YOU CAN BREATHE OUT NOW
DAVE MOHR & IZAK ODENDAAL,OLD MUTUAL MULTI-MANAGERS
Some calm and stability have returned following the intense sell-off
of emerging market assets over the past few weeks. Perhaps the
10-year anniversary of the Lehman Brothers collapse reminded
investors what a real crisis looks like. In contrast, the recent troubles
of emerging markets are very manageable – although clearly tough
times lie ahead for Argentina and Turkey, in particular.
Argentina’s government needs to borrow dollars to manage its cash
flow needs (including rolling over maturing loans), even though its
currency has halved in the last eight months. Turkey’s dollar
denominated debt amounts to 70% of GDP (more than double
South Africa’s ratio). Both Argentina and Turkey have a long road
ahead in regaining the trust of investors, but they have taken steps.
Argentina’s central bank hiked rates to 60% with little impact a few
weeks ago, but Turkey’s central bank hiked by 6.25% to 24% on
Thursday, for once delivering more than what the market expected.
While Turkey’s President Erdogan has in the past pressured the
central bank to keep rates unsustainably low, this time round his
options for containing the crisis were limited: it was either hiking
rates, imposing capital controls or turning to the International
Monetary Fund. As a result of the central bank’s actions, the lira
rallied and with it other emerging market currencies including the
Also removing pressure on emerging markets was softer-than-expected
US inflation numbers. Core consumer inflation was 2.2% in August
against 2.4% expected. While this doesn’t change the outlook of
further gradual interest rate increases by the US Federal Reserve,
it does reduce the risk of aggressive rate increases in the near term.
Meanwhile, the European Central Bank confirmed that it was
sticking to its plans to steadily remove stimulus. It will cut its bond
buying programme from €30 billion per month to €15 billion in
October. It plans to stop completely after December, and then start
the long journey of raising interest rates to more normal levels
around the middle of next year.
The rand appreciated below R15 to the dollar last week. This
provides some breathing room for the Reserve Bank’s monetary
policy committee (MPC) meeting this week. The slightly firmer
currency buys it time to assess how the growth and inflation outlook
evolves, without being forced into emergency rate hikes, as in early
2014 at the height of the “Fragile Five” sell-off.
CREDIBILITY IS NOT FREE
Credibility is not cheap, but it is immensely valuable. The SARB
bought its credibility by maintaining high real interest rates over
time. Given the weak economy and subdued inflation, the real
repo rate is probably too high. But at least it’s not 24%, and the
risk of a 6% jump in one go is limited. The SARB might need to
tweak rates higher, but it doesn’t have to take out a sledgehammer.
South Africa’s biggest challenge is the lack of local economic
growth, not its dollar liabilities or balance of payments constraint.
The dollar liabilities are under control and the free-floating rand
takes care of the latter. But the lack of growth places huge pressure
on government’s finances (both by reducing tax revenue growth
and increasing social spending demands) and increases the risk
of a further credit ratings downgrade. Encouragingly, a Moody’s
analyst noted at a conference last week that they did not expect
a ratings change in the next eight months, and believe the worst
is behind as far as the economic slowdown is concerned. They
also expect a broad-based recovery, supported by strong global
We agree with this view. However, the recent signposts of such a
recovery are still mixed. Business confidence declined in the third
quarter, unsurprisingly given the emerging market turmoil, the lack
of domestic demand and continued policy uncertainty, especially
around land reform. The RMB/BER Business Confidence Index fell
to 39 index points, and remains well into net negative territory.
The BER surveyed 1 700 businesses across five sectors – retail,
wholesale, new vehicle sales, construction and manufacturing – in
August and September. Each of these sectors, chosen because of
their value as cyclical indicators, was negative in the third quarter.
Stats SA released three early data points on third quarter activity.
Manufacturing production was surprisingly strong in July, rising
2.9% from a year ago. Mining production, on the other hand, was
surprisingly weak with a 5% year-on-year decline. Both sectors
have been volatile from month to month and this has contributed
to volatile quarterly economic growth numbers. However, neither
sector has a discernible positive longer-term trend. Manufacturing
output has essentially flat-lined since 2014, and mining output
since 2010. Within each sector there are growth areas such as
food production and chromium mining, but not enough to make a
big difference overall. Gold mining continues to be on a long-term
Retail sales growth was positive in real terms. Spending at retailers
rose 1.3% in July from a year ago in real terms, reflecting very low
volume growth. Adding back inflation, spending growth was 3.3%.
This illustrates how low inflation is at retail level. Some of this is
probably still the lagged impact of a stronger rand up to the first
quarter, and some of this low global goods inflation. But the tough
competitive environment also means that there is a clear reluctance
to raise prices for fear of losing market share. This is likely to dampen
the impact on overall inflation of the rand’s weakness from April
In other words, what is good for consumers is bad for retailers’
margins. And of course the weakness in retail sales extends beyond
the large retailers themselves, most of whom are listed on the JSE.
Food producers, for instance, are also battling not just with growing
the value of sales (pricing power), but also volumes. Similarly, the
SA listed property sector also faces the squeeze from retail spending.
The JSE All Property Index is around half locally and half globally
exposed. Of the local component, around 60% is retail which
faces not only weak consumer demand, but also pressure on the
supply side with the rapid growth in shopping mall space in recent
years. Having said that, the foreign component of the ALPI, heavily
skewed to British retail, is not faring much better. The London
(sterling) prices of the dual-listed Intu is down 40% year-to-date,
Hammerson 15% and Capital & Counties 22%.The UK economy
also suffers from policy uncertainty ahead of its exit from the European
Union and low growth.
LITTLE CHEER, BUT DON’T FEAR
In fact, the JSE had little cheer recently, apart from some of the
resource companies. The domestically-focused companies are
unsurprisingly struggling in the tough local economy. The most
disappointing area has been the big industrial rand hedges where
company-specific issues have overwhelmed the impact of a weaker
rand. Naspers for instance has been held back by the 20% yearto-date
decline in the Tencent share price, while British American
Tobacco’s London share price is down 27% in pounds. Aspen is
down 32% in 2018. And of course MTN had its run-ins with
Nigerian authorities. These four shares alone account for 18% of
the JSE Capped Swix Index and 25% of the JSE All Share Index.
The flip-side of the underperformance of local equities is that
valuations have improved and along with them, prospective returns.
We’ve had a long period of disappointing returns from the JSE
and this is still the main asset class in most portfolios. Investors are
understandably worried. But remember that waiting for the market
to recover before investing invariably means missing out. The best
thing to do in tough, volatile and uncertain times is not to chop
and change your portfolio, but to stick to your investment strategy.
September 18, 2018
The Wealth Room