The South Africa economy continued to struggle in the second quarter despite the more positive political environment. The weakening rand, high oil prices and the increase in the value-added tax (VAT) rate in April put pressure on consumers, while continuing uncertainty over the mining policy environment and the expropriation-without compensation debate has hurt investor confidence and therefore capital formation.
Globally, the environment has also become less certain as trade wars intensify and portfolio investors become more risk-averse. The protectionist moves by the US sparked retaliatory action from major trading partners, with potentially disproportionate effects on smaller open economies such as South Africa. A widespread and protracted trade war would disrupt global demand and weaken commodity prices, a situation that would hurt the fragile economies that are slowly recovering from the effects of the 2014–2015 commodity price crunch.
Implications of the news (Trade wars)
The trade wars have resulted in a change in sentiment towards emerging markets which gave rise to the recent selloff in emerging markets assets. This has already started to negatively impact the pace of growth in world trade. A sustained slowdown in global trade would weaken global growth, further hurting many emerging economies that rely heavily on export earnings.
The increase in the international oil price, which has the potential of pushing consumer inflation higher in many countries, may result in emerging market countries implementing contractionary monetary policies which may have the potential of undermining global growth. In addition, there is an expectation that global interest rates will continue to rise as the major central banks push ahead with their efforts to try and normalise monetary policy. This predominantly been led by the United States. However, in June the ECB indicated their intention to stop their quantitative easing policy by year-end and look to raise interest rates in 2019. A systematic increase in global interest rates will lead to higher debt servicing costs, and a further moderation in global liquidity. This is also likely to reflect in increased risk aversion, which could undermine the economic performance of vulnerable emerging economies, such as South Africa.
As a result of the recent selloff, many emerging market currencies are now under-valued, and could attract renewed foreign investment if the current concerns about the performance of the world economy improve. It does, however, feel like this would be a relatively short-term relief. The graph below shows the EM Currency index in USD terms. It is clear that year to date, that EM currencies have been under pressure as investors pull back to safe havens.
EM Currency (USD)
Implications of the news (Local economy)
The graph below shows SA quarterly GDP growth from the first quarter of 2013 to the first quarter of 2018. Despite the disappointing first quarter growth number and the weak start to the second quarter, the economy is expected to have a modest recovery during the remainder of the year. On the production side there should be recoveries in mining and manufacturing, backed by relatively robust global demand and firmer international commodity prices. We also expect the lower base from the first quarter of 2018 to support the improvement.
Markets during the month
Local equity market (as measured by the JSE All Share Index) prices mostly came under pressure in the second quarter, hurt by economic weakness and rising global risk aversion. Although the FTSE JSE all-share index gained 2.8% in June, this was due mainly to the weaker rand helping resource stocks. Most other sectors saw significant declines or gains off low bases. The performance of the local equity market will remain dependent on global liquidity conditions and risk aversion, with unexpected tightening of monetary policies the key risk.
Source: Morningstar Direct
- Money Market (SA Cash) posted modest gains of 0.6% in June and,
- South African bonds (ALBI) were down 1.2% on the back of the weaker rand and the sell-off in emerging markets. The yield on government’s benchmark R186 bond briefly increased above 9% before finishing the month at 8.84%.
- Against this backdrop, it was hardly surprising that listed property (SAPY) was the worst performing asset class in South Africa in June down 3.5%. What was surprising was that the weakness in listed property was broad-based and even the rand-hedges failed to make any headway despite the more than 8% depreciation in the value of the rand against the major developed markets currencies (USD, GBP and EUR).
Looking ahead, yields will probably increase further as the rand is likely to depreciate over the next few months, putting upward pressure on consumer inflation and increasing the probability of rate hikes. The Reserve Bank’s forward guidance affirms the view that the next move for short-term rates is up, which points to higher bond yields in the future.
The rand ended the month weaker against all the three major currencies, down: –
- 10.1% against the USD
- 8.6% against the British Pound
- 9.4 against the Euro
The rand has been hurt by spikes in emerging market risk aversion, which has been driven so far by hostile US trade policy, geopolitical tensions and monetary policy normalisation in developed economies. More recently, worse-than-expected domestic economic data especially the latest current account deficit figures – have also weighed on the currency.
SA financial markets are likely to be mainly influenced by global risk appetites. With global liquidity expected to tighten as US monetary policy normalises and as most other advanced economies start to wind down extraordinary monetary stimulus. Investors are expected to be more discerning as to where to invest their funds and the rand will probably be volatile and weak. Local political tensions and policy impasses around could also hurt our domestic currency further.
As always, we suggest that you stick to your overall investment plan as these events are part of normal market cycles and should not cause you to derail your long-term planning. It is likely that the rand is going to be even more volatile than usual as emerging markets are often first to react to global economic uncertainty. On a positive note, the mining and resources sector in South Africa is experiencing a mild recovery that could be accelerated should the final mining charter provide the necessary direction for investors.
Reasonable steps have been taken to ensure the validity and accuracy of the information in this document. However, Cornerstone Asset Management (Pty) Ltd (CSAM) does not accept any responsibility for any claim, damages, loss or expense arising out or in connection with the information in this document. The content used in this document is sourced from various media publications, the internet and CSAM internal research. Cornerstone Asset Management is an authorized financial services provider, FSP No. 45700