20 Sep Boom & Gloom: August 2016
Balance sheet of the US Federal Reserve Bank
From the start of the Great Financial Crisis in 2008 the US Federal Reserve (FED) expanded its balance sheet aggressively, from close to $1 trillion to the current $4.5 trillion. In the crash, the Troubled Asset Relief Program (TARP) was actioned and, troubled assets were bought and three rounds of quantitative easing added close to $2 trillion to the balance sheet in assets. The quantum was enormous, with money being printed and injected into the system and long bond yields being forced down to improve credit conditions in the credit market – which understandably resulted in asset prices appreciating at a fast pace. The S&P 500 Index added 124% from 2009 to 2014 when the third round of quantitative easing ended. The US 10 year bond topped 3.95% in June 2009 and rallied to a low of 1.64% at the end of 2014. The importance here is Dollar liquidity, and there is an abundance of it.
The questions being asked in the market recently are: “what is going to happen with Dollar liquidity as the markets realise that the US will eventually start raising the FED Funds rate?” and “Will the US grow fast enough to allow the velocity of money1 to work more efficiently while the FED keep the fat off the fire?”. Thus, one would like to see Nominal GDP grow faster than money supply. The second scenario could be that Dollar liquidity will contract, driving Dollar demand and strength. No one wants the second scenario to materialise, but Euro and Yen liquidity, due to the huge stimulus that they are pumping into the system, will help Emerging Market currencies slightly as the search for yield continues.
We expect the FED to be very cautious in the hiking cycle and to focus on labour market indicators, inflation expectations and asset market volatility. The FED compiles the Labour Market Conditions Index and closely monitors changes to the index. As can be seen in the graph below, labour market conditions are slightly below average, but have been improving from the low in May 2016.
Wage inflation is one of the main inflation concerns for the FED. If we look at the monthly net change of the Nonfarm Payrolls, or the amount of additional jobs created every month using a three month moving average to clear the clutter, one can see that since 2012 around 200 000 jobs have been created per month. This amount is healthy and compares to 2004 to 2006.
What is important though, is the quality of jobs and earnings growth. The US Bureau of Labour Statistics produce the US Average hourly earnings for non-supervisory private nonfarm payrolls index, which is a good indicator for wage growth for the average worker. The graph below plots the year on year (YoY) change of the average Dollar per hour, it is currently growing at 2.5% which is not too bad given the placid global inflation. From a long-term historical perspective it is at the lower end of the range. Job creation is healthy but the average worker does not have much pricing power.
Risk in the asset markets can be evaluated by looking at the Vix Index as an indicator for equity riskiness, and the JPM Embi Plus Index for Emerging Market (EM) risk appetite. Equity risk is moderate, but volatile, where as EM bond risk is elevated but has a lower trend. The latter can be evaluated in conjunction with EM currency behaviour over the past five years.
Looking at the various factors discussed above, we feel that the FED should consider a very slow normalisation. The probability for the next rate hike in December is high, with a slow hiking pace there after. We do not see the FED funds rate exceeding 2.5% in the next five to seven years.
DOMESTIC ECONOMIC ACTIVITY
South African Retail Sales grew a placid and disappointing 0.8% YoY in July, proving the weak state of the consumer.
Mining production contracted 5.4% YoY making it the 11th consecutive negative month, illustrating the terrible state of the mining sector. The weak Rand has been the saving grace, as the plummeting volume indicator was driven by foreign volume demand.
Domestic Manufacturing production volumes are growing subpar at 0.4% YoY with an average growth below 1% since 2015. The slightly elevated growth experienced from April to June did not persist, which confirmed the perception that it was an inventory build in preparation for the strike season.
Both business and consumer confidence are close to all-time lows – driven by low economic growth, high inflation and increasing interest rates coupled with high levels of political uncertainty.
Offshore investors bought R11bn in bonds and sold R3.7bn in equity in August. Year to date offshore investors bought R70bn in bonds and sold R84bn in equities, resulting in a net outflow of R14bn.
Inflation expectations have been trending down after the Nenegate scare, from a high of 7.8% on the 10 year breakeven rates to the current 6.8% (which is still fairly high). The shorter term inflation trend has been weaker as fuel prices decline. CPI slowed to 6% YoY in July and we expect 2016 to average around 6.5%. There will be some pressure over the next three months on inflation, where after we expect it to top out and decelerate into 2017.
Total return to 31/8/2016, in domestic currency
Total return to 31/8/2016
TOP 10 JSE EQUITY PERFORMERS
TOP 10 JSE EQUITY DETRACTORS
SELECTED COMPANY COMMENT
Our View of the Investment Markets
This table reflects our view of the relevant assets, based on expected performance.
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1.The velocity of money is the rate at which money is exchanged from one transaction to another and how much a unit of currency is used in a given period of time. Velocity of money is usually measured as a ratio of GNP to a country’s total supply of money. Source: www.investopedia.com
Sources: Bloomberg LP, Credit Suisse, RMB, BNP Paribas
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