Hanging in the balance
Market participants have broadened their focus beyond Covid and vaccine developments to include the absence of a second fiscal package in the US and escalating uncertainty around the US election. In addition, various countries are facing a resurgence of Covid-19 infections and the threat of renewed lockdowns, despite the substantially lower fatality rate. This comes at a time when the rebound is starting to lose some steam, but without obvious signs of imminent further monetary policy easing (which is understandable given the zero lower bound, large balance sheets, and forward guidance that are already in place).
The anticipated timeline for a widely available vaccine still stretches well into 2H21, with unknown requirements and implications for the supply-chain management related to global distribution. Reports of serial reinfections have also cast some doubt on the likely efficacy of a vaccine, but for now, vaccine news is still generally seen as good for activity and markets. However, investors will have to take a more nuanced view, as who wins the vaccine race will have varying implications for mobility (and geopolitics) in DM versus EM.
The primary uncertainty for financial markets is the upcoming US elections. Not only is Biden being favoured as the next POTUS, based on various polls, but also the most likely outcome is that he wins with a “blue wave” – i.e. that the Democrats take control of the Senate alongside the House of Representatives. Generally, US markets have been jittery on predictions of a “blue wave” given prospects of tax hikes to fund higher spending and re-regulation. Yet one could argue that a US government that is aligned will be more effective (relatively speaking), while redistribution could potentially lead to more equal and sustainable growth.
From an EM (and by derivation an SA perspective), a Biden/Democratic victory would be good news given stronger fiscal stimulus (but with the attendant financial repression to keep the debt burden manageable), reduced hostility towards China (potentially), and a slower pace of de-globalisation. While this would be a net positive in the medium term, the dynamics around the election process itself is a concern for risky assets. It remains a close race, with a surge in mail-in ballots, and it seems likely that the losing party will not readily accept the outcome. This could lead to various delays due to recounts, lawsuits and a potential resolution by the courts.
For SA investors, the immediate focus is on the fiscal position and the 21 October Medium Term Budget Policy Statement (MTBPS). The reopening of the economy has resulted in a steady, albeit slow, recovery in tax receipts. Yet a lot of damage has been done, with the budget deficit still set to be more than double that of the previous fiscal year. Stats SA reported 2.2m job losses in 2Q20, which aligns with the results from various private sector and academic surveys. Over and above the hole in government’s income statement due to government policy, the MTBPS will have to focus on spending priorities. Wage bill reform and the sustainability of State Owned Entities are the main priorities and will require tough trade-offs. As it stands, SAA is set to get R10.4bn at some point, but the requirement that this is in a fiscally neutral manner means that budgets must be cut elsewhere. It will be a tough sell to the numerous unemployed voters that the Covid grant will be temporary, but that there will be even more money for SAA.
Beyond the numbers, some developments have been positive. Renewables, municipal power procurement, and self-generation are being prioritised to deal with the electricity constraints over the next three years, while hopes have resurfaced that the spectrum auction might be concluded in the current fiscal year. Moreover, following on from revelations at the Zondo Commission, there have been high-profile arrests related to various corruption cases. This will assist to restore confidence that President Ramaphosa is succeeding in rebuilding the justice system and that the legal process will take its slow and steady course without political interference.
Cash (0.4%) was king in September, as all the major South African asset classes ended the month in the red. Property (-3.0%) fared the worst, followed by equities (-1.6%), inflation-linked bonds (-1.5%), and fixed-rate bonds (-0.1%). For the quarter ending September, fixed-rate bonds (1.5%) beat inflation-linked bonds (1.2%) and cash (1.2%), while equities (0.7%) and property (-14.1%) fell short.
While the US dollar depreciated by 3.6% during 3Q20 amid falling real yields and the Fed’s adoption of average inflation targeting (AIT), the greenback rallied 1.8% in September as risk aversion increased. A second wave of Covid infections in DM, notably across Europe, and the lack of a second fiscal stimulus package in the US triggered a retreat from risk assets. The rand gained 4.2% against the dollar in Q3, bucking the weakening trend of its EM peer group, where Turkey (-11%), Russia (-8.3%), and Brazil (-2.5%) were relative underperformers on country-specific factors. USD/ZAR traded in a 16.20/17.70 range during Q3, ending the quarter only marginally undervalued at 16.70 versus our fair-value range of 16.00 – 16.50.
US TIPS yields have been fairly steady around -1.0% since the end of July, while the 10-year nominal yield has been trading in a 50bp/80bp range. Upside inflation surprises and AIT were not enough to sustain the widening in breakeven inflation, which has dropped back to 1.6% from a post-March high of 1.8%. EM local market yields have been trading sideways of late, with country-specific factors leading to some deviations. On average, EM 10-year yields were only 10bp higher in September and around 15bp for 3Q20. Falling Eurozone yields benefited low-yielding EM, while risk aversion and fiscal fears negatively affected high-yield bond markets. SA’s 10-year yield traded around 9.30% during Q3, but ended the quarter around 30bp higher, leaving the market tactically cheap versus the repo rate and inflation outlooks, and the peer group.
The slowing pace of the economic rebound alongside the lack of a fiscal package in the US weighed on global equities during September. Yet the 3.8% and 5.1% declines in the S&P500 and Nasdaq, respectively, were not enough to offset the July to August gains, leaving the markets 8.9% and 11.2% higher for the quarter. The MSCI World Index lost 3.5% in September, but gained 7.9% during the quarter. In both instances, EM outperformed with the MSCI EM index losing 1.6%, but gaining 9.6% over the respective periods. The MSCI South Africa Index was a relative laggard for the quarter, gaining only 3.7%, while the loss in September was a modest 0.9%. The ALSI and the SWIX both lost 1.6% in September, while the ALSI eked out a paltry 0.7% gain in Q3 the SWIX lost 0.3%. The underlying performances were wide-ranging during Q3: basic materials (6.0%), consumer services (4.7%), and telco’s (3.3%) were relative outperformers, while consumer goods (-0.2%), industrials (0.3%), financials (-1.6%), technology (-6.1%), and health care (-7.2%) were the laggards. This reflects the uneven impact the lockdown and subsequent reopening has had on the various sectors of the economy.