More of Nothing and Maybe a Little Something
Current South African Economic Growth
After the euphoria around the changing of the guard in early December 2017, economic growth and activity have slowly grinded to a halt. But the news is not all bad. Read on. Maybe with some ginintonix help! I did.
After growing by 3,1% in the fourth quarter of 2017, the South Africa economy wobbled in the first quarter of 2018, shrinking by 2,2% quarter-on-quarter (seasonally adjusted and annualized). This 2,2% fall is the largest quarter-on-quarter decline since the first quarter of 2009. In that quarter, the economy contracted by 6,1%.
On August 7 economic updates on manufacturing and industrial production were made by Stats SA. We summarize both.
Manufacturing Update: Better News
Manufacturing production rose by 0.7% y/y in June. This is after May’s larger than expected increase of 2.0% y/y (revised downwards from 2.3% y/y). This result was slightly below consensus expectations of a 2.2% y/y lift.
Looking at a disaggregation of the data, only two of the ten manufacturing divisions made a positive contribution to the headline outcome. The food and beverages category, based on its heavy weighting of 25.8%, made the largest contribution, adding 1.1% to the topline number, on the back of growth of 4.3% y/y.
On a quarter on quarter seasonally adjusted, annualized basis (qqsaa), which is the measure used to calculate GDP, manufacturing production fell marginally in June, by -0.5%, suggesting that the manufacturing sector should detract slightly from GDP growth in Q2.18.
This is in line with advance indications provided by the June PMI index and the BER’s most recent manufacturing survey for Q2.18, which advised that underlying growth momentum remains relatively weak in the sector, with persistent weak demand holding back production.
However, although cost pressures and waning global export order growth continue to weigh on manufacturers, the recently released July PMI points to a moderate improvement in the manufacturing sector at the start of Q3.18. Strengthening demand was reflected in higher new sales orders in July, which in turn supported a lift in business activity.
Industrial Production Update
Electricity and manufacturing data for June point to a H1.18 recession, along with the likelihood of weak mining statistics for June (still to be released) and another potential contraction in the agricultural sector in Q2.18
SA’s industrial production components released to date (electricity and manufacturing production) show a potential contraction for Q2.18. Manufacturing production fell -0.5% qqsaa in Q2.18. June’s mining production is yet to be released but is expected to continue its deterioration on the quarter qqsaa.
Industrial production accounts for just below 25% of GDP. However, its components, manufacturing, mining and electricity production are in the primary or secondary sectors, and so they both impact the tertiary sector, and tend to have a meaningful influence on GDP growth. In Q2.18 electricity production rose 1.7% qqsaa,but has a tiny weighting.
For industrial production figures to avoid a recession in Q2.18, and so not pull GDP growth down, mining production would need to record growth of at least 4.0% m/m, seasonally adjusted, for June. The risk is that a contraction in industrial production in Q2.18 would contribute to another negative quarter in GDP, and so risk an economic recession.
Indeed, GDP growth remains at risk from a further source, with Agbiz (the Agricultural Business Chamber) estimating that the agricultural sector could contract by close to 20% qqsaa in Q2.18. The Q1.18 figure might be revised up somewhat, but still show a contraction. With the primary and secondary sectors of the economy likely in contraction in Q2.18, much will depend on the tertiary sector.
Specifically, Agbiz reports that the maize harvest will only be partially factored in Q2.18. Roughly 20% of the harvest has been delayed due to a late start of the season on the back of unfavourable weather conditions earlier in the year, particularly in the western parts of the country.
In addition, Agbiz reports the sugar and oilseed harvests also started late. However, the agricultural sector in Q3.18 and Q4.18 should be back in positive territory on the back of the expected large maize harvest (13.2 m.t. which is above the above average production of 12.5 m.t.), record oilseeds harvests and approximately 1.6 m.t. of soybean.
The leading indicator, which has a fairly significant relationship with GDP six months out, predicts that Q2.18 economic activity will improve over Q1.18, even if economic growth is not particularly robust. We continue to expect very weak GDP growth in Q2.18, but not quite a recession in H1.18 on a recovery in retail sales, although the risk for recession is elevating.
A H1.18 recession would likely shock the credit rating agencies. While we continue to expect no credit rating downgrades this year, the agencies’ patience with SA will likely wear thin sooner rather than later, particularly given the ongoing debt and financial issues at Eskom, and some other SOEs.
Business confidence index rises in July
As indicated by the Industrial Production Indicator above, all is not lost. The South African Chamber of Commerce and Industry’s (Sacci) monthly business confidence index (BCI) rose to 94.7 in July from 93.7 in June. The July index was boosted by merchandise export volumes, lower inflation and the recovery in real retail sales.
