the World Bank and the International Monitory Fund (IMF), Moody’s credit rating agency downwardly revised its growth forecasts for South Africa amid intermittent load-shedding and lacklustre demand. The agency now expects the economy to grow just 0.7% in 2020, compared to a previous forecast of 1%. It downgraded its expectations for 2021 from 1.2% to 0.9%.

Finance Minister Tito Mboweni presented South Africa’s 2020 Budget on 26 February. It was a good budget from a market perspective striking a delicate balance of being both bond and equity friendly. The rand strengthened, bond yields fell across the curve and SA Inc. stocks rallied. A decline in non-interest expenses is bond friendly, because it will mean the fiscus will be in better shape and more funds will be available to service debt. The fact that there were no meaningful tax changes is equity positive – particularly because there was significant fear in the system regarding the possibility of value added tax (VAT) increases, additional tax brackets, a one-off wealth tax, and prescribed assets.

Pull out_In line with
Market outlook

An improvement in global economic indicators has been somewhat derailed by the coronavirus outbreak in China. This, together with continued trade war risks (despite the signing of a phase-one deal between China and the US in January), could trigger further stimulus by the Chinese as well as other large economies. Easy monetary conditions are likely to prove supportive medium term. Inflation remains well contained globally and central banks have become more dovish in their rhetoric.

Global equities have more investment merit than global bonds based on an elevated earnings yield versus bond yields. Emerging markets continue to exhibit relative value, and a dovish interest rate environment could well see an ongoing favourable performance. 

In South Africa, substantial evidence of reform will be necessary to boost policy confidence and yield higher private sector investment. Our growth forecasts remain constrained for the forecast horizon due to electricity supply issues as well as weak consumer and business confidence. Despite a pro-markets budget, economic growth will remain constrained in the absence of any meaningful improvement in confidence and underlying activity. Market returns, while expected to be above money market rates, will also remain constrained until then.

The low growth experienced together with a lack of inflation should allow the South African Reserve Bank (SARB) some room to cut the repo rate further over the forecast horizon.
Fitch ratings_pull out We still expect Moody’s to lower South Africa’s sovereign credit rating only in November this year, as opposed to at its next review for the country, which is on 27 March 2020. Although the 2020 budget looks very similar to the 2019 Medium-Term Budget Policy Statement (MTBPS) on a net basis, we assess that the ratings agencies could view it favourably given the concerted effort to cut expenditure.

The credit ratings agency, which rates South Africa’s sovereign credit as sub-investment grade, said that the consolidation efforts rely heavily on a moderation in public sector wages which “might not materialise”.