MARKET & ECONOMIC UPDATE, FEBRUARY 2016
LOCAL MARKETS

The JSE All Share Index regained 3% the last week of January 2016, and closed on 49,141.94 – a spectacular recovery from what has been an eventful month for both local and global markets. Although it is not news that South Africa’s economy is underperforming significantly, there seems to be a general trend amongst most developing and emerging markets all struggling with the same issues—weak economies, sluggish growth, and volatile currencies. While SA is still reeling from the financial-minister blunder from December last year, South African consumers have now been hit with a 50 basis-points rate hike as well as seeing the devastating effects from the current drought.

The panic resulted in large capital outflows which knocked the rand 10% weaker to a record low against the US dollar, and raised the cost of government borrowing. Now, rumours are circulating that the government might have to go the IMF for a loan to tide it through a looming financial crises, although this remains under speculation.

At its first meeting of 2016, the monetary policy committee decided to hike rates 50 basis points to 6.75%. The decision was not unanimous whilst some members of the committee preferred a 25-basis point hike and another thought rates should be kept on hold. Most members of the MPC felt it necessary to increase rates because of the deterioration in the inflation outlook. The MPC is treading on a tightrope to contain inflation without driving the economy into a recession.

Turmoil in local markets erupted in December last year after President Jacob Zuma unexpectedly dismissed finance min-ister Nhlanhla Nene and appointed an inexperienced and unknown David van Rooyen. After a national outcry over the space of a weekend, the President quickly changed his decision and reinstated former Finance Minister Pravin Gordhan, but unfortunately the damage had already been done.

It seems that every year the exchange rate deteriorates even further, and economists believe this is due to the SARB’s interest rate policy not aligning with growth prospects. Over the past twenty years, more than 85% of the patterns of inflation have been connected to periodic crises in the exchange rate, and not due to an over-heating of the economy.

As the worst drought in over a hundred years continues to devastate crops it could be a contributing factor to tip the economy into recession. South Arica would likely harvest 7.44 million tons of maize in 2016, which is 25% less than the 9.94 million tons reaped last year. This would be the smallest crop since 2007 according to the Crop Estimates Committee.
The considerable downward risk from the impact of the drought, the bleak outlook of the mining sector, and the concern that monetary policy will put increasing pressure on domestic demand by raising interest rates in a low-growth environment, caused most economists to share the view that South Africa will likely slip into a recession during the course of the year.

“The extreme hawkish position that the SARB has adopted in pursuit of achieving financial stability is out of kilter with both global monetary policy, and with economic conditions in SA, contributing to the slowdown in economic growth, as well as depressed business and consumer confidence and rising private sector unemployment” Annabel Bishop, chief economist at Investec.

The rand reached record lows in December, bottoming at almost R18 to the US dollar over the festive season, which was unfortunate for South Africans travelling abroad during that time. The Economist’s Big Mac Index for 2016 shows how weak the rand has become – and how the currency theoretically remains one of the most ‘undervalued’ currencies in the world.

Mike Schüssler, chief economist at Economists.co.za says: “South Africa does not normally escape recession when commodity prices fall and we have to face the fact that other commodity-producing emerging markets like Brazil and Russia are in deep recession. We’re not going to have anything quite as severe as those two countries because we are a bit more diversified but we’ve had interest rate hikes in a low growth environment, so it’s difficult to see how we could avoid a recession.”

By making the most out of a dire situation, the JSE launched trading in beef carcass futures in December, which allows buyers and sellers in the industry to hedge their positions, and speculators to take a view on price movements in beef reared in SA. These futures contracts will allow beef producers to hedge against price falls by setting an effective price floor below which they will be paid out at contract expiry. In reverse the contracts can be used to protect food retailers who can use a long hedge to protect against sharp price spikes using the cash adjustments from settled contracts. This is helpful for industry players who seek stability in their financial planning for the year, especially in such uncertain times.

