IN THIS WEEK’S BOTTOM LINE
- The business failure of Basil Read is indicative of the depressed state of gross fixed capital formation in South Africa.Total domestic order books for the construction industry have shown nil growth in the past ten years, reflecting subdued GDP growth, uncertainty over mining legislation and gridlock in government infrastructure spending.
SOUTH AFRICA ECONOMIC REVIEW
- Mining production contracted in April by 4.3% year-on-year following the 8.5% contraction in March. On a month-on-month basis mining production fell 2.0% after contracting 3.5% in March. For the year-to-end April mining production fell 2.2% on the year in contrast to the 5.0% growth achieved in the same period last year. Among the mining categories, those showing the biggest year-on-year declines were other metallic minerals, copper and diamonds with declines of 36.3%, 27.6% and 24.1%. Nickel, platinum and gold followed with declines of 17.5%, 6.5% and 5.7%. The bleak mining production numbers are especially disappointing given the positive global environment for commodity demand and high international commodity prices. Part of the blame lies with continuing uncertainty over mining legislation and potential land expropriation without compensation. Mining production is expected to recover strongly once certainty is restored to key policy areas.
- Minister Gwede Mantashe released the draft Mining Charter. Notably, the current draft recognises the principle of “once empowered, always empowered”. The quid pro quo for this concession is that the overall black ownership requirement is lifted from 26% to 30%, although companies have five years to comply. In a further concession, the requirement under previous mining minister Mosebenzi Zwane that 1% of revenue be allocated to black shareholders, has been watered down to 1% of EBITDA (earnings before interest, tax, depreciation and amortisation). However, the document received mixed reviews from the Minerals Council South Africa (MCSA). Although describing it a “material improvement” the council criticises the 10% “free-carry” provision on new mining rights, which forms part of the 30% black ownership target. The 10% free-carry for communities entails zero cost to the proposed shareholders or any participation in capital raising or expenditure related to that holding. The MCSA said the Mining Charter’s 10% free-carry provision “would render uneconomic a significant proportion of potential new projects, and would undermine and constrain any prospects for growth in the sector and indeed the economy as a whole.” Encouragingly, the public has 30 days to comment on the document amid an expressed willingness on the part of government to amend the draft if necessary. Furthermore, government has committed to allow exemptions for junior miners, based on individual applications.
- Fitch credit rating agency affirmed South Africa’s sovereign debt rating at BB+ (sub-investment grade or junk) while keeping its outlook at “stable” indicating no intention to upgrade or downgrade unless there is a significant change. Although lifting its GDP forecasts for 2018 and 2019 from 1.6% to 1.7% and from 2% to 2.4%, Fitch cited low growth, risks to public finances and risks posed by the highest inequality in the world. Fitch said that despite governance improvements, policy making could be hindered by tensions within the ANC and a preoccupation with general elections, which are due by August 2019.The rating agency stated that: “Current government initiatives are unlikely to improve trend growth significantly, as their implementation and timeline is uncertain and their impact on growth ambiguous.” However, Fitch provided reassurance on land reform, stating that land expropriation without compensation will likely be handled in a way that would avoid significant economic damage.
- Retail sales growth slowed sharply in April to 0.5% year-on-year from 4.6% in March. Part of the blame lies with the VAT increase from 14% to 15% implemented on 1st April. Moreover, the nationwide bus strike and other labour strikes may have undermined consumer confidence. Statistical base effects also exacerbated the weak retail sales data. The Easter holidays fell in April in 2017 but in March in 2018. By retail category, textiles, clothing, footwear and leather goods contracted 0.5% on the year following growth of 10.1% in March. The best performing categories were the furniture and pharmaceutical sectors which grew sales on the year by 11.0% and 6.2%, albeit a slowdown from respective growth rates of 17.6% and 7.6% in March. Despite April’s weak reading retail sales for the year-to-end April increased by 3.2% on the year up from 0% and 2.8% in the same periods in 2017 and 2016. A strong recovery in consumer confidence is expected to keep retail sales growth on an upward trajectory into the second half of the year.
