Social unrest with potentially BIG consequences
The second half of 2021 was off to a rocky start as markets faced a tougher policy and economic backdrop. Risk aversion over rising Covid-19 cases globally, driven by the Delta variant, were compounded by softening commodity prices and regulatory constraints in China. In addition, global growth momentum has very likely peaked, as the trade recovery gives way to the services rebound during the rest of the year.
Diverging DM central banks
The US again stood out with relatively robust data readings, even if these surprised to the downside. The Fed’s dovishness in July eclipsed explicit acknowledgement of taper talk, as well as another large upside surprise in inflation. It seems that the jobs data will be the key determinant of the Fed’s taper, which is likely to commence in 1Q22. The ECB trumped the Fed’s stance, as it adopted a symmetric inflation target of 2% and maintained its asset purchase programmes. Even China’s monetary policy turned less restrictive with a 50bp RRR cut announced in July.
The dovishness was not uniform, however, as the Bank of Canada tapered its QE programme, while the Reserve Bank of Australia and the Reserve Bank of New Zealand both flagged their respective taper timelines.
SA hit by delta, lockdown, and social unrest
Delta’s damage on the SA economy continued in July as the government extended the alert level 4 lockdown, which possibly contributed to a wave of severe social unrest in KwaZulu Natal and Gauteng (see here for our take on the impact on the economy). The political trigger was the arrest of former President Zuma, which reminded markets of the factionalism within the ruling ANC party amid much speculation of an insurrection. Local asset prices weakened during the week of 12 July, but the impact was surprisingly modest and short-lived, highlighting the dominant influence of global dynamics.
The unrest prompted the SARB to turn more dovish on near-term growth risks, but it also led to calls for the reinstatement of welfare support. The anticipated renewal of the Social Relief of Distress grant (the Covid-relief grant) gave way to expectations of the announcement of a basic income grant. This did not materialise, with the Treasury willing to fund a temporary extension of the R350 per month support up to March 2022 with a price tag of R27bn.
Cyclical revenue boost masks fiscal pressures
Robust revenue growth following the surge in commodity prices will prevent fiscal slippage in the near term, even accounting for the acquiescence on the wage front that will add R19bn in spending for FY22. The contingency reserve, recurring underspending, and corporate tax overrun should ensure that the budget deficit falls below the February budget expectations. This will also contribute to a lower debt ratio of around 78%/GDP this year, thanks to serial issuance cuts.
Yet this is merely a short-term boon. We cannot dismiss the elevated likelihood that the Covid relief grant lays the foundation for a basic income grant as early as FY23 (see here for our analysis on a BIG for SA). With super commodity profits an unstable revenue source, it will take fancy footwork from the new Finance Minister, Enoch Godongwana, to balance a widening social welfare net with a fundamentally fragile fiscal position.
During July, equities (4.2%) outperformed the pedestrian gains in the other asset classes. While fixed-rate bonds (0.8%) and inflation-linked bonds (0.5%) managed to beat cash (0.3%), listed property (-0.6%) fell short. The 2.4% depreciation in the rand would have been marginally accretive to offshore asset returns.
EM FX faces headwinds
The dollar was on the front foot for most of July as rising Covid infections and regulatory tightening in China led to heightened risk aversion. However, negative data surprises and the Fed’s dovish bias in the July FOMC meeting put pressure on the greenback, leaving the DXY down 0.3% m/m.
The numerous headwinds caused consternation over the durability of the EM growth recovery. This was reflected in broad based EM FX weakness, with the Peruvian sol (-5.0%) and Brazilian real (-4.6%) underperforming sharply on political uncertainty and lower commodity prices. The Turkish lira (3.0%) and Mexican peso (0.5%) bucked the weakening trend thanks to hawkish MPC rhetoric and policy action.
Despite the global risk aversion and local unrest, the rand lost only 2.0% against the dollar. The depreciation leaves USD/ZAR broadly fairly valued within the 14.50 – 15.00 range.
Little help from falling US yields
Caution was also evident in DM bond yields, as the 10-year UST yield temporarily fell below 1.2% while the 10-year TIPS yield reached almost -1.2%. The dovish Fed, moderating growth momentum, and stagflation fears were widely cited as the triggers for the bond market gains. Yet the dovish ECB and lower German yields contributed to the decline across core rates.
EM bond yields were unchanged, on average, but this belies a widespread performance. Political risk, lower commodity prices, and FX weakness pushed LatAm yields sharply higher, with Peru (83bp), Chile (71bp), and Brazil (45bp) the underperformers. Russia (-36bp) outperformed amid relative exchange rate strength, the elevated oil price, and reasonably sound fiscal metrics.
South Africa eked out modest gains, with the 10-year yield declining by 7bp. Lower US yields and the dovish SARB partly countered the fiscal uncertainty related to the social unrest. Yet there was little evidence of additional credit risk, with the 10-year CDS spread tracking sideways around 290bp. Consensus inflation forecasts rose modestly, but not enough to dent elevated real yields in the local market. The market continues to screen cheap based on our 8.50% fair-value estimate.
Delta and regulatory jitters dampen equities
In line with the uneven global recovery, global equities were far from uniform with July’s performances again rather varied. The S&P500 posted a middling gain of 2.3%, while the Eurostoxx lagged with 1.4%. Tech woes dampened the Nasdaq’s return to 1.2%.
The MSCI World Index gained 1.8%, outperforming the 6.7% decline in the MSCI Emerging Market Index. The latter was dragged down by the MSCI China Index (-13.8%), as regulatory restrictions caused a tech rout that spilled over to other Asian bourses. Turkey (up 6.6% m/m) led the motley crew of outperformers, followed by Argentina (6.4%), Denmark (4.8%), and Sweden (4.8%).
The MSCI South Africa Index lost 1.7% in July largely due to rand weakness, with the ALSI and SWIX gaining 4.2% and 2.6%, respectively. The equity market cheapened further with the PE ratio falling below 10 times. The c.25% discount to the long-run average rating is largely due to the cheapness in basic materials. This has persisted despite the rebound in commodities as the market attempts to price a peak in the cycle. The recent softening in prices, coupled with the lockdown and social unrest has pushed earnings revisions into negative territory.
At an industry level, Basic Materials (11.8%) took gold in the equities race, thanks to robust earnings updates from the diversified mining sector. Consumer Discretionary (6.3%), Health Care (6.2%), and Industrials (5.9%) also outperformed, while Telco’s (1.8%) and Consumer Staples (1.1%) lagged the overall market. Financials (-1.1%) lost out in July amid the social unrest and concerns about insurance claims, while Technology (-5.9%) reflected the effect of administrative tightening on Chinese tech companies on Naspers and Prosus.