IN THIS WEEK’S BOTTOM LINE

  • Why, despite South Africa’s New Dawn, has the JSE All Share Index fallen around 3% since the start of the year, unable to build on the stellar returns enjoyed in December last year? Numerous reasons are cited including anxiety over land expropriation and growing political unrest ahead of the general elections. Sceptics point out that “Ramaphoria” has run out of runway. Now that most of the low hanging fruit, key appointments in cabinet and in state-owned enterprises, has already been picked the next stage involving actual structural reform will be less easy.

SOUTH AFRICA ECONOMIC REVIEW

  • The Labour Force Survey confirmed that the unemployment rate in the first quarter (Q1) remained unchanged from Q4 2017 at 26.7%. While the economy added 206,000 new jobs over the quarter, reflecting a quarter-on-quarter increase of 1.3% this was insufficient to absorb the 307,000 new entrants to the labour force. At the same time the labour participation rate, which measures the percentage of people wo are currently employed or in search of a job, increased from 58.8% in Q4 to 59.3% in Q1. Most of the jobs (111,000) were created in the formal sector with the remaining 93,000 created in the informal sector. The community and social services sector, which mainly comprises government, created the bulk of the new jobs (95,000). By industry sector, the manufacturing, construction and trade sectors created 50,000, 40,000 and 36,000 new jobs, respectively. While the unemployment rate remained unchanged at an elevated 26.7% this beat the consensus forecast of 27.4%. The unemployment rate had been expected to increase as hiring over the festive season is typically reversed in the new year. Moreover, new labour entering the market spikes at the start of the year.
  • Retail sales growth increased in March to 4.8% year-on-year up from a downwardly revised 4.2% in February. However, on a month-on-month basis retail sales growth fell from 1.5% to 0%. In the first quarter (Q1) retail sales contracted by 1.3% quarter-on-quarter, which indicates the sector will have subtracted around 0.3 percentage points from Q1 GDP growth. Combined with the weak Q1 manufacturing and mining production numbers released last week, the quarterly contraction in retail sales indicates a contraction in GDP in Q1 of around 0.4% quarter-on-quarter annualised. (See Bottom Line for further analysis). By retail sector, furniture sales increased in March by 20.7% year-on-year up from 13.7% in February. Textile sales growth increased from 7.1% to 10.6% and pharmaceuticals from 5.0% to 7.9%. Hardware, paint and glass contracted 2.4% following a 1.1% contraction in February. Despite their contraction in Q1, retail sales are expected to maintain their positive momentum into the remainder of the year. Low inflation, easing monetary policy, rising job growth and improved consumer confidence should more than compensate for the negative effect of the VAT increase from 14% to 15%.

SOUTH AFRICA: THE WEEK AHEAD

  • South African Reserve Bank Leading Business Cycle Indicator: Due Tuesday 22nd May. The March reading for the Leading Business Cycle Indicator, a barometer for expected business conditions 6-9 months ahead, will be closely watched as confirmation of a likely rebound in economic activity in the second half of the year. The Leading Business Cycle Indicator increased for a third consecutive month to 108.3 in February its highest level since June 2011.
  • Consumer price inflation: Due Wednesday 23rd May. Consumer price inflation (CPI), which fell in March to 3.8% year-on-year its lowest in seven years, is expected to have accelerated to 4.7% in April due to a 72c petrol price increase and the first-time inclusion of the VAT increase from 14% to 15%.
  • South African Reserve Bank Monetary Policy Committee interest rate decision: Due Thursday 24th May. The Monetary Policy Committee is expected to keep the benchmark repo interest rate unchanged at 6.5%. The MPC will be reluctant to follow on from its 25 basis-point rate cut earlier in the year due to the impact of rising global risk aversion and rising oil prices on the rand and on imported inflation.

GLOBAL

  • The Brent oil price maintained its upward momentum rising above $80 per barrel for the first time since late 2014. The oil price has increased over 50% in the past year due to a combination of rising global demand and production cuts by the OPEC-led consortium, which includes Russia. The US withdrawal from its nuclear deal with Iran and re-imposed sanctions on the country and supply disruptions from Venezuela have exacerbated the supply shortfall. However, higher oil prices may eventually undermine the oil price rally. Last week the International Energy Agency lowered its global oil demand forecast for 2018 from 1.5 million to 1.4 million barrels a day. Nonetheless, oil producing shares are performing strongly. According to Martijn Rats, global oil strategist at Morgan Stanley: “Cost savings are still coming through in the oil and gas industry but it’s now coinciding with rising prices. That combination is powerful… It allows oil companies to do several things all at the same time: pay dividends, buy back shares and pay down debt, all of which is very welcome.”

