28 Apr Economic Overview: March 2015
MARKET OVERVIEW AND DRIVERS
The South African equity market had a diverse month. Resource shares gave back most of the returns generated in February which were down 8.9% mainly due to a strong US Dollar. Financials, driven by banking shares (6.1%), performed well (2.9%) as investors searched for reasonably priced assets with stable earnings expectations. Property stocks kept momentum adding 2.6% as investors chased high yielding assets. South African bonds sold off because of the weaker Rand. Global equity markets were somewhat softer as growth expectations in the USA and Asia were revised down. European and Japanese equities advanced as growth expectations were revised up due to massive monetary stimulus.
The main market drivers remain: the US Dollar (linked to US growth and the Federal funds target rate); European and Japanese quantitative easing (QE) stimulus; and Chinese growth.
- The great growth recovery in the USA drove demand for the Dollar to levels last seen during the Asian crisis (1997) flowing into the Tech bubble (2000). The market expects the Federal Reserve Bank to start hiking the target rate in September 2015. However, the strong dollar is aiding the Federal Reserve Bank, slowing growth somewhat. The “Dollar effect” has retarded the S&P 500 Index growth to an extent and should be seen in the first quarter earnings reports. The S&P 500 Index is trading at a 17 PE on a 1 year rolled basis or a 5.9% earnings yield driven by all time low real interest rates. The US 10 year inflation linked bond is trading at 0.075%, implying an equity risk premium (ERP) of 5.35%. Assuming the US nominal 10 year bond retraces to 2.6% by yearend and inflation expectations are around 1.8%, implying a real rate of 0.8% plus a 4% ERP (long term), equals 5.6% or a PE of 17.8. The current S&P 500 Index PE is still reasonable, but slow near term earnings growth will place a damper on growth.
- Both European and Japanese QE have driven bond yields down to all-time lows in real and nominal terms. The low interest rates in Europe are having a diverse effect. Firstly, they are allowing for lower earnings yields (higher PEs) assuming ERP stability. Secondly, the low yields are forcing corporate funding costs down, allowing for lower weighted average cost of capital that will enable better earnings growth and ROE and higher PEs and price-to-book ratios. Lastly, attractive interest rates have stimulated personal consumption by reducing the cost of credit and helping the personal sector to deleverage.
- The pace of Chinese economic growth expansion has been slowing since 2009 from 12% per annum to 7.3%. Analysis that monitors electricity production, passenger traffic, railway freight volume retail sales and export is pointing to a growth close to 6.3%. The re-engineering of the Chinese economy from a fixed investment and export focused economy to a consumer based economy will be a bumpy ride, we expect real GDP to eventually trend towards 5% growth per annum. China has been adding stimulus to try and manage growth by reducing interest rates and reserve requirements and is expected to keep this stimulus going over the next year. This should assist in stabilising commodity prices.
Real GDP expectations (using IMF forecasts) are set out below:
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