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Market and economic outlook - July 2020

07 July 2020 Momentum Investments
Sanisha Packirisamy, Economist at Momentum Investments

Sanisha Packirisamy, Economist at Momentum Investments

Herman van Papendorp, Head of Investment Research & Asset Allocation at Momentum Investments

Herman van Papendorp, Head of Investment Research & Asset Allocation at Momentum Investments

Markets
• The mood in global financial markets sweetened in the past quarter in reaction to a rapid and sizeable intervention by policymakers to counter the negative effects of the COVID-19 pandemic on health and economic outcomes.
• The MSCI All Country World Index shot up 19.2% in the second quarter of the year, buoyed by equally strong returns from developed markets (DMs) and emerging markets (EMs).
• The local equity market staged a firm recovery of 23.2% in the second quarter. The FTSE/JSE Resources Index rocketed 41.2% in the three months ending June 2020, followed by a 16.6% rise in the FTSE/JSE Industrials Index, while the FTSE/JSE Financials Index trailed at 12.9%.
• The JSE Assa All Bond Index climbed 9.9% in the quarter, while the JSE Assa Government Inflation-linked Bond Index traded 17.7% firmer for the same period. Meanwhile, the FTSE/JSE SA Listed Property Index recouped 20.4% since the end of March 2020.
• History has warned about a quick rebound in earnings. The current optimistic consensus could be in for a negative surprise given the disconnect between share prices and expected company profits against a backdrop of prevailing uncertainties. The bond market and the rand have nevertheless maintained a risk off profile during this period given concerns on the outlook for the economy.
• Although United States (US) equity market valuations appear expensive relative to their own history, they are still far more attractive than bond valuations. We remain cautious of South African (SA) equities as they are likely to take their lead from global equities during a risk-off drawdown period, but we are positive beyond that.
• We favour SA nominal bonds relative to inflation-linked bonds in the near term given the expected slowdown in inflation, but break-evens are likely to expand with an anticipated rise in inflation in 2021.
• The relative rating of SA listed property to nominal bonds is still at historical extremes, suggesting a lot of bad news is already being discounted. We remain cautious in the interim if there is a further leg down in risky assets, but we see the return profile as asymmetric to the upside beyond that.

Economics
• As the world thaws from the containment measures which froze economic activity, economic surprises have started to turn up in a number of economies. However, positive data surprises are not yet a global trend and sharp increases in the number of daily new cases in some countries have halted an easing in restrictions, causing positive data surprises to roll over in some geographies.
• Although a sizeable fiscal response was triggered in DMs and EMs, EMs had fewer resources to deploy in this crisis. As such, a number of economies may operate below their potential beyond 2021 and the divergence between richer and poorer nations is likely to grow.
• Monetary policy measures are likely to steady financial markets and spur inflation on asset prices, but the effects on investment, growth and consumer price inflation are likely to be diluted.
• The COVID-19 pandemic has aggravated SA’s already severe socio-economic and political challenges. With the effectiveness of government’s stimulus package being stymied by administrative challenges, the economy is still likely to contract by a sizeable 8.1% this year. We only see the economy recovering by 2% in 2021.
• In the case of SA, we anticipate a further drop in headline inflation to around the 2% mark on pressured incomes causing a drop in demand. Inflation is likely to average 3% in 2020 before rising to 3.6% in 2021, in our view.
• We see room for up to 50 basis points worth of easing in the repo rate in 2020 in light of dismal growth and well contained inflation.

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