Global equity markets had a reasonable start to the year with strong gains in the beginning of the month tempering in the last week of January. The main themes for the first month of the year were the “reflation trade” on the expectation of further fiscal and monetary stimulus, the vaccine roll-out and the economic impact of the Coronavirus (COVID-19) “second wave”.
*31 December 2020 to 26 January 2021
The Johannesburg Stock Exchange (JSE) also experienced a positive month as foreign buyers returned to the South African market amid a general positive stance on emerging markets
Bonds also gained ground on an aggregate basis, also on positive foreign flows, with the strength in this market more centred on the “belly of the curve”. The rand weakened from a position of strength.
Economic data overview
United States (US) data released in January was broadly positive. The Georgia Senate runoffs were in focus at the start of the year. The outcome certainly surprised markets with the US 10-year yield breaching the 1% mark for the first time since March last year as markets began to price in a more pronounced economic recovery. This can largely be ascribed to a stronger fiscal impulse with a Democratic-led House and Senate, and the resultant impact on stronger inflation expectations. On the data front, the ISM Manufacturing Purchasing Managers’ Index (PMI) surged to 60.7 index points in December compared to a reading of 57.5 the previous month and registers as the strongest pace of expansion since August 2018. The stark improvement in production and new order growth led the increase over the month. Similarly, ISM Non- Manufacturing PMI climbed to a higher 57.2 index points in December compared to a reading of 55.9 the previous month as new orders and business activity growth accelerated at a faster pace. It is worth noting that in both ISM surveys the prices paid subcomponent is relatively elevated, signalling that a reflationary impulse in headline Consumer Price Index (CPI) is likely in sight this year. United States construction spending continued expanding, rising 0.9% month-on-month in November after increasing 1.6% the month before amid a robust expansion in the private sector, particularly in the residential subsector.
Non-farm payroll employment fell by 140 000 over December after rising 336 000 the previous month and registers as the first contraction in employment since April. The bulk of the downturn stemmed from the leisure and hospitality industry (-498 000). Retail trade (+120 500) and professional and business services (+161 000) industries contributed the most to employment gains over the month. Headline inflation climbed higher in December, coming in at 1.4% year-on-year after registering a reading of 1.2% in each of the two preceding months. The reflationary impulse can largely be ascribed to higher energy prices over the month. The trade deficit widened to the largest reading since August 2006, coming in at $68.1 billion in November compared to a deficit of $63.1 billion in October. Retail sales contracted by 0.7% month-on-month in December after falling 1.4% in November. Industrial production climbed 1.6% month-on-month in December after rising 0.5% in November, primarily led by a strong increase in output in the utilities subsector. Heading into the new year, it is worth noting that all sectors on the S&P 500 have registered positive sales and earnings surprises as the year starts off on a more upbeat note compared to last year.
Data out of the euro area was somewhat mixed. The flash IHS Markit Manufacturing PMI lost some steam, edging down to 54.7 index points in January compared to a higher 55.2 in December. Concerningly, the flash IHS Markit Services PMI fell to a reading of 45 index points in January compared to 46.4 the previous month. The softer IHS Markit survey readings can likely be ascribed to more stringent lockdown restrictions within the euro area. Inflation registered its fifth deflationary reading in December as headline CPI came in at -0.3% year-on-year – unchanged in four consecutive prints. Similarly, core inflation remained unchanged at the lowest reading on record, registering just 0.2% year-on-year. In response, the European Central Bank (ECB) opted not to extend further monetary policy support to markets beyond the extension of their Pandemic Emergency Purchase Programme last month. However, if economic and inflation data surprise to the downside, the ECB will likely loosen monetary policy even further this year. Retail sales data plunged 6.1% month-on-month in November after rising 1.4% the previous month. Nevertheless, the unemployment rate remained on a downward trend, easing to 8.3% in November after registering 8.4% the previous month. Industrial production data was relatively upbeat, climbing 2.5% month-on-month in November after rising 2.3% in the preceding month led by a 7% surge in capital goods output. Construction output declined at a more moderate pace, falling 1.3% year-on-year in November after declining 1.9% in the previous month.
On balance, data was relatively negative in the UK. The flash IHS Markit/CIPS Manufacturing PMI eased to 52.9 index points in January from 57.5 in December as most subcomponents in the series slowed in the month. Similarly, the flash IHS Markit/ CIPS Services PMI plunged to 38.8 index points in January from 49.4 the previous month. Overall, the IHS Markit/CIPS survey data likely surprised to the downside due to more stringent lockdown measures. United Kingdom (UK) housing prices eased to 6% year-on-year in December from 7.6% the previous month. Despite the slight deceleration, housing price inflation remains quite strong amid a stamp duty holiday likely incentivising overall purchases. The trade deficit widened significantly, coming in at £5 billion in November after a deficit of £2.3 billion in the previous month and registers as the largest deficit since April 2019. Construction output declined at a more moderate 1.4% year-on-year in November after falling 2.2% in the previous month and much better than market expectations. Industrial production fell 4.7% year-on-year in November after declining 5.8% the previous month. United Kingdom inflation climbed to a higher 0.6% year-on-year in December from 0.3% the previous month largely due to higher energy prices during the month.