NORTH AMERICA

  • Housing starts fell in April by 3.7% month-on-month while residential building plans, which signal the level of construction in the pipeline, also fell by 1.8%, suggesting the housing market may be plateauing amid shortages of land, skilled labour and rising material costs. Lumber costs have risen 50% since the start of 2017 exacerbated by anti-subsidy duties on Canadian softwood lumber. In a builder survey, respondents complained that: “The record high cost of lumber is hurting builders’ bottom lines and making it more difficult to produce competitively priced houses for newcomers to the market.” According to John Pataky, chief consumer and commercial banking executive at Everbank: “After months of fighting to keep up with still-surging demand, the realities of higher input prices, a limited supply of lots and decreasing confidence seem to be taking their toll.”
  • Capital spending by companies has been boosted by cuts in the corporate tax rate. Capital spending by companies comprising the S&P 500 Index is estimated to have increased in the first quarter by 24% quarter-on-quarter to $166 billion, marking the fastest increase since 2011. Stronger capital spending should provide the foundation for much needed productivity improvement, which in turn will enable the economic upswing to continue for longer without being inflationary. While capital spending should boost companies’ long-term profitability investors’ time horizons are steadily shortening. Over the short-term investors generally reward companies which spend cash on increased dividends and share buybacks rather than increased capital expenditure, which may take years to deliver results. A study by Bank of America Merrill Lynch shows that since 1986 companies with the highest capex-to-sales ratios have underperformed their benchmarks by more than 2 percentage points per year.
  • Industrial production increased in April by 0.7% month-on-month matching March’s growth and capping the third consecutive month of expansion. On a year-on-year basis industrial production increased a steady 3.5%. The strengthening in industrial production was driven by machinery, computers and electronics indicating increased equipment spending and capital investment. Mining output also increased sharply by 1.1% on the month and 10.6% on the year. Unusually cold weather in April also boosted utility production by a solid 1.9% on the month and 6.0% on the year. Capacity utilisation across industries increased in April from 77.6% to 78.0% its highest since 2015. The solid industrial production figures reflect continued upward momentum in US domestic demand but may come under pressure from any decline in global trade activity.
  • Retail sales growth slowed to 0.3% month-on-month in April from 0.8% in March. The slowdown is attributed to a sharp decline in motor vehicle sales while electronics, healthcare, personal care items and furniture also experienced lukewarm demand. US GDP growth slowed in the first quarter in large part due to the weather-induced slowdown in consumer spending. Consumer spending contributes over two-thirds of US GDP. While consumer spending is expected to maintain its growth path, helped by strong jobs growth and tax cuts the benefits may be neutralised by rising interest rates and rising gasoline prices. Gasoline station sales rose in April by 0.8% on the month due as much to rising gasoline prices as to increased demand.
  • The average rate on a 30-year fixed-rate mortgage increased last week to 4.6% its highest since 2011 marking a steep incline from under 4% as recently as January. According to mortgage giant Freddie Mac’s chief economist Sam Khater: “There’s been a regime shift in the way the market is thinking about rates. We’ve been waiting for the period (of higher rates) for a while and now it’s finally happening.” Higher mortgage rates will squeeze household disposable income and home price appreciation. The phenomenon of “rate lock” may ensue whereby potential homebuyers will be put off upgrading their properties if it means relinquishing their low-rate mortgages. Lawrence Yun, chief economist at the National Association of Realtors estimates that a one percentage point increase in mortgage rates could result in a 7-8% reduction in home sales.

CHINA

  • China’s economic data provided mixed reading in April. While industrial production increased 7% year-on-year up from 6.0% in March, retail sales and investment growth slowed down. Retail sales growth slowed from 10.1% on the year to 9.4%. In the year to end April fixed asset investment growth slowed to 7.0% on the year down from 8.9% in the same period last year and 7.5% recorded in the January-March 2018 period. On a similar basis infrastructure spending growth slowed to 12.4% from 23.3% in the same period last year and 13.0% recorded in the January-March 2018 period. Even the uplift in industrial production should be viewed in context as the pick-up in growth may have been enhanced by the distortion from public holidays. Moreover, industrial production is prone to disruption from trade protectionism. Among the industrial sectors, it is noteworthy that the production of new energy vehicles, integrated circuits and industrial robots, increased by a solid 82.2%, 14.3% and 35.4% year-on-year, respectively. These sectors form part of the “Made in China 2025” programme, which has been specifically targeted by US trade representatives.

