September 07, 2018
Before we begin this week’s commentary, we’d like to revisit an article by Max du Preez which we referenced last week, titled Land Reform’s Codesa Moment. We found the article to be a bright spot in what has otherwise been a truly wretched few weeks for the SA economy, currency and mood in general.
Mr du Preez provides a more balanced and relatively optimistic picture of where the land debate current stands and how it may evolve should the various interested parties engage in a meaningful manner. Unfortunately, the snippet used below the link to the story completely failed to convey this, as it quoted one of the more extreme views of the situation against which Max stands opposed. We apologise for this oversight, and urge readers to take the time to read the full story, the general tone of which is encapsulated below:
The summit on land reform was a little Codesa moment, flavoured with some of the sensibilities that made the Truth and Reconciliation work. It could very well turn out to be a turning point in the heated debate on expropriation of land and set an example of how we should solve other problems in our economy and political life. This is why South Africa with its bitter past is still in one piece: if the temperature gets too high, we talk to each other. And all this was achieved without the meddling of right wing lobbyists or Western governments.
What we know
There were two main themes to talk about this week: South Africa’s continued economic woes, and ongoing emerging market concerns. The rand started out weaker on Monday morning following a poor ABSA Manufacturing PMI data release – the figure is an indicator of manufacturing activity, with a print below 50 indicating a contraction.
The August figure of 43.4 was thus very disappointing and well below the forecast 51.1. Tuesday’s data was worse however,with the quarter-on-quarter GDP figure coming in at -0.7% and year-on-year growth printing at 0.4%, putting SA in a technical recession, casting doubt on just how poor the full-year GDP growth may be and increasing the odds of a ratings downgrade later in the year.
The only vaguely positive stance one can take is that the GDP figure, being historic in nature, is not necessarily a forecast of how things may pan out in the medium-term. Although the positive mood following our leadership changes has faded in the past few months, Ramaphosa and his finance minister have announced that the government is working on a plan to take the country out of recession and to steady economic recovery.
The president has assured South Africans that the recent events are “transitional issues that are going to pass”. Such rhetoric can be endured for a limited period in lieu of concrete results, although in fairness we do need to be cognisant of the work required in turning around our local woes.
The other concern, and perhaps part of the reason that the ZAR reacted so sharply to the poor local data, is the continued nervousness around Emerging Markets. While we normally leave external articles for the next section of the commentary, we feel that the following article from Bloomberg on Tuesday, Contagion Or Not, These Emerging Markets Hold Key To Selloff, provides an excellent summary of the factors of which our clients should be aware across the relevant markets:
South America’s No. 2 economy has a benchmark interest rate of 60% and inflation tops 31%. The real policy rate now ranks among the world’s highest and is pushing the economy back into recession. Economic activity fell 6.7% in June. New taxes announced this week to restore a balanced budget would only compound the suffering. Argentina is targeting a primary budget surplus by 2020 to ease its demand for foreign financing and prop up the peso, which slumped more than 50% this year. Whether those economically sound and highly unpopular policies can survive the next few years remain to be seen: National elections are scheduled for just 13 months from now.
Brazil’s key weakness lies in fiscal shortfalls thanks to anemic economic growth. While the public sector’s primary budget balance, a measure of fiscal health before interest payments, now stands at a 1.1% deficit of gross domestic product compared with 3% at the worst point of 2016, it still compares unfavorably with an average 2.9% surplus between 2000 and 2014.
Further complicating things is October’s wide-open presidential election. Its proximity and close trade links to Argentina mean contagion could also weigh on sentiment. All that said, a historically low policy rate means Brazil has plenty of room to tighten monetary policy and fend off speculative attacks on the real, the third-worst emerging-market currency this year.
Donald Trump’s trade war couldn’t have been more poorly timed for the world’s second-largest economy. China’s current account surplus has plunged to near zero and is threatening to tip into a deficit. The yuan’s real effective exchange rate against a basket of trading partners is hovering near a record high, signaling the currency may have room to depreciate. The twin pressures pose a challenge to China’s efforts to keep yuan volatility to a minimum and may also undermine a core economic objective: Gaining an enhanced role for the yuan as a means of international payments. The currency’s share in global transactions has fallen to just 1.8% from 2.8% three years ago. Shanghai stocks have under performed emerging-market peers in 10 of the past 12 quarters and trade near the lowest valuations in four years.
Annual expansion above 7 percent and a relative isolation from global economic and trade headwinds make India a consensus buy among emerging-market investors. Oil remains the chief vulnerability: India imports 70% of its energy needs and crude-price fluctuations have taken its current-account deficit to almost 2% of GDP. Prime Minister Narendra Modi is seeking re-election in just eight months and victories for the opposition Congress party in recent state and local elections have raised the possibility his support may be slipping. Even though India’s major parties all agree on the direction of economic reform, a hung parliament could result in policy paralysis.
While the rupiah lost about 9 percent this year, a pittance compared with Turkey and Argentina, the Indonesian currency is now the weakest since the 1998 Asian financial crisis. Repeated rate hikes and FX interventions by Bank Indonesia have failed to stem the depreciation. While monetary tightening, as well as the delay of major investment projects to save foreign-exchange reserves will slow growth, the risk of outright recession is less than in many other countries because the economy has expanded at a clip of about 5% since 2014. Subdued inflation may also alleviate concern of the price pass-through of a weaker currency.
