August 2022 Update
Global News
US CPI rate decelerated to 8.5% y-o-y in July, below expectations of 8.7%. Markets responded well to the deceleration but gave back returns after Jerome Powell’s hawkish tone at the Jackson Hole Symposium suggested that rates could remain higher for longer. Federal Reserve Officials once again emphasised their commitment to bring inflation back to its 2% target. The minutes suggested that monetary policy would remain on a tightening path for some time, however they know there would be a pause on further tightening to assess its impact on the economy.
In the UK, annual consumer inflation accelerated to a four-decade high of 10.1% in July, from 9.4% in June. Surging food prices (12.7% y-o-y in July vs 9.8% in June) continue to intensify the country’s cost-of-living crisis while European gas prices continued to surge higher. UK estimates showed that the economy contracted by 0.1% in 2022Q2. The fall in quarterly GDP stresses the risks to growth from the cost-of-living crisis that the UK economy is facing (discussed in detail in the outlook section).
Local News
The SA Consumer Price Index reached another 13-year high of 7.8% y-o-y in July. Transport was the biggest driver, surging by 25% y-o-y largely due to a 53% rise in fuel prices.
The seasonally adjusted Absa PMI plunged into negative territory in July as rolling power cuts and weak demand hurt output however the S&P Global SA PMI was positive about business conditions in SA’s private sector. The headline index rose to a 14-month high of 52.7.
Manufacturing and mining sector production both decreased by 3.5% and 8.0% y-o-y in June respectively. The major contributors were the flooding in the first quarter of this year, continuous loadshedding and strikes in the gold mining sector.
Market Commentary
Following the relief rally of July, investors experienced a volatile month in August. Throughout the month, global indices performed well however the hawkish comments by the Fed in the final week of August caused markets to react negatively, and therefore a sell off occurred reversing all the month’s earlier gains.
The MSCI World Index returned -2.0% in ZAR, with most global indices tracking lower as well. The overall FTSE/JSE ALSI returned -1.8% for the month in ZAR while the MSCI EM index bucked the trend and delivered investors a return of +2.7% due to markets such as MSCI EM Latin America (+5.1%) & MSCI China (+2.7%) yielding positive returns. Brazil (i.e., Latin America) benefitted from the fact that oil prices are still up over 30% over the past year and Chinese stocks were encouraged by the start of an accounting audit by US regulators on Chinese US listed stocks.
SA bonds experienced a month of two halves – initially rallying into the middle of the month on stronger global risk appetite, and then following developed market yields higher into month end. Overall, the SA yield curve shifted slightly higher in August with the shorter dated R186 bond rising 5bps, and the longer dated R2048 7.5bps. Overall, the FTSE/JSE All Bond Index returned +0.3% for August while globally, the Barclays Global Aggregate lost -1.7% in Rand terms.
Impact on CWM Model ZAR Portfolios
Impact on CWM Global USD Portfolios
A key performance driver across models in August was an overweight position to Small Cap stocks. During the month, the JSE Small Cap Index was up +0.9% (JSE Top 40 and Mid-Cap Indices down -2.1% and -0.9%, respectively) and the MSCI ACWI Small Cap Index down -0.3% (MSCI ACWI Large Cap down -1.6%). Within the local models, exposure to the asset class is largely attributable to the PSG range of funds, with the PSG Balanced fund allocating up to 50% of its equities to small caps. On the global side, exposure was obtained through the Orbis Global Balanced and Orbis Global Equity funds.
Another tailwind to the models was an overweight to Emerging Asia equities. The region spans China (+2.5%) as well as the ASEAN countries (e.g. Indonesia, Philippines, Thailand) – the latter outperforming other regional indices strongly (+5.2%). On the local front, Foord’s range of funds (including Nedgroup Stable) afforded the highest Emerging Asia equity exposure and were the top-performing constituents in the CWM Balanced and CWM Flexible models. On the global side, the Coronation Global Emerging Markets and iShares EM Index funds allocated 29% and 52% to the region, respectively.
A notable detractor across the models was Listed Property – especially where there were overweight’s compared to peers (e.g. CWM Retirement Growth, CWM RI-Defensive, CWM Global Defensive). The asset class struggled both locally (-5.9%) and globally (-3.8%). Despite demanding conditions, our property managers held up well: both Sesfikile Capital and Reitway Global outperformed peers, with the latter fund achieving a top 15 percentile return (-2.5%).
