Market review

South African currency, money and bond markets were mainly driven by a few global and local themes. Globally we had the continued US-China trade wars, interest rate normalisation in the US, higher oil prices and emerging market contagion originating mainly from Turkey and Argentina. Locally there were the continued risk of higher inflation, weak economic growth, budget pressures at the fiscus, expropriation of land without compensation and President Ramaphosa’s economic stimulus plan.

Seasonally adjusted annualised GDP for the second quarter of 2018 contracted by 0.7%, following the 2.6% decline in the first quarter. This means that SA is now in a technical recession. This was substantially lower than the expected 0.6% expansion. Agricultural output had a large contraction for the second consecutive quarter and services output also surprised with an unexpected decline.

Some economic indicators still show that it will take time for the economy to recover. Both the ABSA and Markit PMIs declined further below 50, signalling weak economic activity at the beginning of the third quarter. July mining production contracted by 8.6% month-on-month compared to the 5.0% increase in June. Weak passenger car sales numbers in August and a decline in retail sales to 1.3% in July from 1.8% in June signals weak consumer spending. Ratings agency Moody’s reduced SA’s 2018 GDP forecast to between 0.7% and 1.0% from 1.6%, although it said that its global growth forecast of above 3.0% will be supportive for SA.

At the SA Reserve Bank (SARB)’s MPC meeting in June, all seven members voted to keep the repo rate on hold at 6.50%. The tone of the MPC meeting was characteristically hawkish. The MPC increased its headline and core inflation forecasts for 2019 and 2020 by 0.4% and 0.2% respectively. In stark contrast to the June meeting, only four members voted for the rate to remain unchanged. Consequently the repo rate remained at 6.50% and the voting result signals that inflation risks are to the upside. The SARB kept its inflation forecast for 2018 at 4.8% and 2020 at 5.5%, but raised 2019 to 5.7% from 5.6%, due to higher oil prices and a weaker currency. It also lowered its growth outlook for 2018 to 0.7% from 1.2%, but kept 2019 and 2020 forecasts unchanged at 1.9% and 2.0%.

In September, government intervened to limit the increase in fuel prices. The Minister of Energy, Jeff Radebe, revealed that this intervention will only be a once-off. The recent weakening of the SA Rand and the rise of the oil price (above $80), means that large future fuel price increases are imminent. It is important to note that the SARB explained that they are prepared to look through first-round inflationary effects of a weaker Rand, if the cause of weakening was not domestic.

Early in the quarter SA hosted the tenth BRICS Summit under the theme, “BRICS in Africa: Collaboration for Inclusive Growth and Shared Prosperity in the fourth Industrial Revolution”. Before the start of the summit, China pledged to invest $14.7bn in SA. This, together with the $20bn which Saudi Arabia and the UAE (each $10bn) committed to invest in SA, already makes up a significant contribution of President Ramaphosa’s $100bn foreign direct investment target.

Politically, President Ramaphosa announced that the ANC decided to change SA’s constitution to explicitly allow expropriation of land without compensation. Although they stated that land redistribution will be done in a “just and equitable” manner and without harm to the economy, the market still reacted negatively to the announcement. The issue of nationalising the SARB reappeared again, when the EFF tabled a bill in parliament. The minister of communications, Nomvula Mokonyane, stated on behalf of the cabinet, that the proposed nationalisation of the central bank will not lead to any changes to its operational mandate. The SARB also reiterated this, stating that its independence regarding monetary policy and financial stability is guaranteed by the SA constitution.

End August Argentina surprised the market by hiking their interest rates by 15%. Turkey followed suit by hiking interest rates by 6.25%, providing support for emerging market countries, including SA. Beginning September the US Dollar weakened as a result of further intended tariffs. Later in the month the Federal Reserve lifted their benchmark rate by 25 bps, maintaining their intended interest rate path and reversing dollar weakness.

