SA economy in bad shape, NDP 'all but forgotten'

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Cape Town - Rigid labour laws continue to exacerbate the economy’s high inflationary expectations and steady loss in competitiveness, Overberg Asset Management said in its weekly overview of the SA economic landscape.

"The National Development Plan has been all but forgotten meriting scant mention in the government’s recent policy reviews," OAM said.

"Unfortunately the government seems more preoccupied with protecting jobs (and votes) than creating jobs," according to OAM.

"Instead of focussing on pro-growth reforms and stimulating job creation, government’s focus will tend towards pacifying unions and caving-in to high wage demands.

"The net result is stagflation characterised by economic contraction and worsening unemployment amid accelerating inflation and rising interest rates," OAM said. 

South Africa economic review

• GDP contracted in the second quarter (Q2) by -1.3% quarter-on-quarter annualised in stark contrast to the 0.8% consensus forecast expansion and the 1.3% expansion in Q1. The weakness was broad-based: manufacturing contracted -6.3%, mining by -6.8%, agriculture by -17.4%, and electricity and gas by -2.9%.

Even the wholesale, retail, and motor trade, catering and accommodation category contracted by -0.4%. The GDP slowdown reflects the combined effect of electricity outages, the drought and weak consumer confidence. It is becoming increasingly unlikely that GDP growth for the full year will meet the 2% forecast from the Treasury and SA Reserve Bank (Sarb).

The data will put the Sarb in a difficult position at its next policy meeting. While a 25 basis point increase is expected in November due to the rand’s rapid depreciation and growing inflationary pressure the central bank may be persuaded by the weak GDP data to postpone the rate hike.

• Producer price inflation (PPI) unexpectedly declined in July for a second straight month falling from 3.7% year-on-year in June to 3.3% substantially below the 3.8% consensus forecast. The decline is attributed to a fall in the food, beverages and tobacco component from 6.1% to 5.4% in spite of the severe drought.

Excluding food, PPI inflation fell from 2.2% to 1.9% due largely to the decline in oil prices. The PPI data signals lower pressure on consumer price inflation than previously forecast, which together with the weak GDP numbers may prompt the SA Reserve Bank (Sarb) to postpone its anticipated November interest rate hike. The Sarb monetary policy committee will meet on 23rd September and again in November.

• Following two months of surplus the trade balance registered a deficit of –R0.4bn in July although better than the –R1.6bn consensus forecast. Export growth was boosted by a 16.1% month-on-month increase in mineral product exports and a 17.3% increase in base metals exports which is surprising given the slowdown in demand from China.

Meanwhile imports of mineral products increased 12.7% on the month due mainly to higher oil imports although recent weakness in crude prices should provide some relief in the months ahead. The cumulative trade deficit for the year to end July was –R25.23bn compared with –R53.37 billion in the same period last year signaling a reduction in the current account deficit. The SA Reserve Bank will release its second quarter balance of payments data on 15th September.

• Mining production grew in June by 4% year-on-year up from 2.7% in May. The biggest contributor was the platinum group metals (PGM) category with year-on-year growth of 84% due to the base effect of weak comparative numbers when the platinum strike was in full swing. PGM production contributed 8.8 percentage points.

The biggest detractors were the iron ore and coal categories. Unfortunately the outlook for mining production remains depressed. The PGM base effect will no longer have the same positive benefit on data in the next month or so. Mining production will be impacted by electricity supply constraints at the same time that slack in global demand for mineral resources adds further pressure on prices.

• Growth in broad money supply (M3) unexpectedly accelerated from 8.8% in June to 10.3% in July the highest since March 2009 and well above the 8.7% consensus forecast. Private sector credit extension increased 1% month-on-month with year-on-year growth rising from 8.0% to 8.4% attributed to an 11.4% gain in loans to companies.

By contrast household credit growth remained weak at 3.6% on the year. Annual growth in mortgage advances picked-up slightly from 4.8% to 5%. The stronger than expected credit growth is unlikely to be sustained in the second half of the year due to weak consumer confidence, poor jobs growth, high household debt levels and debt servicing costs and tight lending standards. Meanwhile companies are unlikely to expand their balance sheets given the weakening economic outlook.

• Foreign investors bought a net R1.4bn worth of domestic bonds and sold –R1bn worth of equities in the past week. Surprisingly, despite last week’s volatile market conditions and sell-off in emerging market assets foreigners’ contribution to total market traded volume remained stable at 36.8% below the year-to-date average of 38.5%.

Foreign equity selling was concentrated in the property sector, while net buying was noted in other sectors in particular the financial and resources sector. For the year-to-date foreign net buying of bonds and equities amounts to R14.35bn and R33.66bn respectively.

South Africa political overview

• Following a request by Mogoeng Mogoeng Chief Justice of the Constitutional Court a meeting was held between senior members of the government and the judiciary to re-establish the executive’s commitment to the Constitution. The meeting was prompted by recent indications that government is disregarding the constitution’s rule of law in particular President al-Bashir’s departure from SA in spite of the court’s ruling that he should be prevented from leaving.

Delegates representing the government included President Zuma, Deputy President Ramaphosa, and minister of Human Settlements Lindiwe Sisulu, and notably excluded Gwede Mantashe and Blade Nzimande the more vociferous objectors to judicial powers. The government undertook to “protect and promote the Constitution.”

