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SA sees Scope for further monetary easing - a positive for both fixed income and equity investors

23 May 2018 Bernard Drotschie, Melville Douglas
Bernard Drotschie, Deputy Chief Investment Officer at Melville Douglas.

Bernard Drotschie, Deputy Chief Investment Officer at Melville Douglas.

Domestic equity markets followed global markets higher as trade tensions between the US and China eased somewhat and investors’ attention shifted towards a robust Q1 earnings reporting cycle abroad. The US Dollar strengthened on the back of higher interest rate expectations and weaker European data. This resulted in a lower rand and higher SA bond yields.

The domestic equity market benefited from a weaker rand and a sharp rebound in mining shares as the High Court granted a declaratory order on “once empowered always empowered” thereby removing uncertainty on the ownership of existing mining rights. The spike in the oil price due to increased geopolitical tensions in the Middle East, strong underlying demand and disciplined output from OPEC and Russia further supported the performance of the sector during the month. But it wasn’t just the JSE Resources sector that performed well. Even though headline inflation in South Africa fell further due mainly to lower food prices, domestic bond yields moved much higher in sympathy with higher developed market yields where inflationary pressures are mounting. 

Market euphoria over South Africa’s leadership transition has abated as the year has progressed. Although policy uncertainty with regards to land ownership and the Mining Charter remains, investors should not lose sight of the recent positive changes implemented by president Ramaphosa. In addition to the High Court’s declaratory order relating to ownership of existing mining rights (which will be challenged by government), several other actions were taken during the month, including the appointment of a new Chairperson and Interim board at Denel and the appointment of an Economic Advisory Council with an investment team to help raise over $100bn over the next five years. Furthermore, minister Radebe signed a R56bn contract with renewable energy producers. 

The steps taken so far to stabilise state-owned enterprises (SOEs), with the objective of returning them to financial sustainability, are starting to yield positive outcomes. A few months ago, capital markets were completely shut to the SOEs, but now funders have become more comfortable and SOEs have been able to refinance maturing debt. This is critical not only for the certainty of medium-term service delivery, but also for the reduction of the immediate threat to government finances. The task ahead is still enormous for Public Enterprises Minister Pravin Gordhan, but some success spells good news for industries supplying the various SOEs as well as those consuming their services. 

Consumer and Business confidence has returned, which bodes well for an acceleration in economic activity towards the latter part of this year as companies start the process of rebuilding depleted inventory from an improvement in final demand. The latest confidence survey compiled by the Bureau for Economic Research (BER) highlighted that one of the inputs in measuring confidence, the “Political Constraints to Business” index, has fallen to a two-year low. At the same time, there has been a sharp recovery in intended investment in machinery and equipment, which provides further evidence that the economy is one step closer to the start of the next investment spending cycle. 

Household consumer expenditure may not expand as much as in previous growth cycles due to the fiscal constraints from higher taxes, but real growth in income levels combined with healthy balance sheets will still support an improvement. The impact of inflation and wage settlement outcomes is less certain than previously was the case because of the Reserve Bank’s determination to achieve a permanently lower inflation path, which involves higher real interest rates. 

The improvement in final demand combined with an inventory restocking cycle will add impetus to South Africa’s manufacturing sector. Recent survey data suggests that the sector is finally gaining some traction, and that new sales orders are behind the improvement. The manufacturing sector has declined in size relative to the services sector over a prolonged period. While this trend is not unique to SA, the manufacturing sector’s importance to the rest of the economy should not be underestimated. Research indicates that the manufacturing sector’s potential to drive growth is the highest of all sectors as it has the largest output multiplier in the economy. Deutsche Bank calculates that for “every R1m additional demand for manufactured goods, R9.9m of intermediate demand is generated in the sector.” 

Given the sector’s linkages to other sectors, manufacturing contributes significantly to employment growth in other parts of the economy as well as confidence levels in general. Much of the expected improvement in demand will naturally also depend on the external environment. While the global economy continues to grow and much-needed structural reforms are implemented domestically, the cyclical recovery of South Africa’s economy will likely be sustained. 

South Africa appears well positioned for an improvement in growth momentum which will attract foreign investment, as well as improved delivery by SOEs and reduced policy uncertainty under the new leadership of President Ramaphosa. Inflation is well contained and the Reserve Bank is determined to lower inflation expectations to the mid-point of the 3-6% target band. So, although real interest rates will remain high, there is scope for further monetary easing which will be positive for both fixed income and equity investors.

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