Remaining unchanged from last month global economic growth continues to track the market consensus of 3.3% in real terms this year, slightly stronger from 3.1% in 2016. The latest quarterly data shows that the Eurozone grew by 0.6% quarter on quarter during the second quarter of 2017. This implies that Europe is growing at its fastest rate since the start of 2011. The disappointing US ISM PMI data for July also confirms that the Eurozone continues to outperform.
Recent economic indicators (such as above consensus US non-farm payrolls data) in the United States still points to a strong economy which continues to create private sector jobs, even when it marginally lags Europe. Both the Eurozone and the US are still expected to grow at just over 2.0%, while emerging markets are expected to reach 5%.
Inflation dynamics do not mirror economic growth as these continue to come in below central bank targets in both the US and Europe despite continued acceleration in economic growth. As a result global monetary policy tightening is likely to be very gradual. Both the ECB and the US Federal Reserve have indicated they will start with quantitative tightening — scaling back the pace of quantitative easing soon. The actual interest rate tightening cycle in the US and Europe is likely to only begin in 2018.
According to RMB Global Markets South African GDP will grow at a miserly 0.3% in real terms in 2017 and mildly rebound to 1.0% in 2018. This lags global economic growth (3.3% in 2017) by some margin. Tighter global monetary policy and a possible collapse in China’s debt bubble remain key global risks which may put further pressure on economic activity in South Africa as it may put pressure on the demand for industrial metal exports.
During July headline inflation fell to 4.6% year on year, as food inflation turned lower. Petrol price increases will cause CPI to edge higher in August and September, but core inflation should continue to fall steadily over coming months to a possible trough of below 4% by the first quarter of 2018. After the South African Reserve Bank opted to cut rates in July (taking the repo rate to 6.75%) a next cut of 0.25% is likely in November (with a move as early as September not totally off the table).
The South African Rand has been trading sideways against the greenback for most of this year, with particularly tight ranges, limited liquidity and reduced volatility in the past four months. The ZAR/USD range has been 12.80 – 13.50 since May 2017, with only occasional trades outside of this band.
Political event risk is high through to year-end but the consensus view is that the Rand is likely to end the year within its current trading range.
Growth assets (property and equity) had a pedestrian return over the last ten months and then only delivered a decent outcome for the year thanks to July and August. This was largely due to resource stocks (up more than 17% for the year) and a number of large cap rand hedge stocks (Naspers and Richemont for example) which carried the rest of the SA equity market. As a result SA equities delivered a return similar to bonds (and outperformed cash) over the last twelve months thanks to this final surge. It illustrates the point that investors need to be circumspect of exchanging growth assets for cash as fortunes in stock markets can turn fairly quickly.
Over a full investment cycle these lukewarm returns in equity markets are unlikely to persist, and as a result investors with long term capital growth expectations should retain their exposure to this asset class.
Global equities performed particularly well in US Dollar terms (up more than 17% over the year) but a nearly 12% strengthening of the Rand has diluted the impact on locally based investors.
|Market indices||1 Year to 31 August 2017|
|SA Equities (JSE All Share Index)||10.2%|
|SA Bonds (SA All Bond Index)||10.2%|
|SA Cash (STeFI)||7.6%|
|Global Equities (MSCI All Countries World Index, measured in Rand)||4.0%|
Commentary – Creative destruction and inflation rates
During a recent investment conference in Sandton David McWilliams, an Irish economist proposed that global inflation rates (and monetary rates as a result) are likely to remain low for a long time. He argues that this is the result of “creative destruction”, and used Amazon, Über and Netflix (among others) as examples of this phenomenon. Creative destruction, a term coined by the Austrian economist Joseph Schumpeter in “Capitalism, Socialism and Democracy” in 1942, describes the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” This occurs when innovation deconstructs long-standing arrangements and frees resources to be deployed elsewhere. A great example is one of the black cabs where apprentices used to spend two years to get to know every nook and cranny in London before they could ferry passengers around. This knowledge had economic value which was reflected in the price of a cab ride. With the advent of Google Maps and Über “the knowledge” is now freely available and has been driving the cost of ride hailing down. The Über driver is literally driving his vehicle through the old business model. McWilliams and his associate Paul McCulley (Chief Economist of PIMCO) proposes that the US Federal Reserve’s board members have been expecting inflation to start picking up as unemployment has been coming down (based on the Phillips Curve). In past economic cycles the natural rate of unemployment where inflation started increasing was around 6%, but with the rate at 4.3% the Federal Reserve has not seen the inflationary response that they’ve been expecting. McWilliams and McCulley come to the conclusion that the beneficiaries of this “creative destruction” are likely to be global equities and the US Dollar, but that there may be continued political disruption as winners and losers of this trend have the same say when they come to the ballot box.
Our research associates, MRB Partners, have a more conventional view and argues that the current low inflation expectations are based (incorrectly so) on an over-reaction in 2014 to the then precipitous fall in the oil price and simultaneous increase in the value of the US Dollar against its trading partners’ currency. They propose that, contrary to the view of McCulley and McWilliams above, inflation is likely to surprise on the upside and as a result interest rates in the United States are likely to rise faster than what the market is pricing in at this point in time. Interest rate increases will however be dependent on a continued strength in the US economy, which combined with the rate increases could lead to a turnaround in recent US Dollar weakness.
Please make a note of the dates for our 2017 Investment Seminars. The Cape Town Seminar will be held on 7 November 2017 in Stellenbosch and the Pretoria Seminar will be held on 22 November 2017. More detail will soon be available but you are kindly requested to reserve the date in the interim.