Market review

South African currency, money and bond markets were mainly driven by a few global and local themes. Globally we had the continued US-China trade wars, interest rate normalisation in the US, higher oil prices and emerging market contagion originating mainly from Turkey and Argentina. Locally there were the continued risk of higher inflation, weak economic growth, budget pressures at the fiscus, expropriation of land without compensation and President Ramaphosa’s economic stimulus plan.

Seasonally adjusted annualized GDP for 2Q2018 contracted by 0.7%, following the 2.6% decline in 1Q2018. This means that SA is now in a technical recession. This was substantially lower than the expected 0.6% expansion. Agricultural output had a large contraction for the second consecutive quarter and services output also surprised with an unexpected decline.

Some economic indicators still shows that it will take time for the economy to recover. Both the ABSA and Markit PMIs declined further below 50, signalling weak economic activity at the beginning of Q3. July mining production contracted by 8.6% m/m compared to the 5.0% increase in June. Weak passenger car sales numbers in August and a decline in retail sales to 1.3% in July from 1.8% in June, signals weak consumer spending. Ratings agency Moody’s, reduced SA’s 2018 GDP forecast to between 0.7 - 1.0% from 1.6%, although it said that its global growth forecast of above 3.0% will be supportive for SA.

At the SARB’s MPC meeting in June, all seven members voted to keep the repo rate on hold at 6.50%. The tone of the MPC meeting was characteristically hawkish. The MPC increased its headline and core inflation forecasts for 2019 and 2020 by 0.4% and 0.2% respectively. In stark contrast to the June meeting, only four members voted for the rate to remain unchanged. Consequently the repo rate remained at 6.50% and the voting result signals that inflation risks are to the upside. The SARB kept its inflation forecast for 2018 at 4.8% and 2020 at 5.5%, but raised 2019 to 5.7% from 5.6%, due to higher oil prices and a weaker currency. It also lowered its growth outlook for 2018 to 0.7% from 1.2%, but kept 2019 and 2020 forecasts unchanged at 1.9% and 2.0%.

In September, government intervened to limit the increase in fuel prices. The Minister of Energy, Jeff Radebe, revealed that this intervention will only be a onceoff. The recent weakening of the SA Rand and the rise of the oil price (above $80), means that large future fuel price increases are imminent. It is important to note that the SARB explained that they are prepared to look through first-round inflationary effects of a weaker rand, if the cause of weakening was not domestic.

Early in the quarter SA hosted the 10th BRICS Summit under the theme, “BRICS in Africa: Collaboration for Inclusive Growth and Shared Prosperity in the 4th Industrial Revolution”. Before the start of the summit, China pledged to invest USD14.7 bn in SA. This, together with the USD20 bn, which Saudi Arabia and the UAE (each USD10 bn) committed to invest in SA, already makes up a significant contribution of President Ramaphosa’s USD100 bn foreign direct investment target.

Politically, President Ramaphosa announced that the ANC decided to change SA’s constitution to explicitly allow expropriation of land without compensation. Although they stated that land redistribution will be done in a “just and equitable” manner and without harm to the economy, the market still reacted negatively to the announcement. The issue of nationalizing the SARB reappeared again, when theEFF tabled a bill in parliament. The minister of communications, Nomvula Mokonyane, stated on behalf of the cabinet, that the proposed nationalization of the central bank will not lead to any changes to its operational mandate. The SARB also reiterated this, stating that its independence regarding monetary policy and financial stability is guaranteed by the SA constitution.

End August Argentina surprised the market by hiking their interest rates by 15%. Turkey followed suit by hiking interest rates by 6.25%, providing support for emerging market countries, including SA. Beginning September the US Dollar weakened as a result of further intended tariffs. Later in the month the Federal Reserve lifted their benchmark rate by 25 bps, maintaining their intended interest rate path and reversing dollar weakness.

GDP growth in 2Q2018 contracted by 0.7% q/q after contracting by 2.6% in 1Q2018. The unemployment rate of 2Q2018 increased to 27.2% from 26.7% in 1Q2018. During the quarter CPI YOY increased to 4.9% in August from 4.6% in June. Similarly PPI YOY increased to 6.3% from 5.9%. The USDZAR weakened to 14.17 from 13.76. The 10 YR SA government bond weakened to 9.22% from 9.03%. The trade balance decreased to 8.79bn from 11.9bn.

The MM yield curve shifted upwards and steepened substantially over the quarter, as a result of the weakening in the Rand. If the Rand will continue to remain at the current weaker levels, combined with the current higher oil prices, inflation will most likely be higher than expected in the coming months. This could potentially result in the SARB having to hike interest rates to keep inflation below the 6% upper limit of the inflation band.

What we did

All maturities were invested across the money market yield curve, exploiting the term premium. Quality corporate credit, which traded above the 3 month JIBAR rates, was added to the portfolio. We preferred a combination of floating rate notes (FRN’s) in the portfolio together with some fixed rate negotiable certificates of deposits (NCD’s). The combination of corporate credit, high yielding NCDs and FRNs will enhance portfolio returns.

Our strategy

Our preferred investments would be a combination of fixed rate notes, floating rate notes and quality corporate credit to enhance returns in the portfolio. As a result of the steepening of the MM yield curve over the course of the quarter, fixed rate notes became relatively more attractive than floating rate notes.

