Rough start to September after August turmoil
August was the worst month for global markets since May 2012. It spilled over into the first few days of September as people are returning to work after a long summer holiday in the Northern Hemisphere. However, the closure of Chinese markets to celebrate the 70th anniversary of the end of World War II meant investors elsewhere temporarily had one less thing to worry about.
Global equities down sharply in August
The benchmark US S&P 500 Index lost 6% in August, wiping out the gains for the year and had a return of only 5% over the 12 months to the end of August. European equities also slumped. Germany’s DAX lost 9.3%, while the CAC 40 was down 8.2% and the Eurostoxx 600 8.2% in euros.
Eurozone shares gave back a lot of the gains seen in the first half of the year. Year-to-date returns on the Eurostoxx 600 index were 8.7% at the end of August.Japanese equities also suffered heavy losses in August, with the Nikkei 225 losing 8.2% in yen. The Nikkei is still up 9.2% year-to-date. The MSCI World Index lost 6.6% in August, reducing year-to-date returns to -2.1% and one-year returns to -3.6%.
Emerging Markets were the hardest hit by the sell-off. The MSCI Emerging Markets Index lost 9% in US dollar terms in August. China, Brazil, India and Turkey saw declines, with currency depreciation worsening dollar losses. The MSCI Emerging Markets Index has lost 23% over 12 months lagging the Developed Market MSCI World Index by almost 20%.
China’s growth concerns linger
China’s growth concerns have not been alleviated. In particular, the numbers from China’s industrial sectors have been weak with manufacturing Purchasing Managers’ Indices (PMIs) falling to three-year lows. However, the services PMI was still above 50 in August and keeps on expanding. Services account for half of China’s economy, a significant percentage but lower than those of more developed economies.
A growing service sector is far less commodity and trade-intensive than the stagnating manufacturing and construction sectors. This is bad news for commodity producers (like South Africa and Brazil) and East Asian exporters’ reliant on Chinese demand over the years.
The oil price suffered massive declines in August, only to recover in spectacular fashion. Brent crude fell from US$52 per barrel at the start of the month to US$42 per barrel, before recovering to US$49 per barrel in the last three trading days of the month. The largest three-day jump in the oil price since the Kuwait invasion of 1990 was driven by lower output estimates from the US Government and speculation that the Organisation of the Petroleum Exporting Countries (OPEC) members are considering cutting production.
The volatility in the oil market also spilled over into the first days of September. Fundamentally, the swings still appear to be driven by changing views on supply rather than demand dynamics. In this sense, oil is different from other commodities such as copper and iron ore where Chinese demand is the big driver (compounded by robust supply growth).
If this view is true, lower oil is a boost to the world’s consumers, although consumers have been slow to spend their gains. Producers have taken the pain fairly immediately, cutting capital expansion plans and laying off workers.
Local equities followed global markets lower
The local equity market followed global markets sharply lower during the month, but was shielded to an extent by a weaker rand. The FTSE/JSE All Share lost 3.5% in August, dragging year-to-date returns down to 2.4% and 12-month returns to only 1.1%. In US dollar terms, local equities were down -7.4% in August (MSCI South Africa Index), outperforming the MSCI Emerging Markets index. The local market has lost 12% in US dollar terms over the past four years, while it has gained 64% in rand terms.
The JSE generally benefits from a weaker rand as more than half the earnings generated by JSE-listed firms come from abroad. Rising share prices over the past few years support consumer confidence among middle- and upper- income households.
This is another example of how the rand acts as a shock absorber (but there are obviously negative impacts from a sharply weaker currency too). The weak rand also somewhat offset the impact of falling global share prices on the offshore portion of multi-asset class funds.
The All Bond Index posted a positive return of 0.14% in August, but the very long end of the curve suffered a small loss. The yield on the benchmark R186 Government Bond yield rose from 8.25% to 8.35% during the month, but moved as high as 8.5% when the global sell-off was at its peak. Year-to-date, the All Bond Index (ALBI) returned 2.8% while the twelve-month return of 5.4% is slightly behind cash (6.3%).
