Cape Town - A positive outcome to the upcoming credit rating decision in November and ANC's elective conference in December will have a substantially beneficial impact on the rand and South African equities, according to Overberg Asset Management (OAM).
In its weekly economic and market overview, OAM said that most investors were discounting the loss of the rand investment grade rating when ratings agencies Moody’s and Standard & Poor’s deliberate on the 24th November.
However, the rating agencies will likely postpone the decision until after the ANC elective conference, it argued.
South Africa economic review
• The ABSA manufacturing purchasing managers’ index (PMI) increased sharply from 44.9 in September to 47.8 in October, its highest level since May. Although still below the key 50-level separating expansion from contraction the trend is positive.
Among the PMI sub-indices, the business activity index climbed from 42.8 to 45.0, the employment index edged slightly higher from 44.1 to 44.3 while the forward-looking new orders index enjoyed a solid improvement from 43.2 to 49.9. The future conditions index slipped from 52.4 to 51.2 although still in expansionary territory.
While the PMI remains at contractionary levels the survey’s accuracy in predicting actual manufacturing conditions has been poor in recent month. The PMI hit an eight year low in July just as actual manufacturing production started to exhibit growth setting the foundation for a positive contribution to third quarter GDP.
• Total new vehicle sales increased in October by 4.6% year-on-year. Although slower than the 7.0% growth the prior month this marks the fifth consecutive month of growth and is ahead of the 4.3% consensus forecast. Passenger vehicle sales were especially strong with growth accelerating from 5.9% to 7.9% boosted by competitive new vehicle pricing, July’s 25 basis point interest rate cut and robust demand from car rental companies.
Commercial new vehicle sales fared less well with growth in this segment slipping from 9.3% to a contraction of 2.1%. New vehicle export sales also weakened from growth of 10.9% to a contraction of 8.3% although adverse weather in Durban’s port was a mitigating factor. While vehicle export sales are likely to recover the weakness in domestic commercial vehicle sales is slightly worrying as the data point is a reliable lead indicator of the business investment cycle.
• According to the Quarterly Labour Force Survey the unemployment rate remained unchanged for a third straight quarter in the third quarter (Q3) at 27.7%. While employment increased by 92,000 in Q3 the number of unemployed job seekers increased by 33,000.
During the quarter seven out of the ten economic sectors showed jobs growth, led by the finance and other business services sector with 68,000, followed by community and social services with 56,000, transport 34,000, trade 21,000, mining 12,000 and utilities 5,000. Job losses were suffered in the manufacturing sector at 50,000, construction 30,000 and agriculture 25,000.
The formal sector added 187,000 jobs during the quarter while the informal sector shed 71,000. Among age thresholds, the unemployment rate between the ages of 25-34 increased from 32.8% to 33.5%. Between the ages of 15-24 unemployment improved from 55.9% to 52.2% although remains at elevated levels.
The labour participation rate, measuring the active portion of the country’s labour force, remained unchanged at a depressed level of 59.9% indicating that many have given up job seeking.
• The trade surplus measured R4.0 billion in September marking the eighth straight monthly surplus. The trade surplus for the year to date increased to R47.12 billion compared with a deficit of R6.66 billion in the same period last year.
However, the trade surplus did narrow slightly from R5.98 billion in August as exports declined 1.6% month-on-month while imports increased 0.4%. On a year-on-year basis both exports and imports increased by 2.6% and 6.0% respectively. In the third quarter mineral exports increased by a substantial 29.8% on the year.
The trade balance is likely to remain in surplus over coming months, helped by buoyant export demand and rising international commodity prices. At the same time import volumes remain constrained by weak domestic demand. The trade balance bodes well for a narrowing of the current account deficit, which in turn should support the rand.
• The National Treasury’s October government bond holding data reveals that foreign investors’ holding of South African government bonds increased to 49.66% from 48.22% in August.
Between August and October net foreign bond inflows totaled R23.7 billion well above the JSE’s reported figure of R5.3 billion. The Treasury reported year-to-date inflows of R127 billion exceeding the JSE’s estimate by around R60 billion.
While bond inflows are encouraging the high level of foreign bond ownership is a concern in case further credit rating downgrades cause forced selling by foreign investors.