China data continues to surpass expectations. China’s gross domestic product (GDP) accelerated in the last quarter of the year, surging 6.5% year-on-year compared to 4.9% in the previous quarter and above Bloomberg market expectations of 6.2%. The print registers as the fastest pace of expansion since the fourth quarter of 2018. Information transmission, software and information technology services (+19.7% year-on-year); transport, storage, and post (+7.6% year-on-year); and manufacturing (+7.3% year-on-year) were among the fastest expanding sectors in the quarter. The Caixin Manufacturing PMI edged down to 53 index points in December from a particularly upbeat reading of 54.9 the previous month. New orders and output growth softened somewhat, although the overall index level remains relatively upbeat. Similarly, the Caixin Services PMI edged down to 56.3 index points in December from 57.8 the previous month. It is worth noting that, according to the respective Caixin surveys, business optimism is exceptionally upbeat heading into the new year. Consumer Price Index bounced back into inflation territory, registering 0.2% year-on-year in December after a deflationary reading of -0.5% in the previous month. Pork prices fell at a more decelerated pace of 1.3% year-on-year compared to a downturn of 12.5% in November. Producer Price Index (PPI) data was less deflationary as the headline reading fell 0.4% year-on-year compared to a 1.5% fall in November. New home prices continued to slow, registering 3.8% year-on-year in December from 4% in November. The trade balance surplus accelerated at a faster pace in December to a record-high reading of $78.2 billion amid a strong rebound in exports putting global growth on a strong footing in 2021. Industrial production climbed 7.3% year-on-year in December compared to 7% in November as manufacturing output remained relatively upbeat, rising 7.7% year-on-year – unchanged from the previous month. Retail sales softened in December, easing to 4.6% year-on-year from an increase of 5% the previous month.
Data out of Japan largely softened. The flash au Jibun Bank Manufacturing PMI edged down to 49.7 index points in January after a neutral reading of 50 in the previous month amid more stringent lockdown measures. Similarly, the flash au Jibun Bank Services PMI plunged to a reading of 45.7 index points in January from 47.2 in the previous month. Consumer Price Index data delved deeper into deflationary territory, registering a decline of 1.2% year-on-year in December after falling 0.9% the previous month. This registers as the lowest inflation print since April 2010. While the Bank of Japan did not announce any further monetary policy stimulus, the bank did reiterate that it will increase its asset purchasing programme if required. The trade balance registered a higher reading of JPY751 billion in December from JPY366 billion the previous month as exports improved, while imports declined at a faster pace. Core machinery orders climbed 1.5% month-on-month in November after surging 17.1% the previous month as non-manufacturing orders (+5.6% month-on-month) kept the overall reading in expansionary territory, while manufacturing orders contracted 2.4%. Industrial output contracted 0.5% month-on-month in November after rising 4% in the previous month and registers as the first decline in output since May.
In South Africa, data released pointed to a notable softening in the post-lockdown recovery. Manufacturing production declined by 3.5% year-on-year in November following decreases of 3.4% and 2% year-on-year in October and September respectively. This was the 18th consecutive year-on-year decline in factory output. Because of renewed lockdown regulations in key trading partner countries, domestic mining production took a nosedive in November as it dropped by an astounding 11.6% year-on-year. Retail sales volumes showed muted shopping activity in November, falling 4% year-on-year – noticeably bigger in comparison to the 2.3% decline recorded in October. This suggests that shopping activity during Black Friday was more muted in 2020 than in 2019. Consumer price inflation surprised marginally to the upside, coming in at 3.1% in December, versus expectations of 3.0%.
The Monetary Policy Committee opted to keep interest rates unchanged at 3.5%. For the third consecutive meeting two members of the committee preferred a 25 basis point cut while three preferred to keep rates on hold.
- We remain constructive on emerging markets amid potential high growth rates in corporate earnings and maintain our overweight position. We continue to believe that the dollar will depreciate as risk appetite increases, allowing for an attractive entry point into emerging markets. Relatively robust high-frequency data and contained COVID-19 cases in Asia also bolster our investment thesis at this point.
We are aware that overextended contract short positioning on the dollar may well result in a mild pullback. If this occurs, we believe it will likely be transitory.
- Global growth is rebounding. A more material recovery is expected this year as precautionary savings unwind, and as economic activity recovers off a low base.
- The roll-out of a vaccine is expected to be a positive boost to equity markets and an accelerated shift to “risk on” sentiment should also be beneficial to our current positioning.
- Monetary policy has become more supportive and is expected to remain accommodative in 2021. Central banks will continue to add significant liquidity and balance sheet support to their economies.
- Inflation is expected to rebound in 2021, although will likely struggle to remain near target levels on a sustainable basis for a prolonged period.
- Commodities to broadly benefit from a pickup in global demand.
- Yield curves in many developed economies will likely remain flat or gradually rise, diminishing the capital gain return in bonds as economic growth and inflation accelerate; hence our underweight position at this stage. We do, however, believe that many central banks will continue to intervene in the bond market and supress the pace of yield curve steepening in many of these developed economies.
- Global equities have more investment merit than global bonds based on an elevated earnings yield versus bond yields.
- South African economic growth is expected to improve in 2021 from a low base but will remain low by historical standards.
- We expect ongoing labour market weakness as the economy emerges from the initial contraction in the first half of 2020. Potential labour market unrest poses further downside risk.
- Concrete implementation of structural economic reforms will pose upside risk to our forecasts.
- A better sense of unity and patriotism post the COVID-19 disaster might lead to a greater level of consensus on the need to frontload growth-boosting reforms.
- Fiscal pressures continue to be exacerbated by a weak nominal growth experience.
- Inflation is expected to remain benign. Weak demand, lower inflation expectations, lower oil prices and/or a sudden reversal in the rand weakness pose downside risk.
- The South African Reserve Bank (SARB) cut rates by 300 basis points in 2020, taking the base rate to 3.5%. We expect the SARB to cut rates by a further 25 basis points in 2021.
- Credit growth to remain under pressure.
- We anticipate better than money market returns from growth assets over the next 12 months, although muted business confidence remains a significant impediment. An improvement in confidence would be required to generate returns in the double-digit range.
- The government’s worsening debt burden and nominal GDP growth underpin our view of further credit rating downgrades.