Listed property held up well in August while equities were tumbling, returning 0.2%. It remains the stand-out asset class year-to-date and over a one-year period with returns of 12.3% and 27.5% respectively. Positive returns from bonds and property during the turbulent month of August once again highlight the value of a diversified portfolio.
Chart 1: Asset class performance over 12 months in rand, rebased to 100
Export growth the only good news
We already know that the economy contracted in real terms the second quarter. This will make it very difficult to hit the South African Reserve Bank’s (SARB’s) target of 2% growth this year (the 5% growth target of the National Development Plan appears light years away).
More recent data gives an idea of how the third quarter is progressing. According to statistics from the SARB, total loans and advances to the private sector grew by 7.2% year-on-year in July, up from 7% in June. Corporate borrowing remains the driver of the headline credit growth, but slowed substantially in recent months. Household credit growth firmed moderately in July, rising to 3.6% year-on-year from 3.5% in June.
However, household credit growth remains very slow overall compared to the pre-2008 property boom and the 2012 and 2013 unsecured lending boom. Since households and companies borrow to spend, credit numbers tell us something about overall demand in the economy (although they also reflect the willingness of the banks to lend). Total credit growth has been stuck in a 7% - 9% growth range for the past two years. This is more or less in line with nominal economic growth (real growth with inflation added back).
Decent export growth despite lower commodity prices
The only bit of good news locally is that export values are growing, despite falling commodity prices. Export values grew by 10.3% year-on-year in July, while import values grew by 2.6%. The trade balance - the difference between exports and imports (including trade with Botswana, Lesotho, Namibia and Swaziland) – moved to a small R397 million deficit in July, from June’s large R5 billion surplus.
On a cumulative basis (i.e. January to July), the trade deficit declined to R25 billion compared to the R53 billion shortfall in the corresponding period last year. The sharp fall in the oil price over this period has helped to close the deficit. Vehicle exports are a particular area of optimism. According to data from Naamsa, South Africa now exports in the region of 30 000 new units a month, compared to local new vehicle sales of around 55 000 (the latter is unfortunately declining, indicating how consumers are cutting back on big-ticket items).
Volkswagen recently announced a R4.5 billion investment in its Uitenhage factory to expand its export capability. Although the motor industry receives considerable tax incentives and subsidies from the state, it at least demonstrates that local manufacturing has something to offer the rest of the world on a longer-term view.
In the short term, however, the prospects for local manufacturing do not look good. The Barclays/ PMI declined by 2.5 index points to 48.9 in August, indicating a continued contraction in manufacturing production. The JP Morgan Global Manufacturing PMI was weaker in August, but still in positive territory at 50.7. South Africa’s manufacturing sector is lagging the rest of the world, because of load-shedding.
The weak rand will lift revenues for export firms and provide some protection for those firms competing with imports such as the local steel industry who have successfully lobbied Government for a 10% import tariff (although the tariffs come too late for ArcelorMittal’s Vereeniging plant that faces closure). However, the weak rand inflates import costs needed in the production process.
How does the SARB react to all this?
The next Monetary Policy Committee (MPC) meeting will take place in two weeks’ time, a week after the announcement of the US interest rate decision. Monetary policy remains delicately balanced. The SARB has been right in its longstanding concern about currency weakness, as further declines in the rand (10% against the dollar quarter-to-date) have shown. It is too early to tell if this will feed through into higher inflation, but the risk is that inflation expectations will become unhinged as a result.
There are also other upside risks to inflation, especially from food prices, but the decline in the oil price brings some relief. In rand terms, the oil price is substantially lower than a year ago, but unfortunately the September average rand oil price is higher than last month’s average, which can lead to a petrol price hike in October. Meanwhile, the falling core inflation rate suggests inflation has been kept in check by the weak economy.
There is also no reason to fear that a credit-driven rise in spending could push up inflation. The growth outlook has deteriorated significantly as commodity prices have fallen further. Juggling all these balls will be challenging for the SARB.
Chart 2: South African imports and exports (Rand million, seasonally-adjusted and smoothed)
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