The markets in August 2018 were dominated by news of Rand weakness which plumbed fresh two-year lows, caught up in emerging markets storms and the recent announcement of a domestic economic technical recession. The onset of a technical recession is generally brought about by two consecutive quarters of negative economic growth as measured by a country`s gross domestic product GDP.
South African economic activity contracted by 0.7% in the second quarter of 2018, following a downwardly revised 2.6% contraction in the first quarter. The outcome was worse than market expectations of marginal growth of around 0,6% quarter on quarter (q-o-q).
The main contributors to the fiscal drag came from sharp declines in value added by agriculture, transport, storage and communications, domestic trade, accommodation and catering. Encouragingly however, there were some positives, with mining, construction and electricity, gas and water bouncing back, while the pace of activity in finance, real estate and business services accelerated somewhat.
Implications of the news.
To highlight the implications of the market headlines in August, we used a graph below which is an extension to the graph we used in our June 2018 Market Commentary.The graph shows SA quarterly GDP growth from the first quarter of 2013 to the second quarter of 2018. The outcome for the second quarter of 2018 was worse than market expectation, which was for a slight recovery in the economy. This worse than expected outcome reflected the deterioration in consumer and business confidence as the debate around land expropriation intensified and the global backdrop for emerging markets deteriorated.
The lower than expected GDP figure announcement had a negative impact on the rand which was already under pressure from concerns around emerging markets, largely driven by fears of contagion from Turkey and Argentina. However, local issues like the ability of the government to meet is fiscal targets, policy uncertainty (especially around the land reform) also weighed down the rand performance for the month. This renewed the risk of a downgrade from the rating agencies.
Considering that South Africa is an open economy with a flexible exchange rate, a weaker currency will result in imports becoming more expensive and exports becoming more competitive in the international market. When imported goods become more expensive, it has a direct negative impact on inflation. This is what we are experiencing now with the fuel price being driven higher by rand weakness. This means that the South African Reserve Bank faces a difficult decision. Should the SARB lower interest rates, it risks higher inflation which will devalue the rand further. Or should the SARB take a more contractionary monetary policy and raise interest rates which might risk stagnating growth in an economy that is already in a technical recession. In order to give the economy a chance to recover, CSAM thinks that the SARB will maintain the current loose monetary stance as long as inflation is still in its target of 3 to 6%.
CSAM’s view that we are probably sitting at peak levels of pessimism regarding economic growth, confidence and currency was confirmed in a recent publication by Old Mutual. We believe that South Africa still has a strong investment case, but we think that it will take some time for this view to be expressed in performance. With elections coming up, we should not expect significant policy changes before then. But if President Ramaphosa’s investment target of $100 billion over five years materialises, it is possible that in conjunction with other policy measures, we can reach 3% or even 3.5% GDP growth by the early 2020s.
Markets During the month
The graph below shows the market movements for the month ending August 2018.
Local equity market (as measured by the JSE All Share Index) outperformed global markets in August 2018, with a weaker rand boosting returns. The FTSE/JSE All Share Index added 2.3% in the month.
Global equity market (MSCI World) finished the month up 1.2%, largely driven by gains in the US equity market. President Donald Trump’s trade war with China has clouded the outlook for global economic growth and undermined investor confidence in non-US equity markets.
Listed property index (SAPY) ticked 2.1% higher in August 2018 on the back of a 14.8% increase in the price of NEPI Rockcastle. The Resilient group of companies also supported the returns up 10.2% by the end of August.
Bond index (ALBI) come under pressure from the recent sell-off in Turkey, amid the contagious risk-off that gripped emerging markets ending the month of August down 1.9%. Cash posted a modest 0.60% in August 2018.
Long term Markets and Currency performance
The USDZAR weakened by over 10% against all developed markets currencies in August, down:
- 11.3% against the US dollar
- 10.1% against the British Pound
- 10.9% against the Euro.
It is worth noting that the rand is a high beta currency, prone to severe side-effects of EM distresses.
In August, the Turkish central bank disappointed markets by keeping interest rates unchanged in the midst of rising inflation and a sharply weaker currency. Combined with this, diplomatic ties between Turkey and the US deteriorated, with the US doubling import tariffs on Turkish aluminium and steel. The Turkish president retaliated by then promising to boycott US goods. The loss of credibility of the Turkish central bank, combined with Argentinian financial crisis, catalysed an EM risk-off, with the Argentine Peso (ARS) falling 28.8%, and the Turkish Lira (TRY) falling 23.4% in August, both against the USD. The rand is the third-worst performing currency in the world in August after the TRY and ARS.
CSAM still believes that SA provides a sufficiently high enough real return to warrant portfolio inflows as opposed to outflows. Hence, we could see portfolio flows recovering in the short term, particularly if local fundamentals remain stable. However, foreign investor sentiment (driven by a variety of factors – some of which are discussed above) remains a key risk to our rand and inflation forecasts.
The benefits from the election of president Ramaphosa earlier in the year have been overshadowed by global developments. While CSAM still expects an improvement in the currency after the August weakness, it might take time given unprecedented geopolitical tensions combined with uncertainty over land reform locally.
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
 Nedbank economic commentary, Gross Domestic Product. https://www.nedbank.co.za/content/dam/nedbank/site-assets/AboutUs/Economics_Unit/Research/Economic%20Commentary/GDP%20Q2%202018.pdf
 Old Mutual Investment, SA enters a technical recession. http://ww2.oldmutual.co.za/old-mutual-investment-group/insights/insights-details/south-africa-enters-a-technical-recession