JAPAN

  • GDP growth contracted in the first quarter (Q1) by 0.6% quarter-on-quarter annualised ending eight consecutive quarters of growth, Japan’s longest winning streak since 1989. The slowdown was broad-based with a contraction in household spending, residential and non-residential investment, and exports, reflecting a slowdown in both domestic and external demand. However, the decline is expected to be temporary. According to Economy Minister Toshimitsu Motegi: “There is no change in our view that the economy is recovering moderately.” Household consumer spending, which comprises around 60% of Japan’s GDP, was held back in Q1 by unseasonably cold weather in January and February, and should normalise in Q2 while also benefiting from strengthening wage growth, which increased in March at its fastest pace since 2003. Moreover, inventory drawdowns subtracted 0.6 percentage points from Q1 GDP growth. Excluding the inventory drawdown, GDP growth in Q1 would have been 0% rather than recording a contraction. In coming quarters, inventory replenishment will provide an added boost to GDP growth.
  • Japan’s trade figures recovered sharply in April, reflecting solid gains in both export and import volumes. Exports increased 7.8% year-on-year, the fastest pace in three months up from 2.1% in March. Imports grew 5.9% rebounding from the 0.6% contraction in March. By destination, exports to Asia increased by a solid 6.0% with growth in China-bound shipments rising from 10.8% to 10.9%. Export growth to the US picked-up strongly from 0.2% to 4.3%. The data bodes well for the continued health of global trade despite threats of US protectionism and a trade war between the US and China.

EUROPE

  • The closely watched ZEW economic sentiment index, a reliable leading indicator for the German economy, remained unchanged at -8.2 in May unchanged from April’s level when it fell to its lowest since November 2012. ZEW President Achim Wambach attributes the weak sentiment index to: “Uncertainty motivated by recent political developments. The US decision to back out of the nuclear treaty with Iran and fears of a further escalation of the international trade conflict with the US, as well as a further rise of crude oil prices, have had an overall negative impact on economic expectations in Germany.” The ZEW index indicates Germany’s GDP growth, which slowed from 0.6% quarter-on-quarter in the fourth quarter (Q4) last year to 0.3% in Q1, is at risk of slowing further over coming quarters posing the risk of a broader downturn in the Eurozone economy.
  • Italy’s far-left 5 Star Movement and the anti-immigration far-right League Party shocked financial markets when the Huffington Post Italia posted a draft government programme proposing procedures to allow Eurozone member countries to quit the currency bloc. The coalition partners subsequently stated that the draft was old. However, the updated draft lacked reassurance outlining populist economic policy measures such as the reversal of pension reforms, income tax cuts and increased social benefits, all adding to an already stretched fiscus. Investor anxiety has been steadily rising pushing Italy’s 10-year government bond yield from 1.75% to 2.12% over the past fortnight. The yield spread between German and Italian 10-year government bonds has widened over the same period from 1.15% to 1.55%. In its quarterly update on the Eurozone’s economic outlook the IMF warned of a series of threats to growth including Italy’s newly elected populist coalition government.