Russian assets get some of the lowest valuations in emerging markets because of investor perceptions that private wealth isn’t protected enough. While the country has rebounded from a currency crisis in 2014, it remains one of the first targets in an emerging-market selloff. A key vulnerability: A U.S.climate in which being seen as pro-Russia is politically disadvantageous. Criticism by Democrats has pushed President Donald Trump to add to existing sanctions. Russia has a strong current-account surplus and inflation is near a record low. That helped the central bank cut interest rates. But policymakers are signalling an end to the easing cycle as price pressures build, laying the groundwork for Russia’s first increase in borrowing costs since 2014. The ruble was the fourth worst performer against the dollar last month.
Africa’s most industrialised economy is already in recession, driven by a slump in agricultural output. South Africa has one of the worst current accounts deficit in the developing world, with a shortfall of 4.8 percent of GDP. Optimism over President Cyril Ramaphosa’s economic plan has waned, while a worsening trade war, or a slowdown in China, may push the commodity-dependent economy further downhill. South Africa’s main weakness is excess liquidity, according to Charles Robertson, the London-based global chief economist at Renaissance Capital Ltd. South Africa has the highest foreign-exchange turnover-to-GDP ratio among emerging markets, he said, helping explain why South Africa is often at the forefront of developing-world routs.
Events during the past several months underscore the grave political risks facing investors in the Turkish market. The appointment of a new cabinet, in which President Recep Tayyip Erdogan’s son-in-law took over economic affairs, the leader’s own opposition to rate hikes and the diplomatic spat over a detained U.S. pastor have all dented confidence, prompting a 31% collapse in the lira since the end of June, the most among emerging-market currencies. In addition, Turkey is coping with double-digit inflation and the biggest current-account deficit among major emerging economies. Currency depreciation may be sorely needed to help drastically cut imports and trim the current account gap.
By Srinivasan Sivabalan and George Lei
Bloomberg.com, Tuesday, 4 September 2018
What others say
03 September 2018
Nedbank Strategy Note – Global Forces Driving The SA Stock Market
“We remain of the opinion we have seen the high in global equity markets for the time being as the disinflationary forces starts to gain momentum again on the back of the strong US dollar which we expect to strengthen again in 4Q18… Our preferred view remains over-weight non-cyclical/defensive SA stocks, underweight tech counters. Over-weight SA bonds vs equities, over-weight global bonds vs. stocks.”
05 September 2018
Investec – Currency Comment
“What is clear is that all of South Africa’s problems have become very evident very quickly, and International investors are running scared… Technically we see some resistance at around the 15.50000-15.5500 area. But I must say in this environment technical analysis is a little like trying to decipher a Picasso painting – beauty is in the eye of the beholder.”
Investec Treasury Sales and Structuring – Johannesburg Morning Markets
“This is a tricky time in the market and any position either long or short USDs is speculative. Fundamentals are being largely ignored and sentiment has taken over. It will likely be fleeting in the broader scheme of things, but it is unnerving nonetheless. Arguing for a reversal might be justified at a fundamental level, but at this point the technicals are not pointing to any significant improvement in sentiment. That may take a little longer. The core view however is maintained, that the current ZAR sell-off is feeling extreme and not justified on SA fundamentals alone.”
Fin24 – Recession Reignites Credit-Rating Downgrade Concern
“The South African Reserve Bank faces a major dilemma of whether it should raise rates due to rising inflationary pressure from a weaker currency or refrain from doing so due to very weak economic activity. It’s a close call, but it is reasonable to expect that the overall message will be relatively hawkish when the bank announces its next decision September 20,” said Piotr Matys, a London-based emerging-market strategist Rabobank.”
Eye Witness News – Nene: South Africans Must Not Panic Over Slide Into Recession
“We didn’t think we would have the second contraction, we were hoping we would have a moderate recovery… government is working on a plan to finalise the structural reform package… I [Nene] don’t think that the latest figures have something to do with the current heated debate around the expropriation of land without compensation, but government can’t deny that the VAT increase and fuel price hikes have had an impact on the numbers.”
06 September 2018
RMB Global Market Research – Spotlight On Current Account Data
“Has the EM sell-off gone too far? Or are there still a lot of land mines waiting to be triggered? One of these potential land mines is the Moody’s ratings review on the 12th of October. Should Moody’s downgrade SA to sub-investment grade, then SA will fall out of the WGBI and passive funds will be forced to liquidate their government bond holdings. There are various theories as to how much this will affect bonds and the local currency, but we can all safely assume that there will be a large initial shock. But, with time, we will get to that inflection point where investors will start so see value again, and the rewards outweigh the risk. What that price is… is yet to be determined.”
City Press – SA Will Rally, Says Ramaphosa As He Wraps Up China Investment Drive
“We must be able to ride these waves because they will keep coming. Whoever is president will find that they have to ride these waves. All we need to do is focus on the medium and long term because sometimes the short term will make us miss our steps.”
What we think
Last week we wrote that “…we once again find ourselves firmly on the back-foot and underperforming our peers. Our previous resistance levels (to further ZAR weakness) now need to be considered as possible support (i.e. preventing further ZAR strength) in the short-term.”
We really do not like appearing vague in our outlook; however, we do believe – together with many other market commentators with whom we engage and follow – that there is simply very little direction that can be ascertained at this point. Some time and signs of consolidation will give us an indication as to where things may be headed. It is precisely this that we have been telling our clients for most of this week.
Having lost 6.4% from Monday’s open to Wednesday’s highs at 15.70, we saw a gradual pullback below 15.40 and, this morning, a somewhat more aggressive improvement to 15.13 as at the time of writing. We suspect that some built up $ demand and orders that weren’t filled prior to the sell-off may result in the 15.00-level providing resistance to further gains, after which 14.70 would be the next target.
Markets remain skittish though and we’re certainly not out of the woods in terms of being susceptible to further bouts of weakness. As such, our fairly wide range for the week ahead is 14.70 – 15.50.
Have a great weekend!