- South Africa did not escape the general withdrawal by global investors from emerging markets. Disinvestment continued in the week to 15th June with South African equity and bond markets suffering net foreign investor outflows of R4.24 billion and R1.90 billion. Total net outflows for the week amounted to R6.15 billion. For the month-to-date total net investor outflows reached R23.82 billion with R3.73 billion coming from the equity market and the bulk, R20.08 billion, from the bond market. Helped by solid inflows earlier in the year, the total net outflows for the year-to-date are less severe at a total of R16.57 billion, comprising R25 billion from the bond market and a slender net inflow of R9.03 billion to the equity market. The outlook remains clouded by global investor unease over the worsening trade dispute between the US and China.
SOUTH AFRICA: THE WEEK AHEAD
- Consumer price inflation: Due Wednesday 20th June. The VAT increase from 14% to 15%, implemented on 1st April, which pushed consumer price inflation (CPI) up sharply in April from 3.8% to 4.5% year-on-year, is expected to have nudged inflation even higher in May, to 4.7% according to consensus forecast. Besides the residual impact of the VAT increase fuel prices climbed 3.5% in May.
- Reserve Bank Quarterly Bulletin: Due Thursday 21st June. A highlight of the Quarterly Bulletin will be the first quarter (Q1) current account forecast, which is expected to have deteriorated from a deficit of 2.9% of GDP in Q4 to around 3.5-4.0% in Q1. The main culprit is the widening in the income deficit on the balance of payments. A weak current account reading may exacerbate the rand’s recent slide.
- In its monthly oil market report the International Energy Agency (IEA) warned that the oil market remained vulnerable to a further escalation in prices. The IEA estimated that the loss of supply from Venezuela and Iran could reduce global supply by 1.5 million barrels per day (bpd) while at the same time global demand was expected to rise by 1.4 million bpd in 2018 and by the same amount again in 2019. According to the IEA, commercial petroleum inventories in OECD nations fell in April by 3.1 million barrels month-on-month to 2.809 billion barrels, the lowest in three years. The supply shortfall is expected to be partly met by a 1 million bpd increase in OPEC supply, to be ratified when the organisation meets in Vienna on the 22nd June. US production is also rising rapidly boosting non-OPEC supply growth by a forecast 2 million bpd in 2018. However, this rate of growth is forecast to slow to 1.7 million bpd in 2019.
- Following the US decision to impose additional tariffs of 25% on $50 billion of Chinese products, China’s State Council announced tit-for tat tariffs on US goods of the same value. The US move is motivated by what Trump calls Beijing’s systematic theft of US intellectual property and comes despite China’s recent pledge to buy around $70 billion in US farm and energy products. China’s commerce ministry said: “All the economic and trade-related achievements previously reached by the two sides will be rendered invalid.” Trump threatened any Chinese retaliation with additional tariffs on $100 billion of Chinese imports, while China’s commerce ministry said it would “immediately introduce countermeasures of the same scale and strength”. The US Chamber of Commerce said new tariffs would place “the cost of China’s unfair trade practices squarely on the shoulders of American consumers, manufacturers, farmers, and ranchers.”
- As expected the Fed hiked its benchmark fed funds rate by a further 25 basis points to a target range of 1.75-2.0%, marking the seventh increase in the current monetary tightening cycle. The outlook statement was more “hawkish” than expected. Fed chairman Jay Powell said: “The decision you see today is another sign that the US economy is in great shape. Growth is strong, labour markets are strong, and inflation is close to target.” The Fed reduced its unemployment forecast for 2019 to 3.5% from a previous 3.6%. It expects core consumer inflation to rise to 2.1% in 2019 and remain at that level in 2020. While Powell dismissed the slight overshoot of the Fed’s 2% target as short-lived and of “little, if any, consequence for inflation over the next few years”, the majority of Fed policy members now expect four rate hikes in 2018. This compared with a majority expectation of just three rate hikes at the previous policy meeting in March. According to the “dot plot” of policy member rate expectations, the Fed will hike the interest rate a further three times in 2019 and at least once more in 2020, bringing the fed funds rate to 3.25-3.50%. This is above the estimated neutral rate of 2.75-3.0%, which neither stimulates nor constrains growth.