FAR EAST AND EMERGING MARKETS

  • Singapore’s exports recovered strongly in April, reversing the prior two months’ contraction. Non-oil exports increased by 11.8% year-on-year more than double the 5.4% consensus forecast and rebounding from the 3.2% decline in March. The slowdown in electronics exports eased to a contraction of just 6.9% compared with 12.7% in February. Singapore’s relatively upbeat trade data, closely watched as a leading indicator for international trade, bodes well for the continuation of global synchronised growth.
  • Thailand’s GDP grew in the first quarter (Q1) by 4.8% year-on-year accelerating from 4.0% the previous quarter, marking its fastest rate of growth since Q1 2013. On a quarter-on-quarter basis GDP grew 2.0% up from 0.5% in Q4 2017, also the fastest in five years. However, inventory stocking was the main growth driver, contributing more than half the GDP growth during the quarter. From current elevated levels inventories are likely to draw-down and weigh on GDP growth over coming quarters. Private consumption growth only lifted slightly from 3.4% on the year to 3.6% with its contribution to GDP growth remaining unchanged at 1.7 percentage points. Thailand’s GDP may have peaked given the steady narrowing in the trade surplus. Having made a positive contribution in the prior two quarters, net exports were a drag on GDP growth in Q1. Moreover, the political outlook remains uncertain due to the military government pushing back the date for a general election to early 2019.
  • Confounding expectations for a further interest rate cut Brazil’s central bank left its benchmark Selic rate unchanged at 6.5%. The central bank had previously signalled a continuation of monetary easing. The Selic rate has been cut from 14.25% to 6.5% since 2016 via a dozen consecutive interest rate cuts. In the accompanying policy statement, the central bank said: “The external scenario became more challenging and volatile. The evolution of risks, largely associated with the normalisation of interest rates in some advanced economies, has led to adjustments in the international financial markets. As a result, there was a reduction in risk appetite for emerging markets.” Recent volatility in the Brazilian real would likely need to stabilise before the Selic rate resumes its downward trajectory.

KEY MARKET INDICATORS (YEAR TO DATE %)

JSE All Share - 02.83
JSE Fini 15 - 06.35
JSE Indi 25 - 05.98
JSE Resi 20 + 14.35
R/$ - 02.38
R/€ - 00.56
R/£ - 01.64
S&P 500 + 02.22
Nikkei + 01.04
Hang Seng + 04.40
FTSE 100 + 02.23
DAX + 01.24
CAC 40 + 06.12
MSCI Emerging - 01.90
MSCI World + 01.30
Gold - 01.10
Platinum - 05.45
Brent oil + 19.56

TECHNICAL ANALYSIS

  • Having broken the key resistance level at R/$12.50, the rand has returned to its appreciating trend, targeting a break below R/$11.00 over coming months.
  • 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 above key resistance at £/$1.35 promoting further near-term currency gains to a target range of £/$1.40-1.50.
  • 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 below key resistance at 8.6%% indicating a new target trading range of 8.0-8.5%.
  • 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.

BOTTOM LINE

  • Why, despite South Africa’s New Dawn, has the JSE All Share Index fallen around 3% since the start of the year, unable to build on the stellar returns enjoyed in December last year? Numerous reasons are cited including anxiety over land expropriation and growing political unrest ahead of the general elections. Sceptics point out that “Ramaphoria” has run out of runway. Now that most of the low hanging fruit, key appointments in cabinet and in state-owned enterprises, has already been picked the next stage involving actual structural reform will be less easy.
  • The greatest cause of the JSE’s weak year-to-date performance, as always lies less in political developments than in economic fundamentals. Political developments affect sentiment but economic fundamentals affect the hard numbers including earnings growth and dividend growth.
  • In contrast to the fourth quarter last year when GDP grew by a stronger than expected 3.1% quarter-on-quarter annualised, GDP in the first quarter (Q1) is likely to have contracted by 0.4%. This number is based on weak manufacturing, mining and retail figures, which due to the base effect of high comparative levels in Q4, all contracted in Q1 on a quarter-on-quarter basis by 1.7%, 2.5% and 1.3%, respectively. Manufacturing, mining and retail shaved an estimated 0.8, 0.7 and 0.3 percentage points from Q1 GDP. Ramaphoria sceptics appear to have plenty to hang their hats on, pointing to the actual “hard numbers”.
  • Some key hard numbers are more encouraging. Growth in private sector credit extension picked-up in March to 6.0% year-on-year from 5.7% the prior month, boosted by stronger corporate credit growth which accelerated from 7.3% to 7.7%.
  • The unemployment rate remained unchanged from the Q4 level of 26.7% despite 307,000 new entrants to the labour market at the start of the year and despite the typical reversal of festive season hiring. The South African economy created 206,000 new jobs in Q1. The total number employed increased by 1.3% quarter-on-quarter. The labour force participation rate, measuring the percentage of people wo are currently employed or in search of a job, increased from 58.8% in Q4 to 59.3% in Q1.
  • These hard numbers have boosted consumer confidence to an all-time record high and business confidence to a decade-high. Business and consumer confidence indicators, together with the forward-looking Reserve Bank composite leading business cycle indicator, are consistent with GDP growth rebounding in the second half of the year to at least the 3.1% level achieved in Q4. 
  • The rebound in economic growth in the second half of the year will likely be celebrated with a proportionate rebound in the JSE.