GDP growth in the second quarter of 2018 contracted by 0.7% quarter-on -quarter after contracting by 2.6% in the first quarter. The unemployment rate of the second quarter increased to 27.2% from 26.7% in the first quarter. During the quarter year-on-year CPI increased to 4.9% in August from 4.6% in June. Similarly, year-on-year PPI increased to 6.3% from 5.9%. The Rand weakened to 14.17 from 13.76 against the Dollar. The 10 -year SA government bond weakened to 9.22% from 9.03%. The trade balance decreased to 8.79bn from 11.9bn.

The money market yield curve shifted upwards and steepened substantially over the quarter, as a result of the weakening in the Rand. If the Rand will continue to remain at the current weaker levels, combined with the current higher oil prices, inflation will most likely be higher than expected in the coming months. This could potentially result in the SARB having to hike interest rates to keep inflation below the 6% upper limit of the inflation band.

What SIM did

All maturities were invested across the money market yield curve, exploiting the term premium. Quality corporate credit, which traded above the 3-month JIBAR rates, was added to the portfolio. We preferred a combination of floating rate notes (FRNs) in the portfolio together with some fixed rate negotiable certificates of deposits (NCDs). The combination of corporate credit, high yielding NCDs and FRNs will enhance portfolio returns.

SIM strategy

Our preferred investments would be a combination of fixed rate notes, floating rate notes and quality corporate credit to enhance returns in the portfolio. As a result of the steepening of the money market yield curve over the course of the quarter, fixed rate notes became relatively more attractive than floating rate notes.

Market review

The first quarter of the year was quite an eventful one, dominated mainly by positive outcomes, which were spurred on by the “Cyril Ramaphosa election” impetus.

In January, Viceroy Research released a research report on Capitec Bank, a microfinance provider to a majority low income demographic. They observed that Capitec outperforms all major commercial banks globally, including competing high-risk lenders. According to them, Capitec is understating loan write-offs. Initially the share price declined substantially (approximately 25%), but subsequent to receiving support from the Reserve Bank and National Treasury, most losses were recovered.

Early in February President Zuma continued to cling to his position. This forced the ANC National Executive Committee to potentially recall him by means of a vote of no confidence. Mid-month, after much resistance, President Zuma resigned, avoiding having to face a vote of no confidence. This was a good result for the ANC, which would allow Deputy President Cyril Ramaphosa to give the SONA and it also provided an opportunity to strengthen the Budget.

Key outcomes from the SONA were the initiatives to tackle corruption, narrower cooperation between business, government and state-owned enterprises (SOEs) and job creation (which includes a national minimum wage from May 2018). Mining is a very important part of the economy and Ramaphosa said that the mining charter must be refined in such a way that it both accelerates transformation and grows the sector.

Next up was the Budget speech, where it was decided to hike VAT by 1% from 14% to 15%. The VAT increase will contribute around R23bn of an additional R36bn revenue collection. The remainder will come from a combination of personal income tax, higher “sin taxes” and fuel levies. The free university education introduced by Zuma limits the reduction in overall expenditures and upside spending risks remain in the form of the current public sector wage negotiations and further possible demands for bailouts of SOEs. Consequently the fiscal consolidation path remains weak, with National Treasury (NT) projecting that the budget deficit will narrow from 4.3% of GDP to 3.5% by 2020/21 and the debt-GDP ratio will peak at 56% of GDP.

Towards the end of February, President Ramaphosa initiated the much anticipated cabinet changes. He removed several ministers who were tainted by allegations of state capture, but he also accommodated some Zuma loyalists, while appointing very good people to key economic policies. Former Finance Minister (FM) Nhlanhla Nene, replaced Malusi Gigaba and Pravin Gordhan was given the tough post of Public Enterprises Minister. ANC Deputy President David Mabuza was appointed as Deputy President of the country.