As the world’s largest platinum producer, South Africa has seen production of this metal tumble by almost 70% in the past eight years and based on the latest production figures, this trend is likely to continue. Platinum producers have been punished by a perfect storm of 2008’s global financial crises, a five-month industry strike which cost the industry R24-million in revenue, and a slowdown in demand from China, the biggest platinum consumer. Although global factors played a large role in the drop in production, platinum companies also made poor decisions that contributed to the decline of this industry, such as borrowing a great deal of money when the platinum price just seemed to be on the increase. The increase in the platinum price over the last week of January, up 4% in one week, might provide a small glimmer of hope for the troubled industry.

Over the last decade, the Listed Property sector in SA has enjoyed stellar returns, culminating in a frenzy of new listings in 2015. But due to a global sell-off of listed property, as well as fears that interest rates may rise up to 150 basis points over the course of the next 12 months, the sector has seen a drop of almost 14% since October last year. A possible credit rating downgrade on SA could also have an effect on the property sector, but not as negative as one would think. Property stocks are trading at reasonably good forward yields and according to some analysts, there is certainly a place for property REIT’s in an investor’s portfolio at this time. Our SA government R186 bond yield due in 10/11 years saw its yield fall sharply again, by 18 basis points since Friday morning to 9.19%.

Adding to all the economic concerns is the loss of investor faith in President Jacob Zuma, possibly stoking social and racial tensions ahead of local elections this year. The President will be delivering his State of the Nation Address on February 11.

Increasing water shortages as South Africa experiences the worst draught in decades are threatening the expansion of mines and factories in KwaZulu-Natal, affecting big industrial players such as Tongaat Hulett, Mondi, BHP Billiton, Foskor, Richards Bay Minerals, Tronox Fairbreeze mine, and others. Not only considered a precious commodity, water is now a growing cost for industries in the worst of the drought-stricken areas and will considerably add to the cost of production, becoming a major concern for both industrial and agricultural sectors.

In a bid to boost their economy and raise inflation, the Bank of Japan lowered interest rates into negative territory, discouraging banks from depositing with them. This led to strong gains in global stock markets for the last week of January, causing markets to end in positive territory on Friday despite its worst monthly start to the year since 2009. The S&P 500 Index rose 2.5% to settle at 1,940.24, while the Dow Jones Industrial Average Index advanced 2.5% to close at 16,466.30. The NASDAQ Index added 2.4% to finish at 4,613.95. Europe gained +2.2% and London’s FTSE 100 Index gained +2.6%.
The US 10-year yield is down 3 more basis points under 2% at 1.92%, the lowest in a while, after the Fed held off on raising rates, while Germany’s 10-year yield is down 8 basis points at 0.32%, also the lowest in a while.
A factor that worked in favour of global markets over the last week of January was mainly the rally in oil prices amid speculation that the Organisation of Petroleum Exporting Countries (OPEC) might convene an extraordinary meeting aimed at cutting production. Brent crude oil slid down to $26 a barrel in January before bouncing back to $34 a barrel over the last week. Although the drop in the oil price caused a bit of a wobble in world equities, some analysts have countered that lower oil prices are more beneficial for world economies and global growth prospects.

INTERNATIONAL MARKETS

Despite strong gains during the last week, world markets have still ended the month of January with sizable losses. China’s Shanghai Composite index leading the major indices as the “biggest loser” of the month with a 22% drop in dollar terms. The economic slowdown in China and emerging markets remain a concern for global markets.

In uncertain economic times such as these, with poor local market performance, a struggling South African economy and our rand free- falling from the sky, would it not be great for investors to have a capital guaranteed rand-hedged product to turn to? Investec Corporate and Institutional Banking (ICIB) has just launched an exciting new offering of shares in China Seas Basket Limited, where the principal investment amount is preserved. The tranche closes on the 3rd of March 2016, so if you are interested in this unique investment opportunity, please get in touch with your Brenthurst financial advisor without delay!