When good news became bad news
It was all looking good at the start of the second quarter – stock markets were reaching historical highs and sentiment was buoyant – and then the US Federal Reserve ruined the party by drip-feeding the market with comments about the possibility of it beginning to withdraw liquidity support. It took a while for reality to dawn on investors but then, in May, Ben Bernanke finally spooked the market by indicating the Fed could start “tapering off” its $85bn a month stimulus programme as early as September.
This had the following results:
- Stock markets in the developed world tumbled off their highs
- Sentiment towards emerging markets soured
- Volatility jumped
- The rand’s depreciation accelerated
After that point, any news that showed the US economy was on the road to recovery was taken as bad news for the market, particularly when it came to the three key statistics used to gauge the US recovery: jobs growth, the housing market and private sector credit extension. So, during June and July whenever a better-than-expected figure was released to the market, the market tended to react negatively.
World economic review
- The US Federal Reserve ruffled markets when it indicated it was scaling back on quantitative easing if US real economic data continued to improve.
- At the first sign that it could be as soon as September, developed market equities came off their record highs in May but has since rebounded.
- The US housing market continued to improve but some recent measures indicated that the pace of recovery may be slowing.
- The US unemployment rate declined and growth in the private sector credit extension has slowly started picking up.
- US real consumer spending grew at an annual rate of 2% during the first quarter of the year.
- The US Institute for Supply Management’s (ISM) manufacturing index jumped from 50.9 to 55.4 in July, ahead of expectations and its highest reading for two years.
- Growth in the US was also a healthy 1.7% during the second quarter this year and well ahead of expectations.
- In the Euro-zone, Purchasing Managers Index (PMI) figures showed manufacturing activity expanded slightly for the first time in two years.
- Both the European Central Bank and the Bank of England left interest rates unchanged and reiterated they would remain low for an extended period.
- China’s GDP growth slowed slightly to 7.4% in the second quarter as weak foreign demand weighed on output and investment.
- In SA, the rand weakened sharply during the second quarter, amid falling precious metal prices and the Fed’s announcement that it may begin scaling back quantitative easing.
- Inflation surprised on the low side, with headline CPI slowing to 5.6% in May from 5.9% in April.
- GDP in current prices advanced by 7.8% during the year to the first quarter of 2013 – well short of the 10% pace assumed by the National Treasury in its National Budget revenue projections for fiscal year 2013/14.
In developed markets, investors now realize that the US Federal Reserve and China cannot keep the world’s economy afloat forever. The US will need to ratchet down quantitative easing measures and China is attempting to make the transition to a consumer rather than investment driven economy. At the same time, it dawned on investors – who disinvested en masse in disappointment during May and June - that emerging markets could no longer be treated as a basket of countries, but had to be looked at on a country by country basis.
In SA, there’s been a growing realisation that we are facing some tough economic and political challenges and, as a commodity-producing economy, we have also been hard hit by the global commodity price meltdown and potentially explosive local labour issues. As behavioural economists would have predicted, the response to these unfolding realities was to panic – at first. But slowly investors are coming to grips with this new state of play and taking comfort from route markers like the outcome of the recent G-20 meeting, which saw leaders put their support behind continuing to prioritise growth over austerity. So by the mid-year mark investors were getting onto a more even keel and, for SA, the rand’s slide had run out of steam, with the local currency pulling back to R9.70 to the dollar by late July – possibly on its way back to fair value.
SA’s twin achilles heels looming current account and fiscal deficits
- When the rand pushed above the R10 to the dollar level, it became the worst performing emerging market currency this year – highlighting SA’s particular fragilities.
- At the heart of the problem is SA’s large current account deficit and the complete erosion of any fiscal financial progress made by former Finance Minister Trevor Manual during his tenure.
- Now the country sits with a budget deficit that will be hard to finance during the years ahead in an environment of lacklustre growth. In fact, the fiscal situation is unlikely to be turned around without increasing the government’s tax take.
- The lack of savings on behalf of South Africans, government and the private sector has exposed the country to serious vulnerability to offshore investor sentiment because it will have to continue relying on foreign investment inflows to fund these twin shortfalls: the huge current account and budget deficits.
- Given SA’s reliance on the mining sector, the country has also been subjected to the worst of the turn in sentiment against emerging markets because of the sudden and steep decline in commodity prices during the second quarter, which could signal the end of the secular boom in commodities.
- It will take some careful macro-economic management to win back the substantial ground lost over the last five years and to make matters worse, it will need to happen within a precarious and unnerving global and emerging market economic environment.
What this means for equities
When it comes to equities, from a long-term perspective some market commentators believe the SA stock market is now trading slightly above fair value, i.e. equities are generally expensive. This means that the stock market return over the medium term may be lower than what investors have become used to over the past few years. In addition, the divergent trend of the various indices of late (such as the Industrial Index gaining ground, the Financial Index effectively flat and the Resources Index losing significant ground) could persist for a while.
For the economy, it is clear central bank balance sheet expansion in developed markets has failed to ignite a strong recovery in real economic activity. Global real GDP growth has continued to disappoint in the aftermath of the Great Recession. Ultimately, economists do not believe the current environment of a high level of government claims on available savings; restraint of financial sector activity and weakened productivity growth are conducive to a robust global economic upswing.
Meanwhile, with investors now concerned that the Fed and other central banks may remove stimulus from the global economy at too fast a pace, the era of excess liquidity and low funding rates is indeed coming to an end and this could provide another headwind to company earnings growth. In addition, the Chinese economy is showing signs of sputtering, which is negative for commodity demand. Markets could accordingly remain rocked by emotions.
Satrix Divi ETF review
We have received enquiries about recent performance of the Satrix Divi ETF and thought it worthwhile providing some commentary in this regard. To start with, it cannot be reiterated enough that the Satrix Divi ETF is an equity fund and like all other equity products will show volatile performance at times. It should furthermore be noted that the Satrix Divi ETF is achieving its investment objective by continuing to track (as closely as possible) the index over which is has been established. Because of its calculation methodology which focuses on one year forecast dividends, the FTSE/JSE Dividend Plus Index will perform differently in changing market conditions to other indices such as the FTSE/JSE All Share Index. However, therein also lies the opportunity that over time a dividend yield based index should perform differently to a traditional market cap weighted index (an investment thesis supported by ample research) thereby offering the benefit of diversification of your investments.
Looking at the specifics this year, the FTSE/JSE Dividend Plus Index (and therefore the Satrix Divi ETF performance) was negatively affected by its inclusion of smaller cap stocks and its omission of industrial rand hedge stocks like SAB, Naspers and Richemont, which significantly outperformed due to the depreciation of the rand and their rand hedge qualities. The fund’s exposure to retail stocks also negatively affected the performance as Lewis and JD Group fell dramatically to end April. However, with the Dividend Plus Index trading at a forward PE of close to 10.5 x (less expensive), relative to the All Share of about 12.6 x (more expensive), the Satrix Divi ETF may be better placed to yield positive investment results in the long run.
|Equity indices Total returns in R's
||% change (1 Year)
||% change (3 Year)
||% change (5 Year)
The Satrix Team | www.satrix.co.za
Call Centre contact: 086 110 0670 Call Centre fax: 011 388 8558
Call Centre email: email@example.com