2014 Market and economic outlook
The JSE last year set a fresh record high against a South African economy that will probably fail to achieve even 2% growth, and financial divergences like this were common across the globe. Essentially, this is the effect of the extremely easy monetary policies of the major central banks, with interest rates at zero, reinforced through massive amounts of quantitative easing (QE). The US Federal Reserve is to start tapering QE this year, which has the potential to significantly affect the SA economy and financial markets.
The first economic challenge SA faces is to deal with its twin deficits of a burgeoning current account deficit and government budget deficit. If the household deficit is included, it is better described as a triple deficit that has to be resolved. While the credit-rating agencies gave SA a lifeline late in 2013 by not further downgrading the sovereign debt, this will prove temporary if the deficits are not pared back. The deficits have also exposed the country to possible external contagion and reduced resilience. The rand has been a casualty of the deficits, weakening from R8.40/$ at the start of 2013 to end the year at R10.35/$. The nominal effective exchange rate against a basket of currencies weakened by 18.4% over 2013. This index closed 2013 at the lowest level since November 2008 and has since fallen to an all-time low in January 2014. The rand has been in a weakening trend over the past three years. However, the trend accelerated somewhat in 2013 despite conditions in global financial markets being largely in a "risk-on” mode. Safehaven assets such as the US dollar, bonds and gold weakened in 2013, while riskier assets such as equities and property gained. The rand would normally be expected to strengthen in these circumstances. The accelerated US QE programme that saw the US Fed buying $85 billion in bonds through 2013 was a major factor behind the shift towards greater risk.
The Industrial sector led the JSE
Certainly, the JSE, in rand terms, gained 17.9% and closed on a record high. However, in US dollar terms it was down around 4% over 2013. This was in line with the MSCI Emerging Market Index in dollar terms, which was down 2.3%. The gain in the JSE in rand terms was largely compensation for currency weakness and this was reflected in some key rand-hedge counters. The Industrial sector led the JSE, gaining 31.7% through the year, while Financials gained 14.3%. Resources were down 1.8%, reflecting a sector that struggled in 2013 due to rising costs, falling commodity prices and a series of crippling strikes that hit the local mining sector. The sub-sectors that led the JSE with gains of more than 40% in 2013 were Oil & Gas, Consumer Goods and Health Care. Basic Materials stood out as the laggard. with an overall loss of 1.8%. Gold Miners, a subset of Basic Materials, were down more than 50% for the year. Essentially, the rand-hedge shares did better than the rand-leverage shares as investors reduced exposure to SA labour. From a valuation perspective, the JSE is regarded as expensive, with Industrials the most overvalued and Resources reflecting the cheapest sector.
The shift from lower-risk assets, combined with the weakness of the rand, saw SA government bond yields rise from 6.76% at the start of 2013 and end the year on 7.95%. The rand’s weakness also weighed down this asset class and the ALBI total return index was flat for 2013. This index has yielded strong positive returns since 1999 with the exception of 2009, when it was also flat for the year.
The outlook for 2014 will again depend on the actions of the major central banks. The massive QE programme of last year is to be cut back, with the Fed indicating it would start tapering the monthly $85 billion in asset purchases in January 2014. This means global financial markets will shift from the "risk-on” mode of 2013 to a "risk-off” mode in 2014. This implies equity markets will come under pressure while the Fed is tapering. Safe-haven assets such as US treasuries, the US dollar and gold are likely to strengthen. It is also possible that the nascent economic recovery will weaken somewhat. It is therefore expected that the Fed’s tapering will be halted and asset purchasing increased to perhaps even higher levels than the $85 billion by the end of the year.
The rand likely to weaken substantially
The local financial markets will respond to the Fed’s actions, with the rand likely to weaken substantially while the tapering continues. Early indications in January 2014 have reflected substantial rand weakness, with the currency already trading weaker than R11/$. The randhedge sectors of the JSE have been instrumental in the JSE All Share Index climbing above the 47 000 level. However, in line with global markets, some JSE sectors that do not have a rand-hedge dimension, such as Financials, have fallen.
In essence, while the Fed is committed to tapering its asset purchases, the rand can be expected to weaken further. The weakening of the currency has been orderly over the past three years, but the tapering may cause it to start trading in a disorderly manner, which will result in a more rapid weakening over a short period. However, the rand is already oversold and cheap and any accelerated weakness will probably mark the end of its current weakening trend. Past patterns will probably repeat, meaning the rapid short-term weakness should be followed by a recovery and strengthening trend over the nextseveral years. This was the case with the rand crises of 1998, 2001, 2008 and possibly 2014.
While the Fed is tapering, global equity markets will weaken from the record levels at the end of 2013. Certainly, these markets are overbought and due for a correction in any case. The taper effect will merely accelerate the correction. The JSE would normally be expected to follow the global markets, but the performance of the SA currency will mute any downturn on the local bourse in rand terms. However, this will distort the performance of the different sectors. The large-cap rand-hedge Industrials should hold up well in rand terms, but this sector is expensive. The Basic Materials sector could even advance against the global trend if the rand weakens sufficiently and this sector is relatively cheap.
Financial markets will then revert to "risk-on”
However, the Fed is unlikely to persist with a tapering programme if markets continue to fall. Its economic recovery mechanisms are in part dependent on the positive wealth effects that come from a rising stock market. This means that at some point during 2014, the Fed will reverse course. Financial markets will then revert to "risk-on” and by the end of the year, the JSE will be setting fresh record highs. By that stage, the rand will be recovering, although so will global stock markets. Commodities will also be moving higher, which will help offset the effect of a recovering rand. An investment strategy often considers the winners and losers of a particular year and shifts from the winners to the losers.
This year may prove to be odd in that 2013’s winners and dogs may turn out to be 2014’s winners. This will be because of the rand-hedge and rand-leverage nature of large-cap Industrials and also Basic Materials. If the above scenario between the rand and the Fed’s tapering plays out, Financials will end up the laggard sector of 2014.
From an interest-rate perspective, the SARB remains in an uncomfortable position. CPI inflation moved above the 6% threshold in third-quarter 2013 but dropped back into the target range in the fourth period. The lower inflation was despite the weakness in the rand over the same period. Cost pressures in the SA economy are relatively high, stemming from currency weakness and an increase in administered prices such as electricity and municipal charges. However, the economy remains relatively weak and growth below 2% is expected for 2014, which is well below expectations reflected at the start of 2013. Weak final demand may well be why the transmission of cost pressures has not translated into a higher CPI number.
This is one reason the SARB has been able to hold off on any interest-rate increases, although further rand weakness will put pressure on it to act. However, weak economic growth is also a consideration in setting monetary policy. This, then, is the SARB’s dilemma: inflationary pressures would...
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