• Deputy President Cyril Ramaphosa who is leading a trade delegation in Japan said at a media briefing that the slowdown in demand from China is having a negative impact on SA’s domestic economy activity. However, Ramaphosa remained confident that China’s slowdown would be temporary. Ramaphosa who is widely expected to take over as leader of the ANC in 2017, said that SA would find solutions to its economic slowdown putting the country on a higher growth trajectory.

• The SA Local Government Association agreed with trade unions to a three-year wage deal for the country’s 270 000 municipal workers. The wage deal is similar to that agreed for public sector employees, comprising a 7% increase in year one and consumer price inflation +1% in years two and three. The wage deal also includes a 28.4% increase in the housing allowance.

Although the wage deal is inherently inflationary and will add further strain on the state budget deficit, there is relief that it removes the threat of strike action by the SA Municipal Workers Union (Samwu) for a full three years. Samwu has been one of the more aggressive Cosatu-affiliated public sector unions.

South Africa: The week ahead

• Barclays SA manufacturing purchasing managers’ index (PMI). Due Tuesday 1st September. July’s PMI was 51.4.

• Vehicle sales. New vehicle sales slumped 8.2% year-on-year to 51 055 units in August, figures released by the Department of Trade and Industry showed on Tuesday.

• Petrol price decrease. Due Wednesday 2nd September. All grades of petrol will decrease by 69 cents per litre. The fall in oil prices has outweighed the steep depreciation in the rand. The cut in the petrol price will be equivalent to a month-on-month decline of -5.3% which will impact positively on September’s consumer price inflation data.

• Standard Bank SA purchasing managers’ index (PMI). Due Thursday 3rd September. July’s PMI was 48.9.

• SA Chamber of Commerce & Industry (Sacci) business confidence index. Due Thursday 3rd September. July’s index was 87.9.

Technical analysis

• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. A break above the key “Fibonacci” level of R/$13.00 signals further depreciation in the rand to the R/$13.50 level.

• The US dollar index is testing a major 30-year resistance line, which if broken will pave the way for further strong gains in the currency.

• Despite the recent uptick in bond yields the long-term JPMorgan global bond index bull trend remains intact, with the yield targeting a new low during the fifth and final wave.

• The US 10-year Treasury yield has broken above key resistance levels of 2% and 2.2%. However, there is unlikely to be a major bear trend in US bonds as the deleveraging phase is still in its early stages.

• The benchmark R186 SA Gilt yield is testing support at 8.15% and needs to break below resistance at 7.90% in order to resume its bull trend.

• The MSCI World Equity index is in the 5th and final wave of a rising-wedge formation. A rising-wedge formation is a typical trend-ending signal. European equities are set to outperform US markets. The Nikkei exhibits the most bullish pattern.  

• Since the 1950s the Dow Jones and S&P 500 have displayed 7-year up-cycles and the top of the current US equity cycle can be expected in the next year. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur around June 2016.

• The S&P 500 has broken down from a rising wedge pattern, which is traditionally a trend-changing pattern. The break below the 2070 level confirms a reversal of the upward trend. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is leading the broader market lower on the downside.

Brent crude’s break below the key $50 support level suggests a continuation of the weakening long-term trend. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the key $5 300 support level suggesting further downside ahead.  

• Despite recent advances Gold is in a protracted bear market signalled by rapid declines through successive support levels at $1 300, $1 250 and $1 100. Gold’s next target is $1000 which is likely to be breached before the bear market ends.  

• The All Share index has lost most of its gains since the start of the year. The All Share Index is testing the key support line which has been in place since 2009. A break below 50 000 signals a sharp move lower to the October low of 47,000.

Bottom line

• It was a data shock: SA’s GDP unexpectedly contracted in the second quarter by -1.3% quarter-on-quarter annualised, far worse than the 0.8% consensus forecast expansion. The economy is in bad shape, GDP is contracting and unemployment is running at around 25% with youth unemployment close to 54%.

At the same time inflationary pressure is accelerating and interest rates are rising in spite of the impending recession. The rand has lost -20% of its value against the US dollar over the past twelve months.

• Much of the blame for the negative GDP figure is attributed to weak external markets, in particular China which is SA’s largest export market. However, there is also a reluctance by government to pursue growth-oriented policies. Unfortunately the government seems more preoccupied with protecting jobs (and votes) than creating jobs.

The National Development Plan has been all but forgotten meriting scant mention in the government’s recent policy reviews. Rigid labour laws continue to exacerbate the economy’s high inflationary expectations and steady loss in competitiveness.

• It is a vicious circle. Greater unemployment leads to more political dissatisfaction. As unemployment rises and the threat from the left of the political spectrum gathers pace the government is likely to rely increasingly on populist policy measures aimed at shoring-up political support.

Instead of focussing on pro-growth reforms and stimulating job creation, government’s focus will tend towards pacifying unions and caving-in to high wage demands. As a result the economic slowdown is likely to worsen.

• The net result is stagflation characterised by economic contraction and worsening unemployment amid accelerating inflation and rising interest rates. At the same time tax revenues will decline providing less funds for fiscal stimulus and infrastructural development.

• Policy populism will continue to pressure the value of the rand and dent the earnings growth potential of domestically focussed equities. Fortunately exchange controls have been gradually dismantled and there are many rand hedge equities listed on the JSE providing investors substantial choice for protecting their financial wealth.

Despite the -20% decline in the rand/dollar exchange rate over the past twelve months it is advisable that investors continue to emphasise overseas listed shares and rand hedge stocks in their portfolios.

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.

Disclaimer: 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.

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