- Consumer price inflation (CPI) jumped higher in May to 2.8% year-on-year its strongest reading since February 2012, up sharply from 2.5% in April. Part of the surge is due to the base effect of weak year-ago numbers. Moreover, rising fuel prices also played a part with energy prices rising 11.7% on the year. Core CPI, which excludes food and energy prices due to their volatility, edged up more gradually from 2.1% to 2.2% albeit above the Fed’s 2% target. Although inflation is not surging it is gently edging higher. Among the core CPI categories, shelter prices increased in May by 0.3% month-on-month, signalling broader inflationary pressures. Producer price inflation (PPI), which can affect CPI over time, registered a larger than expected increase in May of 0.5% on the month and 3.1% on the year, its highest annual reading since January 2012.Inflation may be exacerbated by rising import tariffs, a tightening labour market and increasing wage pressure.
- Retail sales surged in May by 0.8% month-on-month its largest monthly increase since November. Much of the growth is attributed to increased gasoline sales. “Control” retail sales, which exclude volatile items such as gasoline and building materials, increased by 0.5% on the month. Despite the once-off effect of rising energy prices, retail sales are buoyant, helped by the combination of tax cuts and rising employment growth. On a year-on-year basis, retail sales increased in May by a robust 5.9%. The strong retail sales data is consistent with second quarter (Q2) GDP growth in the 3.5-4.0% region a marked improvement on the 2.2% expansion recorded in Q1.
- The IMF poured cold water on the US Treasury’s forecasts in its annual review of the US economy. In contrast to the Treasury’s forecast of an acceleration in GDP growth to a sustained 3% annual growth rate within five years, the IMF forecasts growth of 2.9% in 2018, slipping to 2.7% in 2019, then dropping to 1.9% in 2020 and 1.7% in 2021. The IMF warns that the Trump tax stimulus will increase the budget deficit to 4.5% of GDP by 2019 almost double its level three years ago, while government debt would rise from its current level of below 80% to above 90% of GDP by the middle of the next decade. The IMF cites the consequences as being faster than expected inflation. According to IMF managing director Christine Lagarde: “That would be accompanied by a more rapid rise in interest rates that could increase financial market volatility both in the US and abroad”.
- Economic data signal a general slowdown in China’s economy. Retail sales growth slowed in May to 8.5% year-on-year down from 9.4% in April, marking the slowest growth since June 2003. Vehicle sales fell 1.0% on the year. Industrial output growth slowed from 7.0% to 6.8%. Growth in fixed-asset investment fell sharply on a year-on-year basis to 6.1% in the January-May period down from 8.6% in the same period last year and down from 7.0% in the January-April period this year. Property investment offered some respite with growth in May of 10.2% on the year. Housing starts grew by 10.8% on the year in the January-May period up from 7.3% in the January-April period. While the housing sector appeared to rebound the overall data points to a steady loss in momentum in China’s economy, indicating a slowing growth rate in the second half of the year, attributed to continued financial deleveraging.
- Japan’s exports increased in May by 8.1% year-on-year the fastest pace in four months up from 7.8% in April and 2.1% in March, marking the 18th consecutive increase. Imports growth also increased to 13.9% up from 5.9% in April and -0.5% in March. Export growth was characterised by strengthening demand for automobiles, auto-parts and chip making equipment. Shipments to Asia were especially strong with growth of 9.8% while shipments to China increased by a solid 13.9% on the year up from 10.9% the previous month. The positive trade data indicates solid global growth continues to support Japan’s economic recovery while rising imports confirm that domestic demand remains robust.
