28 Jul Boom & Gloom: June 2016
OUR VIEW OF THE INVESTMENT MARKETS
This table reflects our view of the relevant assets, based on expected performance.
The JP Morgan Global Services PMI weakened slightly in June to 51.3 from 51.4 in May, still in expansionary zone. The JP Morgan Global Manufacturing PMI picked up to 50.4 in June from 50 in May. It seems as if the manufacturing PMI`s across the globe stabilised as commodity prices started to bottom out. Domestically, the Barclays PMI accelerated further to 53.7 in June from 51.9 in May. It appears that import substitution is contributing to the improvement. The broad based Standard Bank PMI printed 49.6 in June down from 50.2 in May.
The horror story around the SACCI Business Confidence Index saw somewhat of an improvement from 91.8 in May to 95.1 in June. The confidence levels remain below the lows experienced in the Great Financial Crisis (GFC) in 2008. South African real GDP contracted -0.2% year on year (YoY) in June, explaining the weak confidence levels in the country. Consumer confidence levels remain extremely low, as consumers’ wallets felt the impact of the increases in inflation and interest rates.. The BER Consumer Confidence index printed -11 in June from -9 in May. These levels are below the FGC levels and close to the lows of 2000 Tech Bubble era.
Offshore investors bought bonds (R28.6bn) and sold equities (R23bn) in June.
Inflation moderated somewhat in June to 6.1% YoY from 6.2% YoY in May.
The Brexit vote shocked the market, as the UK voters decided to exit the European Union. Expectations of the impact are wide but the immediate impact will be on business and consumer confidence, as policy uncertainty will impair spending.
The risks around Brexit are endless and are skewed to the downside. The impact of Brexit can drag down UK GDP by 2% by the end of 2017 and the Eurozone GDP by around 0.5%. The impact elsewhere will be more subdued.
Some risks that can be considered are:
- Property and construction sectors will feel the impact as unemployment rises and consumer and business spending contracts. Lower interest rates will dampen the effect. Foreign investors will stay nervous, dampening asset prices.
- A banking sector is sensitive to a worsening economic environment, especially in countries like Italy. This may require some sovereign support for banks with weak balance sheets.
- Deflation risk in Europe is back. The output gap in Europe is wide, and can widen further with subdued growth – which will drive inflation down. Monitory authorities will struggle to help as they have very little ammo left to fight this.
- Political contagion can develop. Anti-EU sentiment could possibly spread with the major elections coming up in France and Germany in 2017 and an Italian constitutional referendum on the cards.
Total return to 30/6/2016, in domestic currency
Total return to 30/6/2016
Top 10 JSE Equity Performers
Top 10 JSE Equity Detractors
Our equity view uses a top down macro model, bottom up equity model and equity risk premium modelling (bond/equity relative). We also consider global risk appetite and emerging market (EM) versus developed market (DM) valuations, credit conditions and behavioural elements.
- With the top down macro model, using consensus expectations over one year, the modelled Top 40 Index target is 54 672 (+17.7%). Core drivers are the S&P 500 Index with a target level of 2336 (+8.1%), South African 10 year bond with a target yield 9.06%, a ZAR/USD currency target of 15.99, the Bloomberg Precious Metals Index with a target of 315 (0.3%) and Bloomberg Base Metals Index target of 151 (2.1%). The consensus Rand view is diverse, with a low of 14 and high of 20 to the USD for 2017. Our house view is constructive to the Rand, we see the currency as fair to cheap at the current level of 14.3. We do acknowledge that currency normalisation is a long-term game. Applying a strong Rand scenario assuming that 2017 will end with the ZAR/USD at 13.5, sets a modelled Top 40 target of 52 500 (13.4%). This combined with a flat S&P 500 Index, sets a modelled Top 40 target of 50 219 (8.5%) which we feel is realistic.
- With the bottom up equity model, consensus expects earnings on the FTSE/JSE Top 40 Index to grow 12.4% rolled FY1 and 11.3% rolled FY2 bottom-up. We estimate the current rolled PE of the index to be 19.3. The current rolled PE is seen as expensive, given the earnings growth expectations for the next two years. The driver of the high PE is mainly the multinational Rand hedges that have substantial weightings in the index. We expect the index to de-rate to a 16.5 PE, pencilling in a 1.7% total return.
- We use a long-term domestic equity risk premium (ERP) of 5% and long-term trend inflation of 6%, requiring a return of 11%. However with the high multinational component in the South African equity universe, one can reduce the ERP to 4.5. So on a risk adjusted basis equities are not expected to exceed the hurdle rate relative to bonds and cash. We remain underweight on South African equities.
The domestic bond market is not reflecting the South African geo-political and credit risks. The global drive for yield is placing a cap on bonds for now and the liquidity pumped into the market by developed market monetary authorities is going to stimulate this quest for yield over the next year or two. The stronger Rand and lower bond yields are helping to keep shorter term interest rates static and assist in working towards the Treasury’s goal to keep the South African credit rating above junk level.
Our macro top down model expects the Govi Index to deliver a total return of 8.02% over one year. The model expects the 10 year bond to end the period at 8.9%. On a global peer comparative basis, our 10 year bond is trading close to 1% above the mean of countries with a similar credit rating. Although, our 10 year bond yield is still way lower than the Brazilian 10 year bond (BB-, 12.04%) but close to the Russian 10 year bond yield (BB+, 8.78%). The US 10 year implied yield is modelled at around 9.08%. We require bonds to exceed inflation by 3% to deliver acceptable relative returns. We will maintain our hold on South African bonds but will reduce our hold as the R 186 yield moves towards 8.5%.
The domestic money market is offering one year NCD’s at 8.5%, which is 2.2% above inflation. This is a very attractive yield compared to the bond and equity markets. We retain our overweight position.
Our top down property model expects a total return of 10% over one year. We require inflation plus 4% as a hurdle rate, making property attractive relative to other domestic asset classes. The risk on the UK and European focused REIT’s is high after Brexit, so exposure needs to be managed carefully.
We break the international markets up into the major regions and evaluate the regions fundamentally by looking at the valuation, margin and ROE of selected equity indices.
The most attractive valuation metrics for indices are the MSCI Asia ex Japan, the MSCI Japan and the MSCI EM Eur, ME & Africa (Emerging Europe, Middle East and Africa) indices – looking at the Price to book (PB) and PE. The MSCI Japan margin and ROE are at high levels, allowing little opportunity for expansion. Both the MSCI EM Eur, ME & Africa and MSCI Asia ex Japan score well in both margin and ROE, but liquidity and geo-political risk is high in the MSCI EM Eur, ME & Africa region.
On a total score we prefer MSCI AC Asia ex Japan and MSCI AC EU. However, we will remain cautious with Europe until there is more certainty as Brexit evolve.
We are of the view that the commodity cycle is bottoming out. However, price action will include high volatility and prices will trade in a wide band. We expect base metal (neutral) performance to be flat due to supply, but see some support for precious metals (buy).
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Sources: Bloomberg LP, Credit Suisse, RMB, BNP Paribas
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