Business confidence raced to a 2-1/2 year high in January after Cyril Ramaphosa’s election as leader of the ruling African National Congress in December, with the private sector anticipating business-friendly policy changes following years of uncertainty under former president Jacob Zuma. The enthusiasm has since stalled following a raft of lukewarm economic data figures, such as the contraction in gross domestic product in the first quarter and rising unemployment.
Although there are still major economic challenges facing South Africa, it appears the downward trend in the business climate since February 2018, has lost its momentum and confidence could turn more positive.
For the current rise in business confidence to be at least maintained, there need to be several processes in place.
South Africa is hopefully in the early stages of a complex political and institutional turnaround. This must include all government department and sate owned enterprises
The latter process must lead to and facilitate structural reforms and more government policy certainty. Particularly around corruption, land reform, the mining charter and key state-owned enterprises.
The above should go together, and live in tandem with, the removal of monetary, fiscal and economic policy uncertainly, especially so from a foreign perspective, and the nurturing of global economic relations with both the developed and emerging worlds. More about the recent BRICS summit here in South Africa in our closing paragraph below.
The success of such processes will create much improved levels of local business and consumer confidence.
The latter will very soon create an environment where both local and foreign investors are eager to discover investment opportunities.
The result will be inclusive long-term economic growth and job creation resulting in a reduction in unemployment, poverty and of course inequality.
While government is probably primarily responsible for the final shaping of policies pertaining to economic, monetary, fiscal, corruption, land reform, the mining charter and key state-owned enterprises, the potential influence and possible roles of business, civil society, and labour must be emphasized. So, whoever you are and wherever you are, get involved. (Source 2)
So, Quo Vadis SA Equity Markets?
Again, we begin with our famous, by now infamous, graph of the JSE Alsi40 (in the top block) over the last 60 months. As is clear from the graph this index was in a sideways channel from April 2014 to mid-June 2017. In the bottom block of the graph is the relative strength of the Alsi40 Index measured against the S&P500.
We know that there is a very long history of a strong co-movement of equity markets over the globe. During the period April 2014 to June 2017 it appeared as if the South African equity markets (as measured by the Alsi 40) have somehow lost its connectivity with world markets. The good news is that we have regained traction as we reported recently. Over the last month the Alsi40 did not do as well as the S&P 500, but here are the numbers: measured from 1 June 2017 to 8 August 2018 the S&P500 delivered a 17.6% return while the Alsi40 harvested 11% (both in local currencies), while the latter returned 13.4% in dollar terms. Both numbers are sans a dividend.
By inspection, our market has not gone anywhere over the last 6 months from 19 February 2018 to 8 August 2018. In fact, in rand terms the Alsi 40 lost 0.2%. The S&P500 in local currency harvested 4.6%. So, have we started lagging again? In terms of relative strength, it seems so. Look at the red line in the bottom block of the graph above. The negative incline shows that the S&P500 advanced more rapidly over time than the Alsi40.
Yes, the lag seems to be there if compared to the S&P500. After the euphoria around the changing of the guard in early December 2017, economic growth and activity declined as policy risks mounted.
The average daily volume of shares traded on the JSE in the past month fell to 247 million on Wednesday. Factors such as the land issue as well the US-China trade deal may impact the fall. As a result, trading volumes on the JSE (Africa’s biggest stock exchange) have dwindled amid uncertainty about the ruling party’s policies on land, mining and others mentioned above ahead of elections set for next year. Factors such as the US-China trade wars (see our previous Some Notes on the World Around Us) and its effect on emerging markets may of course have an impact as well.
The average daily volume of shares traded on the Johannesburg Stock Exchange in the past month fell to 247 million on Wednesday, from as high as 408 million in January. On Monday 6 August, only 151 million shares changed hands, the lowest number since January 2.
Trading volumes fell in June and July and are on track for a decline in August, a month in which trading has picked up in four of the past six years. A decline in August would represent the first time in two years that trading volumes fell in three consecutive months.
The Graph below shows some recent correlation between trading activity and price movement.
While the drop-off in volumes may be ascribed partly to global factors including the trade war between China and the US and the withdrawal of monetary stimulus by developed-nation central banks, local political developments are also to blame. The euphoria that greeted Cyril Ramaphosa’s election as leader of the African National Congress in December, which elevated trading volumes in the first quarter, has dissipated, while policy uncertainty around land reform, mining ownership and others are rattling international and local investors.
In this current environment we maintain a larger than average cash position in conjunction with very low exposure to non Alsi40 equities with our normal emphasis on quality international players.
Oh yes, the final note about the very recent BRICS summit here in South Africa. The words of a song come to mind.
(Source 2 and 4)
Source 1: Investec Economic Research Source 2: FAL Research Source 3: The business confidence index rises. Reuters. 8 August 2018.
Source 4: Trading Volumes. Bloomberg. 7 August 2018.