Taking stock at half year

At the start of 2014 market participants were aware of the issues facing the global investment landscape with the key focus being on the Federal Reserve’s “tapering policy” and the hoped for recovery in global economic growth. Stimulus packages over a number of years had provided support to equity and bond markets and in particular the emerging markets. The only certainty for South African investors going into 2014 was that they would continue to be challenged by both local and international factors as the year unfolded.

International factors at play included the US tapering policy, the implementation of China’s economic reforms, concerns over the rate of global GDP growth and especially the uncertainty as to the state of both the US and Chinese economies. The recent downward revision of the US first quarter GDP growth to -2.90% (blamed on the severity of the local winter), triggered concerns amongst certain investors that US growth was no longer on track and that QE (quantitative easing) was likely to continue. QE is expected to reduce by US$10 billion per Fed meeting and to end in October/November 2014. Over the period under review inflation in the more developed economies remained surprisingly under control, thus deferring expectations that an interest rate hiking cycle was imminent.

During the first six months of 2014 South Africa faced numerous headwinds on the local economic front including, amongst others:

The South African Reserve Bank’s unexpected increase in interest rates by 0.50% in late January in response to upward pressure on inflation which was primarily driven by the weakening currency. The upper level of the CPI target range was indeed breached, with CPI reaching 6.60% in May. South Africa recorded a first quarter contraction in GDP of -0.60% clearly undershooting expectations and resulting in further downward revisions of GDP growth for 2014 and 2015 to just over 1.50% and 2.50%, respectively. Furthermore, the worsening “Twin Deficits” resulted in the country continuing to be seen as part of the so called “fragile five” emerging economies.

Domestic consumers entered 2014 already under pressure and their deteriorating household finances were further aggravated by the interest rate hike and rising inflation. The labour strike in the platinum industry that was to go on for almost six months (at an estimated cost to the economy of approx. R34 billion) added to the pressures faced by companies operating in the consumer sector. One of the consequences of such an environment was the relative lackluster performance of a number of South Africa’s listed retail shares.

June saw a downgrade of the South African sovereign foreign and local currency ratings by S&P to BBB+ (from A-) and to BBB- (from BBB), respectively, while maintaining their stable outlook. S&P also downgraded local issuers such as Eskom, DBSA, Transnet as well as FirstRand, Nedbank and Investec. All moves reflected the sovereign changes. Similarly, while Fitch kept their foreign currency rating unchanged at BBB, they did change their credit rating outlook from stable to negative. The power supply constraints faced by Eskom were highlighted by the rating agencies as a concern and remains one of the factors to be addressed in order to support planned future economic growth.

Despite the headwinds mentioned above, the JSE All Share Index (ALSI) recovered from its early February decline of 5.53% and rallied over the remaining period, attaining a new all-time high of 51 322.67 on 20 June. ALSI returns even in US dollar terms, stacked favourably when compared to many developed and emerging markets globally (see table below). Strong performance contributions over the period under review to the JSE ALSI returns came from shares such as Anglo American (13.65%), Aspen (11.23%), British American Tobacco (13.23%), FirstRand (13.54%) Naspers (14.23%), SAB (15.73%), Sanlam (15.98%), Sasol (22.91%) and Steinhoff (31.29%).

What lies ahead?

It is likely that the US and the Eurozone will continue showing on-going economic growth momentum. Consensus economic forecasts indicate that China will likely experience a soft landing which should ensure that their economy continues to grow at between 7.00% and 7.50%. While the US Fed continues tapering, the European Central Bank, the Bank of Japan and the Peoples Bank of China may continue with various forms of stimulus as they struggle with their own fears of deflation and growth.

Globally, risk appetite remains relatively high and inflows into emerging markets continue. The ending of the US quantitative easing program by year-end and the apparent bottoming out of inflation is likely to place additional upward pressure on emerging market interest rates as some developed markets potentially begin their hiking cycles. This would adversely affect the emerging market “carry trade” which has over time resulted in significant inflows into their bond markets. The large current account deficit in South Africa and resultant reliance on foreign capital inflows suggests the Rand will remain relatively fragile and ongoing volatility should be expected.

Sub-par domestic economic growth is likely to continue to prove challenging for corporate-earnings especially in those areas which are consumer and interest rate sensitive. The SA consumer is expected to remain under pressure with subdued wage growth also playing a constraining role. Further labour unrest will add to uncertainty and may lead to additional downgrades by the various rating agencies. Implied risk premiums in the local equity market remain below long-term average levels, which, together with an expected upward drifting of bond yields is likely to dampen near-term equity returns.

The low-yield environment globally and locally will continue to provide support for equity markets and despite our reduced return expectations, equities still remain our preferred asset class. Financial markets are likely to remain volatile for the remainder of the year and any expectations of a repeat of the high returns of 2013 should be tempered with caution. Offshore investment remains attractive from a diversification point of view and global equity market ratings appear to be relatively undemanding.