Market review

The first quarter of the year was quite an eventful one, dominated mainly by positive outcomes, which were spurred on by the “Cyril Ramaphosa election” impetus.

In January, Viceroy Research released a research report on Capitec Bank, a microfinance provider to a majority low income demographic. They observed that Capitec outperforms all major commercial banks globally, including competing highrisk lenders. According to them, Capitec is understating loan write-offs. Initially the share price declined substantially (approximately 25%), but subsequent to receiving support from the Reserve Bank and National Treasury, most losses were recovered.

Early in February President Zuma continued to cling to his position. This forced the ANC National Executive Committee to potentially recall him by means of a vote of no confidence. Mid-month, after much resistance, President Zuma resigned, avoiding having to face a vote of no confidence. This was a good result for the ANC, which would allow Deputy President Cyril Ramaphosa to give the SONA and it also provides an opportunity to strengthen the Budget.

Key outcomes from the SONA, were the initiatives to tackle corruption, more narrow cooperation between business, government and state-owned enterprises (SOEs) and job creation (which includes a national minimum wage from May 2018). Mining is a very important part of the economy and Ramaphosa said that the mining charter must be refined in such a way that it both accelerate transformation and grows the sector.

Next up was the Budget speech, where it was decided to hike VAT by 1% from 14% to 15%. The VAT increase will contribute around ZAR 23bn of an additional ZAR 36bn revenue collection. The remainder will come from a combination of personal income tax, higher “sin taxes” and fuel levies. The free university education introduced by Zuma limits the reduction in overall expenditures and upside spending risks remains in the form of the current public sector wage negotiations and further possible demands for bailouts of SOEs. Consequently the fiscal consolidation path remains weak, with National Treasury (NT) projecting that the budget deficit will narrow from 4.3% of GDP to 3.5% by 2020/21 and the debt-GDP ratio will peak at 56% of GDP.

Towards the end of February, President Ramaphosa initiated the much anticipated cabinet changes. He removed several ministers which were tainted by allegations of state capture, but he also accommodated some Zuma loyalists, while appointing very good people to key economic policies. Former Finance Minister (FM), Nhlanhla Nene, replaced Malusi Gigaba and Pravin Gordhan was given the tough post of Public Enterprises Minister. ANC Deputy President, David Mabuza, was appointed as Deputy President of the country.

In March, Moody’s left SA’s sovereign credit rating unchanged at Baa3 (lowest investment grade rating), but somewhat surprisingly changed the rating outlook from negative to positive. They stated three main factors for leaving the rating unchanged. First, it looks like there has been a halt or a reversal to the deterioration unchanged. First, it looks like there has been a halt or a reversal to the deterioration of SA’s institutional strength. Secondly, GDP growth prospects picked up and thirdly that the 2018 fiscal budget is very credible. Furthermore they stated that the outlook change reflects an even balance between upside and downside risks, with “the new administration facing equally significant opportunities and challenges”.

Up next, following the rating decision by Moody’s, was the SARB monetary policy meeting. The SARB cut interest rates by 25 bps in a finely balanced 4:3 vote, providing further support for the economy. They revised their inflation forecasts down moderately, citing that the increase in CPI by VAT and excise taxes are offset by the stronger rand. They also stated that Q1 2018 likely represents the lowest point for CPI. The SARB now projects CPI to rise above 5.0% in Q3 2018 and stay above this level until end 2020, peaking at 5.5% in Q1 2019. With regards to growth, they took a conservative stance, increasing their 2018 forecast to 1.7% from 1.4% and lowering 2019 to 1.5% from 1.6%. This growth forecast is in contrast with the Treasury and consensus forecast, considering the recent big boost to business and consumer confidence, which the SARB acknowledges. Until end 2020 they still forecast three 25 bps rate hikes, but at a slower pace than previously indicated.

In the US the Federal Reserve continued their “rate normalization” by hiking interest rates by 25 bps. During the quarter, President Trump imposed tariffs on solar panels, washing machines, steel and aluminium. This was followed with tariffs of $50 billion on Chinese goods, which sparked retaliation by China. The US stock market had a correction in February and continued to drop in March, with technology stocks contributing the most. GDP growth in 2017Q4 came in at 3.1% q/q, beating expectations of 1.8%. SA’s unemployment rate decreased slightly to 26.7% from 27.7%. During the quarter CPI YOY improved from 4.7% to 4.0% and PPI YOY improved to 4.2% from 5.2%. The USDZAR strengthened to 11.82 from 12.39. The 10 YR SA government bond strengthened to 8.15% from 8.78%. The trade balance decreased to 0.43bn from 15.31bn.

The MM yield curve shifted downwards because of the 25 bps Repo rate cut, but it also steepened a little. With CPI most likely bottoming in Q1 2018 and the VAT hike being inflationary over the next year, we expect a very shallow rate cutting cycle.

What we did

All maturities were invested across the money market yield curve, exploiting the term premium. Quality corporate credit, which traded above the 3 month JIBAR rates, was added to the portfolio. We preferred a combination of floating rate notes (FRN’s) in the portfolio together with some fixed rate negotiable certificates of deposits (NCD’s). The combination of corporate credit, high yielding NCDs and FRNs will enhance portfolio returns.

Our strategy

Our preferred investments would be a combination of fixed rate notes, floating rate notes and quality corporate credit to enhance returns in the portfolio. Currently we prefer floating rate instruments above fixed rate instruments.