In March, Moody’s left SA’s sovereign credit rating unchanged at Baa3 (lowest investment grade rating), but somewhat surprisingly changed the rating outlook from negative to positive. They stated three main factors for leaving the rating unchanged. First, it looks like there has been a halt or a reversal to the deterioration of SA’s institutional strength. Secondly, GDP growth prospects picked up and thirdly that the 2018 fiscal budget is very credible. Furthermore they stated that the outlook change reflects an even balance between upside and downside risks, with “the new Sanlam Namibia Money Market Fund April 2018 even balance between upside and downside risks, with “the new administration facing equally significant opportunities and challenges”. Up next, following the rating decision by Moody’s, was the SA Reserve Bank (SARB) monetary policy meeting. The SARB cut interest rates by 25 bps in a finely balanced 4:3 vote, providing further support for the economy. They revised their inflation forecasts down moderately, citing that the increase in CPI by VAT and excise taxes are offset by the stronger rand. They also stated that Q1 2018 likely represents the lowest point for CPI. The SARB now projects CPI to rise above 5.0% in Q3 2018 and stay above this level until end 2020, peaking at 5.5% in Q1 2019. With regards to growth, they took a conservative stance, increasing their 2018 forecast to 1.7% from 1.4% and lowering 2019 to 1.5% from 1.6%. This growth forecast is in contrast with the Treasury and consensus forecast, considering the recent big boost to business and consumer confidence, which the SARB acknowledges. Until end 2020 they still forecast three 25 bps rate hikes, but at a slower pace than previously indicated.

In the US the Federal Reserve continued their “rate normalization” by hiking interest rates by 25 bps. During the quarter, President Trump imposed tariffs on solar panels, washing machines, steel and aluminium. This was followed with tariffs of $50 billion on Chinese goods, which sparked retaliation by China. The US stock market had a correction in February and continued to drop in March, with technology stocks contributing the most.

GDP growth in Q4 2017 came in at 3.1% q/q, beating expectations of 1.8%. SA’s unemployment rate decreased slightly to 26.7% from 27.7%. During the quarter CPI YOY improved from 4.7% to 4.0% and PPI YOY improved to 4.2% from 5.2%. The USDZAR strengthened to 11.82 from 12.39. The 10-year SA government bond strengthened to 8.15% from 8.78%. The trade balance decreased to 0.43bn from 15.31bn.

The money market yield curve shifted downwards because of the 25 bps repo rate cut, but it also steepened a little. With CPI most likely bottoming in Q1 2018 and the VAT hike being inflationary over the next year, we expect a very shallow rate cutting cycle.

What SIM did

All maturities were invested across the money market yield curve, exploiting the term premium. Quality corporate credit, which traded above the 3-month JIBAR rates, was added to the portfolio. We preferred a combination of floating rate notes (FRNs) in the portfolio together with some fixed rate negotiable certificates of deposits (NCDs). The combination of corporate credit, high yielding NCDs and FRNs will enhance portfolio returns.

SIM strategy

Our preferred investments would be a combination of fixed rate notes, floating rate notes and quality corporate credit to enhance returns in the portfolio. Currently we prefer floating rate instruments above fixed rate instruments

Market review

Early in the quarter the most notable event was the Medium Term Budget Policy Statement (MTBPS), which was presented towards the end of October. This was Finance Minister Malusi Gigaba’s maiden budget speech and it couldn’t be any easier. Most economists expected a revenue shortfall of R30 billion, but the actual number presented was R51 billion. Together with downward revised gross domestic product (GDP) growth for 2017 from 1.3% to 0.7%, this will result in a projected budget deficit of 4.3% for the 2017/2018 financial year, which is substantially higher than the 3.1% target set at the February 2017 Budget. Unless drastic measures are taken to cut expenditures or raise taxes, debt will rise to 60% of GDP by 2020. The three rating agencies, Fitch, S&P and Moody’s, were highly critical of the budget statement. All three agencies stated that the budget was credit-negative by pointing out the change in policy direction by National Treasury shown by the lack of plans/actions to achieve fiscal consolidation.