- As expected the Bank of Japan (BOJ) kept its short-term deposit rate unchanged at -0.1% and maintained its asset purchase programme at an annual rate of ¥80 trillion. BOJ governor Haruhiko Kuroda said: “It is appropriate for Japan to patiently continue current monetary easing.” Referring to the fact that the BOJ is now the only major central bank still pursuing quantitative easing, Kuroda said: “The divergence of monetary policies reflects different economic and price conditions in each country.” The BOJ forecasts the economy is “expanding moderately” amid rising private consumption, business investment and growing corporate profits. However, it confirms that inflation remains stuck in the 0.5-1.0% range well below the central bank’s 2% target. While maintaining its asset purchase programme, actual purchases slowed down in the year to end March to ¥49 trillion well below the targeted level. Moreover, the time frame for reaching the BOJ’s 2% target was abandoned at the last policy meeting. These developments indicate increased policy flexibility.
- Despite lingering concerns over Italy’s politics, the threat of a trade war between the US and China, and rising oil prices, the ECB announced the end of its quantitative easing programme. The ECB said it would reduce its bond purchases from the current pace of €30 billion per month at the end of September to €15 billion per month until the end of December, when the purchases will end. However, the ECB maintained a “dovish” tone, stating that it would reinvest proceeds from the bonds on its balance sheet for “an extended period of time (and) for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.” Moreover, the ECB pledged to keep its benchmark deposit rate at its current level of -0.4% “at least through the summer of 2019.” Referring to his leaving the ECB and concerns that his successor may follow a more “hawkish” monetary policy ECB president Mario Draghi provided reassurance that asset purchase programmes will remain a new part of standard monetary policy. The ECB lowered its forecast for Eurozone GDP growth for 2018 from 2.4% to 2.1% while maintaining its forecast for 2019 and 2020 at 1.9% and 1.7%. It raised its inflation forecast for 2018, 2019 and 2020 to 1.7% from a previous 1.4%.
- Eurozone industrial production fell in April by 0.9% month-on-month marking the fourth month of declines in the past five months. On a year-on-year basis industrial production maintained growth of 1.7% although well below the 2.8% consensus forecast. Declines in production were broad-based across industrial sectors, with falls recorded in intermediate, durable and non-durable goods. Energy production fell sharply while capital goods production managed to buck the trend with a gain of 1.9% on the month. Despite the bright spot in capital goods production, the overall data points to a general slowdown in economic growth with recent surveys indicating little sign of pick-up in activity in the second quarter. Industrial output contributes around a quarter of Eurozone GDP.
- Germany’s ZEW economic sentiment index fell by more than expected in June. The current conditions index fell from 87.4 to 80.6 well below the 85.0 consensus forecast. The forward-looking expectations index fell from -8.2 to -16.1 its lowest since 2012. ZEW President Achim Wambach said: “The recent escalation in the trade dispute with the United States as well as fears over the new Italian government pursuing a policy which potentially destabilises the financial markets have left their mark on the economic outlook for Germany.” He added that: “On top of this, German industry has been reporting worse than expected figures for exports, production and incoming orders for April. As a result, the economic outlook for the next six months has worsened considerably.”
- The British Chamber of Commerce (BCC) lowered its forecast for UK GDP growth in 2018 from 1.4% to 1.3%, citing weak consumer spending, low business investment and lacklustre trade. This would be the UK’s weakest growth performance since 2009. The BCC said that while household incomes are starting to show growth in real terms household finances are stretched due to high indebtedness. It forecasts business investment growth will slow in 2018 to 0.9% year-on-year down from 2.4% in 2017 due to ongoing uncertainty over Brexit.
- Retail sales surged in May by 1.3% month-on-month well ahead of the 0.5% consensus forecast. On a year-on-year basis, retail sales increased by 3.9% the biggest annual increase since April 2017. The sharp increase is attributed to unseasonably warm weather and the royal wedding. Internet sales increased by 4.5% on the month, now accounting for a record high 18% of total retail sales. Following upwardly revised retail sales growth of 1.8% on the month in April, the latest data suggests consumer spending, which accounts for around two-thirds of UK GDP, made a solid contribution to economic growth in the second quarter. While the May numbers benefited from once-off factors, Ruth Gregory, an economist at Capital Economics said: “With real pay rises in prospect, consumer spending should receive more fundamental support as the year progresses.”
