MISSILES, HURRICANES AND OTHER DISTRACTING HEADLINES
DAVE MOHR & IZAK ODENDAAL,OLD MUTUAL MULTI-MANAGERS 2
Hurricane Harvey slammed into Houston dumping an unimaginable
amount of water on the Texan city. Apart from the unfolding human
tragedy, the hurricane is expected to have a devastating impact on
the region’s economy. The Houston metropolitan area is the fourth
largest in the US, and its massive economy is even larger than South
Africa’s. It is at the heart of the American oil and gas industry, and
almost half the refining capacity in the US is located on the Gulf Coast.
The city is also a key port for exports of other commodities, such as
cotton and wheat.
Early estimates of the cost are in the region of $50 billion and likely
to exceed that of most previous natural disasters. Rebuilding efforts
after the flood will at least lead to a bump in spending and activity,
but both the destruction and reconstruction impact needs to be seen
in the context of a US economy that generates $18 trillion in output a
year. There is no reason to believe that Hurricane Harvey will have a
longer-term influence on overall US economic growth, which has been
chugging along at around 2% per year. While this is one of the longest
expansions on record at 32 quarters, it is also one of the slowest.
There is no obvious sign of overheating anywhere, with inflation low
(too low actually at 1.4%), wage growth steady at 2.5% and borrowing
activity subdued. Interest rates should therefore remain benign – even
as the debate rages as to whether the Federal Reserve will hike twice
or three times this year – and the expansion can be sustained for longer.
In contrast, when Hurricane Katrina (still the most costly natural disaster
in US history) hit in August 2005, the US housing market was close to
peaking after a multi-year boom. The subsequent decline in house
prices bankrupted hundreds of thousands of over-borrowed households,
while the collapse in homebuilding activity cost almost two million jobs.
But even more devastating was the entire industry of financial products
built upon US mortgages, sliced and diced, repackaged and stuffed
into portfolios worldwide. By 2007, these products and their derivatives
had turned toxic and threatened to take down large parts of the global
financial system. The economic toll was many times greater and more
widespread than any natural disaster.
STORMS OF A DIFFERENT KIND IN WASHINGTON
Meanwhile, President Trump has revived three of his favourite positions,
two of which would likely have negative consequences for markets.
Firstly, the White House is making a renewed push for tax reform. This
should be positive for company profits, but investors are no longer as
enthusiastic about the prospect for speedy implementation. Secondly,
he has threatened to veto the spending bill that Congress needs to
pass before the end of the month, unless it contains funding for a wall
on the Mexican border. A veto would shut down the Federal government
and complicate negotiations around raising the debt ceiling. Thirdly,
he has revived a push for import tariffs to protect American industry
which, in a worst-case scenario, could lead to a trade war.
NORTH KOREA’S SABRE RATTLING
Even worse than a trade war is an actual war. North Korea, seemingly
worried that the world had forgotten about it amid the flooding in Texas
and the latest White House controversies, fired a missile that flew over
Japan and crashed into the Northern Pacific. Over the weekend it also
tested a nuclear bomb. This rattled markets and sent safe-haven assets
– the yen, gold and US Treasuries – higher. The US dollar, however,
continues to weaken. The euro rose above $1.20 for the first time
since early 2015. The strength of the euro has been the notable surprise
of the year, given that many forecasts at the start of 2017 saw it
heading in the other direction towards parity with the dollar. Instead,
the euro has appreciated against the dollar by 13% since January. The
main reason is that the European economy has picked up speed after
years in the doldrums. But even here inflation and borrowing remains
low. Meanwhile, European Central Bank President Mario Draghi’s
comments at the recent Jackson Hole summit of central bankers were
not seen to be sufficiently dovish to talk down the euro. The market
clearly thinks that the ECB will pare back stimulus earlier than previously
expected, while the US hiking cycle will be more gradual than expected.
Both Draghi and Fed Chair Yellen, focused their Jackson Hole speeches
on the importance of financial regulation rather than on monetary policy
matters – precisely to prevent the sort of reckless lending that fuelled
the financial crisis. While united on this matter, the move in the euro/
dollar exchange rate creates a headache for Draghi, as it will suppress
inflation while it will be cautiously welcomed by Yellen.
SOFT DOLLAR IMPROVES LOCAL INTEREST RATE OUTLOOK
The softer dollar and firmer gold and platinum prices have seen the
rand head back towards R13 per dollar. Since most of our imports are
typically priced in dollars (especially oil and petroleum), it contains
imported inflation (while a weaker rand against the euro should help
exports to Europe and tourism from Europe). This should give our own
central bank comfort that they can continue cutting interest rates.
Producer inflation declined to 3.6% in July, while the economy posted
another trade surplus in July, and the R36 billion surplus for the first
seven months of the year, compared to a R4.7 billion deficit for the
same period last year. This should help contain the current account
deficit, one of the risk factors for the exchange rate. The economy
certainly needs lower interest rates. Total bank lending growth slowed
sharply to 5.3% in July, while it was growing by almost 9% at the start
of the year.
PATIENCE PAYING OFF FOR LOCAL INVESTORS
Largely shrugging off the developments in the US and North Korea,
local markets had another solid month in August. The local market also
outperformed global markets in the month: while the S&P 500 lost 1%
in August, the FTSE/JSE All Share Index returned 2.6% in rand and
more than 3% in US dollars.
Resources led the charge on the JSE, unsurprisingly, given gains in
precious metals prices. The gold and platinum mining indices returned
around 9% but the diversified heavyweights, Anglo American, Glencore
and BHP Billiton, also performed well.
Financials returned 2% in August, with banks gaining 4% amid a rosier
interest rate outlook. The big rand-hedge industrials were mixed in
August. Richemont gained 3% and Naspers 1%, but British American
Tobacco lost 1%, while Steinhoff, hit by fraud allegations, lost 4%.
Local bonds also had a good month, with the ALBI returning 1%. Listed
property was basically flat in August and cash returned 0.5%.
With eight months of the year now over, 2017 returns are certainly
much better than last year’s. Declining inflation means real returns are
increasing. Local equity returns are in double digits, bonds and property
are ahead of cash and global equity returns exceed the extent of rand
appreciation (i.e. positive for local investors). This is despite all the
political uncertainty, conflict and negative headlines both at home and
abroad, showing once again that it pays to keep a cool head when
September 5, 2017
The Wealth Room