The week ahead
• Manufacturing production: Due Thursday 9th November. Manufacturing production is expected to maintain its recent upturn in September. While domestic conditions have been depressed global demand is rebounding. Manufacturing production is expected to make a positive contribution to third quarter GDP.
• Mining production: Due Thursday 9th November. Mining output, which has shown strong growth over the past year helped by rising international commodity prices and rising production volumes, is expected to maintain the positive trend in September. Mining production is likely to make a substantial contribution to third quarter GDP.
• To return to its medium-term appreciating trend of the past 18 months the rand needs to break through key resistance at R/$14.00 and R/$13.50, which if broken would target further gains to R/$12.50. A range of R/$13.50-14.50 is more likely signalling a gradual and controlled depreciation in the rand.
• The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.
• The British pound has broken above key resistance at £/$1.30 promoting further near-term currency gains to a target range of £/$1.35-1.40.
• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
• The US 10-year Treasury yield has failed to break below key resistance at 2.0% raising the probability that the multi-year bull trend in US bonds is over.
• The benchmark R186 2025 SA Gilt yield has broken above key support at 9.0% indicating the potential for a rapid upward move to the 10.5% target level. A break back below the new resistance level of 9.0% is required to remove the danger of a further upward spike in bond yields.
• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
• The Brent oil price has broken above key resistance at $50 and likely to remain in a trading range of $50-60 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $6000 per ton.
• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1400 target level.
• The break in the JSE All Share index above key resistance levels at 56,000 and 60,000 signal the early stages of a new bull market.
The bottom line
• The JSE All Share Index exceeded the key 60,000 level for the first time. Although beating most investors’ expectations, with gains for the quarter-to-date and year-to-date of over 6% and 18% respectively, the budding JSE bull market is only just getting started.
• The JSE is far from being in frenzied overbought territory. Despite recent gains the broader market in terms of its price-earnings multiple has de-rated by almost 20% since the start of the year. Excluding Naspers (which accounts for over 25% of the JSE All Share Index), the price earnings (PE) multiple of the All Share Index has de-rated sharply since the beginning of the year from close to 21 times earnings to just over 16 times earnings.
• South Africa’s standing amongst emerging markets has steadily de-rated since 2015. The JSE All Share Index PE multiple is the fourth lowest among emerging markets, only ahead of South Korea, Turkey and Russia.
• Despite the recent uptick in the JSE both foreign and domestic investors appear to be pricing-in the worst-case scenario in the upcoming credit rating decision on 24th November and the ANC elective conference from 16th-20th December.
Most domestic investors are positioned very defensively in South African equities with well above average exposure to non-equity asset classes such as cash and bonds.
Within their reduced equity allocation domestic investors have a well above average exposure to rand-hedge stocks. Foreign investors also appear to be discounting the worst-case scenario, having been consistent net sellers of South African equities since 2015. In the year-to-date, foreign investors have been net sellers of a massive R77 billion worth of South African equities.
• Most investors are discounting the loss of South Africa’s local currency investment grade rating when Moody’s and Standard & Poor’s deliberate on the 24th November. However, the rating agencies will likely postpone the momentous decision until after the ANC elective conference.
In recognition of the binary outcome of the ANC elective conference in December the rating agencies, rather than downgrade local currency debt to “junk” status will likely place South Africa on “credit watch”. A credit watch needs to be resolved within three months giving the rating agencies until the February Budget to make a more informed decision.
• There are four potential outcomes to the ANC elective conference. That the conference doesn’t take place at all, that President Zuma manages to get his chosen successor Nkosazana Dlamini-Zuma elected president of the ANC, that Cyril Ramaphosa is elected president as champion of the reformist voice of the party, or that a compromise candidate such as Zweli Mkhize is elected.
Of the four potential outcomes at December’s ANC elective conference, the least likely is the election of Zuma’s chosen successor, yet this is the outcome currently being discounted in equity markets.
• A positive outcome to the upcoming credit rating decision in November and ANC elective conference in December will have a substantially beneficial impact on the rand and South African equities.
In this scenario, domestically focused cyclical stocks will strongly outperform rand hedge counters. The caveat is that the favourable global outlook for emerging market equities remains intact.
For the full report, including a look at international markets, click here.
* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
SUBSCRIBE FOR FREE UPDATE: Get Fin24's top morning business news and opinions in your inbox.