KEY MARKET INDICATORS (YEAR TO DATE %)
|JSE All Share
|JSE Fini 15
|JSE Indi 25
|JSE Resi 20
- The rand has broken decisively through key resistance at R/$13.35 indicating further weakness to the R/$14.00 level. However, the rand is deeply oversold at current levels, which suggests a trading range of R/$13.00-13.50 is more likely.
- The rally in the US dollar index has reached its medium-term goal suggesting a correction from current levels. The dollar remains below a major 30-year resistance line suggesting the bull run in the dollar may be over.
- The British pound has broken back below key resistance at £/$1.35 suggesting a trading range of £/$1.30-1.35. The £/$1.30 level is expected to provide strong resistance.
- The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
- The US 10-year Treasury yield has broken decisively above key resistance at 3.0%, targeting the next key resistance level at 3.6%. A break above long-term resistance at 3.6% would indicate an end to the multi-decade bull market in bonds.
- The benchmark R186 2025 SA Gilt yield has broken above key support levels of 8.6%% and 9.0% indicating a new target trading range of 9.0-9.5%.
- Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
- The Brent oil price has broken above key resistance at $75 indicating a new trading range of $75-85 per barrel. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $7000 per ton.
- Gold has developed an inverse “head and shoulders” pattern, which indicates a price recovery and a test of the $1400 target level.
- Despite the consolidation since the start of the year the break in the JSE All Share index above key resistance levels at 56,000 and 60,000 in December signals the early stages of a new bull market.
- Basil Read, previously one of South Africa’s blue-chip construction companies, was placed under business rescue on 15th June, prompting the share price to collapse from 21 cents to just 2 cents. Basil Read, listed on the JSE in 1987, took top position in the Business Times Top 100 Companies Survey in 2008 and 2009, following phenomenal share price growth in the prior five years from 92 cents to R37.00.
- The business failure of Basil Read is indicative of the depressed state of gross fixed capital formation in South Africa. Total domestic order books for the construction industry have shown nil growth in the past ten years, reflecting subdued GDP growth, uncertainty over mining legislation and gridlock in government infrastructure spending.
- To make matters worse, the profitability of order books has declined amid a desperation for survival. Reflecting the depressed operating environment, the rating of the building and construction sector has collapsed. The market capitalisation of Group Five, for instance, is around a quarter of the value of the cash on the company’s balance sheet. The share price of Murray & Roberts, which increased from R14.00 to R100.00 between 2005-2008, is back to its 2005 levels.
- The tide may be turning. Compelling value in the building and construction sector is attracting the attentions of seasoned global peers and institutional investors. Earlier this year, global cement companies and consortia, including Holcim-Lafarge, CRH, and Fairfax, were queuing up to acquire but were ultimately resisted by South Africa’s cement giant PPC. Canada’s Fairfax, likened to Warren Buffett’s Berkshire Hathaway, is on track to build up a 58.7% stake in Consolidated Infrastructure Group. German investment company Aton is making an aggressive bid for construction blue chip Murray & Roberts.
- Foreign appetite for South Africa’s building and construction sector is motivated by the exceptional value on offer and the opportunity for substantial earnings growth. Following a bleak decade of falling investment and declining margins, the outlook is gradually improving. Greater political and policy certainty coupled with a more business friendly mining charter should boost government and private gross fixed capital formation. As construction orders rise so too will the profitability of the order books, providing a double whammy for the building and construction sector.
- Government policy will tilt in favour of infrastructure spending, either through state-funded initiatives or public-private partnerships. Being labour intensive, infrastructure spending offers one of the easiest and most realistic means for South Africa to achieve an inclusive economic recovery. Moreover, infrastructure spending would address the bottlenecks which are hampering the country’s productivity and export competitiveness. The building and construction sector is a clear beneficiary of any ramp-up in infrastructure spending.
- Of all the sectors on the JSE, the building and constructions sector is probably the most cyclical and the most volatile. From current depressed levels the scale of a cyclical upturn could be dramatic. While a repeat of the sector’s massive upswing from 2005-2009, is by no means a foregone conclusion, the calibre of overseas investors in the sector suggests significant potential.