At the November Monetary Policy Committee (MPC) meeting of the South African Reserve Bank (SARB) the repo rate was left unchanged at 6.75%. The SARB was more hawkish than in recent MPC meetings. This was because of the weak and deteriorating fiscal condition, the knock-on effects of higher credit rating downgrade risks and the weakening of the rand, which would result in weaker/higher future inflation. Furthermore, the SARB provided policy guidance for the first time, indicating that three rate hikes (75 basis points) are possible over the forecast horizon (2018- 2019). It will also aim to move inflation closer to the midpoint of the band (4.5%). With regards to the growth outlook, it stated that risks are still mainly to the downside.

Immediately following the MPC meeting Fitch, S&P and Moody’s released updated SA credit ratings. Fitch left SA’s local and foreign ratings at BB+ (highest non-investment grade rating) with a stable outlook. S&P downgraded SA’s local and foreign ratings to BB+ and BB respectively. Moody’s decided to put the country’s Baa3 (lowest investment grade) ratings on review for a downgrade, stating that the fiscal position’s deterioration was much more than expected. As a result of the S&P local rating downgrade, already some forced selling of SA bonds was triggered. In case Moody’s decides to downgrade the local rating, more SA bonds will have to be sold. This will cause the rand to weaken, which in turn will lead to higher future inflation.

In early December the credit market was negatively affected by Steinhoff, when it was reported that ‘a probe had been launched into accounting irregularities and that its chief executive was stepping down immediately’. This caused the share price to decline by 92% during the month. Moody’s also downgraded its credit rating from BBB- to CCC+.

During the ANC elective conference towards the end of the quarter, current Deputy President Cyril Ramaphosa was elected as the new leader of the ANC party after a gripping battle with Nkosazana DlaminiZuma. Considering that Dlamini-Zuma was the candidate backed by President Zuma and also that Ramaphosa has promised to revive SA’s stagnating economy and to reduce state corruption, Ramaphosa’s victoryis viewed as the beginning of the end of the Zuma era, which brought about years of economic decline and rampant corruption. Already before the final election result was known, the market was pricing in a Ramaphosa victory. Consequently, the currency, money and bond markets all strengthened significantly.

In the US, Janet Yellen is coming towards the end of her term as Federal Reserve Chair and Jerome Powell was elected to replace her. In the UK, the Bank of England hiked interest rates for the first time in 10 years. The Fed raised interest rates by 25 basis points in December as expected, as it lifted its outlook for growth, but left its inflation outlook unchanged. Paradoxically the tax reform bill initially strengthened the dollar and towards the end of the quarter it caused the dollar to weaken.

GDP growth in the third quarter of 2017 came in at 2.0% quarter-onquarter, which was broadly in line with expectations. SA’s unemployment rate stayed elevated at 27.7%. During the quarter, CPI year-on-year (y/y) improved from 5.1% to 4.6% and PPI y/y improved slightly to 5.1% from 5.2%. The rand/US dollar exchange rate strengthened to R12.39 from R13.54. The 10-year SA government bond weakened slightly to 8.78% from 8.69%. The trade balance increased to R13.02 billion from R4.48 billion.

The money market yield curve shifted upwards over the quarter, pricing in some potential future interest rate hikes. The stronger currency, because of the optimism (less pessimism otherwise) created by the election of Ramaphosa, should be less inflationary, potentially giving the SARB a little scope for an interest rate cut to support the economy.

What SIM did
All maturities were invested across the money market yield curve, exploiting the term premium. Quality corporate credit, which traded above the three-month Johannesburg Interbank Average Rate (Jibar), was added to the portfolio. We preferred a combination of floating rate notes (FRNs) in the portfolio together with some fixed-rate negotiable certificates of deposit (NCDs). The combination of corporate credit, highyielding NCDs and FRNs will enhance portfolio returns.

SIM strategy
Our preferred investments would be a combination of fixed-rate notes, floating rate notes and quality corporate credit to enhance returns in the portfolio. We are taking a balanced approach between fixed- and floating rate instruments, considering current relative valuation, also that there could still be a rate cut or two and the upside risk to the inflation profile.