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A cause for pause: Economic and asset return outlook

Global growth intact, but Trump bump starting to fade.
US President Donald Trump

Economic outlook

Global GDP is improving, but upward revisions are slowing. The IMF has estimated growth for 2017 at 3.4% and market consensus growth for 2017 at 3.3%. The very poor macroeconomic conditions experienced by all commodity-exporting countries are expected to continue to improve gradually. The US is still set to drive overall growth in developed markets.

The post-Trump election euphoria is dissipating, however. While growth is still improving, there have been signs that the growth rate may start decelerating. Coupled with this, there are also signs that inflation expectations are also moderating, after having risen significantly since 2016. All of this seems to suggest that the US Federal Reserve may be a little less aggressive in their rate hikes. While rate hikes will still occur, they may be a bit more spaced out than anticipated a few months ago.

Global uncertainty is still unfortunately the new normal. Some studies suggest that uncertainty is currently as high as what we have seen since 1997. This uncertainty is centered around Trump (uncertainty around implementation of policies and/or truly maverick actions) and Europe after Brexit. Luckily the recent election results, especially the French election, has allayed fears of a Euro zone disintegration. This recovery in global growth may already be reflected in asset prices.

There are signs that the growth rate in the Chinese economy is slowing, specifically industrial activity. While not of immediate concern, the overall Chinese growth rate will most likely continue to slow over the next few years, as well as continuing the swing away from fixed investment towards consumerism. The Chinese housing market is clearly slowing, with negative growth and a slowdown in sales and prices. We are not, however, concerned about a collapse in China. The government has ample reserves to stimulate growth if necessary.

Emerging markets, on the back of rising commodity prices and very attractive real yields, continue to attract inflows. While commodity prices have retraced a little so far this year, after the re-stocking 2016 rally, appear to have stabilised at current levels.

Domestic situation

Cabinet reshuffle and junk status jitters have clearly dominated recently. However, even given the self-inflicted decline in 2017’s growth rate, we are still going to have a slightly better year than 2016. Last year was so disastrous! Domestic political news will still continue, but seems to be coming to a head and (whatever the outcome) we will know at latest by the end of the year the leadership issues. Damage has been done by the cabinet reshuffle to fixed investment and consumer expenditure and it is likely that we will over the medium term, pay more in tax than already announced. If the government is to keep to their fiscal targets, this seems inevitable.

There is good news:

  • Agricultural output will rebound strongly after the drought;
  • Inflation is set to fall, primarily due to the stronger rand and agricultural price moderation;
  • The current account had improved dramatically, mainly because the economy is so weak that we are importing less.

South Africa and junk status

There are three rating agencies:

  • S&P – the most important agency of them all. It rates foreign (non-rand) and domestic (rand) debt separately. Only foreign debt is junk.
  • Moody’s has one overall rating. It is still two notches above junk. It is very soon going to announce its decision and will most likely downgrade one notch only. We will still be investment grade.
  • Because most foreign investors follow either S&P or Moody’s, Fitch’s rating is less important. Fitch also (like Moody’s) only has one overall rating. It has already downgraded SA to junk.

Simplistically then, we are currently 20% of the way to full junk status. If Moody’s drops us one notch, SA will move to 30%. It is likely that after the Moody’s decision, we will (barring any further political induced instability) remain at this level for a while still. It does not seem imminent that SA will go to full junk status for a while. There is still some breathing space!

Read: Will Moody’s junk SA?

The ANC-led government must take a large percentage of the blame for the downgrades. It would, however, be incorrect to heap all the blame on the government. Commodity producers have had a very rough time from 2011 to end 2015, on the back of a precipitous fall in commodity prices. The 2016 rally in commodity prices has given some respite, but many commodity exporters were downgraded to full junk status.

Growth for 2017 is estimated to be around 0.7% (about 0.4% lower than estimates before the downgrades).

The rand has held up remarkably well post the March 31 announcement. This is because of the improving position that commodity exporters find themselves. We should not, however, underestimate the negative effects that politics has had. On a relative basis, in comparison to other exporters, South African bond spreads are as high as when Nhlanhla Nene was fired. Banking shares are also in a similar relative valuation position, when measuring dividend yields. Therefore, if we did not have the reshuffle, we would have clearly been in a much better position. SA is a boat with a hole in it, but in a strongly rising tide!

Asset return expectations

We estimate that returns will be in the single digit range over the next 12 months for the major asset classes, with domestic equities slightly higher than the other asset classes.

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