As always, the most important number to keep an eye on in the tables above, is the “since inception” figure. Our models’ excess returns remain in positive territory over the long-term. The compounding effect over time is significant. In November, we will be hitting a 10-year track record for the CWM Income, Defensive Balanced, and Retirement Growth models.
Global Outlook
- The extraordinary surge in gas prices & climate change causing droughts in Europe and China
The price of natural gas (graph on the left below) has risen to unprecedented levels [Europe (up 6x), UK (up 5x) and the US (up 3x)]. Even with the relatively lower move in the US, which is accounted for by their high level of domestic gas production, the rise in prices has pushed one in six households into arrears on their utility bills.
The graph on the right above shows the amount of disposable income that will be eaten away by energy price increases in European countries. The blue arrow pointing towards the UK shows the significant problem facing the country given that poorer households will experience a disproportionate increase in their cost of living (eroding roughly 15% of their disposal income). It creates a real urgency for the UK government to introduce a large package that will support poorer households.
Furthermore, around 47% of European countries were under some form of drought warning in August. Types of drought warning include rainfall deficits, soil moisture deficits and wider overall alerts. This is a global phenomenon as the same types of droughts are being experienced in China’s Yangtze River, the longest river in Asia and third longest river in the world.
These effects are inflationary in nature and therefore CPI is expected to reach double digits in the foreseeable future. The Bank of England predicts inflation to peak at 13% y-o-y in 2022Q4 while CitiBank sees annual UK inflation breaching 18% in early 2023.
2. China’s weak demand, power shortages and property stress
Chinese activity data for July, released in August, came out weaker than expected as sporadic lockdowns and issues in the property sector weighed on demand. Industrial production rose by 3.8% y-o-y (marginally faster than June, but below consensus of 4.3%), while retail sales and fixed asset investment growth slowed relative to June. To boost growth, the Peoples Bank of China (PBoC) cut the interest rate on key lending facilities for a second time this year.
In addition, support from the government has been in the form of tax refunds ($21bn) and deferred social security payments ($48bn). Other stimulus packages by the Chinese government will be an infrastructure spend of $45bn towards railway construction (funded by bonds) as well as an open pledge to support overseas listings of Chinese companies. On the supply chain front, the government has pledged to allow freight to move freely and to issue $30bn of bonds to support airlines.
Expansionary tools such as these could be quite significant for world growth in the months ahead.
Local Outlook
- South Africa’s growth trajectory:
The environment in South Africa has improved and the country’s growth path has shifted from a downward to expected growth now heading towards 2.5% annual average GDP over the medium term (from only 1% p.a. over the five years to 2019).
For economic growth to reach strong levels last seen prior to the global financial crisis in 2008, South Africa needs sustained stronger confidence on the business, consumer, and political front. Based on estimates from Johann Els (a senior economist at Old Mutual), there is a high probability that Cyril Ramaphosa remains in office after the 2022 elective conference in December.
This would allow economic reforms to gain further ground, even if implementation is slow. Additionally, more emphasis will be placed on the private sector’s role in the economy. The private sector employs around three quarters of South Africa’s workers and accounts for over two-thirds of investment and research & development expenditure. A key example of allowing privatization in the economy is the energy reform where the government raised the limit of private power generation to 100MW. These types of reforms are necessary to continue to lift growth towards 3% and upwards on a sustained basis.
2. Will the global slowdown affect South Africa badly?
The short answer to this is no (or not as severely) given that the country is in a much better position than at previous times when a similar set of global circumstances were at play.
SA’s inflation is less severe than global counterparts, the current account is in a surplus and there is likely growth momentum lift expected from China. While local rates are expected to rise another 75 basis points by year end (which will bring the repo rate to 6.25%), it will still not exceed the pre-Covid level of February 2020 and is expected to be the end of the upcycle.
Furthermore, SA’s growth outlook, for this year and the medium term, should also be supportive for the Rand (much of what we’ve seen so far in Q3 is a function of the strong US dollar, as opposed to domestic weakness). The graph below shows how significantly undervalued the currency was in August relative to the US dollar. Over the long-term, this is expected to return to fair value levels of roughly R15 but with factors such as recession fears and the war in Ukraine, it is uncertain as to where the local unit will trade by year end.
Conclusion
- It is increasingly apparent that the UK is in for difficult times, especially poorer households,
- Higher oil & gas prices, coupled with higher rates, could see the Eurozone enter a recession shortly,
- China’s growth outlook is less optimistic but help from the government and central bank is expected to support the economy and buoy other EM markets,
- South Africa has far improved from the years of the Zuma administration and the medium-term growth outlook is positive.
