ECONOMIC AND MARKET OVERVIEW
Global
Throughout 2019, the global economic backdrop, while seemingly strong, has kept investors on edge. Tantalum Capital attributes this to both the length of the current economic expansion as well as the belief and knowledge that the expansion has been fueled by unsustainably low interest rates amidst rising socio- and geo-political tensions.
Fiscal constraints imposed after the 2008/2009 global financial crisis have systematically been dismantled in many key economies. Labour markets in the United States and Europe showed signs of peak health, levels which usually signal that inflationary wage pressures are imminent. Commodity prices have also continued their rally, which would usually raise the prices of goods and fuel the forecast for consequent cost-push inflation. When coupled with a pending trade war between the two large economic superpowers of the United States and China, where tariff imposition should also inevitably lead to greater goods price inflation, market participants have fretted all year that asset prices could and should reflect more risk. They should also de-rate in line with the deterioration in new growth capacity and a more hawkish policy stance. Despite a briefly inverted US Treasury yield curve mid-year, this did not happen. Investors rather stayed in the trade, supporting the prices of known growth
assets (equities in particular) boosting cyclical stocks in many cases and even supporting stuttering economies like South Africa, where attractive yield remains on offer.
In their December market commentary the team from Tantalum argued that economic expansions do not die of old age, but typically end suddenly due to policy mistakes and pent- up imbalances in specific areas of the global economy. In the current cycle the booming, doomed imbalances are not that easily identifiable. The known “suspects” like US housing, sovereign debt in Europe and Japan, and Chinese bank lending appear to have found their own supporters and policy enablers. This merely kicked the economic growth can down the road.
The most significant and pressing other risk to global growth is not of an economic nature, but rather socio- and geo-political in nature, with a rapidly polarizing world order developing. Within countries and across continents global political tension has arguably not been higher since the Cold War. This reality should claim some level of risk discount in asset prices, as the tension can readily manifest itself in fiscal and economic policy missteps and misallocation of capital and spending.
As an alternative to this consensus view TS Lombard, a global macro research house, holds the view that positive surprises could set the scene in 2020. 2019 didn’t go the way the consensus expected. After a shock selloff in equities, GDP growth in most economies deteriorated unexpectedly sharply and inflation dipped lower, in contrast to what a hawkish consensus had anticipated. Central banks arguably provided the biggest surprise in 2019, shifting their ‘reaction function’ in a way few analysts had anticipated. The authorities ditched their traditional inflation models and reacted aggressively in an effort to keep the decade-long global expansion going. The consensus for 2020 is that these efforts will prove successful (sort of), with growth a tiny bit higher, inflation steady and monetary policy on hold. Given the recent ceasefire in the US-China trade war, plus Fed “liquidity” support, TS Lombard argues that market confidence (and asset prices) could bounce more sharply than the consensus expects. The question is whether this improvement in sentiment will also materially boost global growth and lift inflation – this is the scenario nobody seems to be talking about for 2020.
South Africa
In South Africa, the economic situation remains tense. Renewed power generation problems at Eskom in December stemmed growing optimism over the appointment of their new CEO and the decisive action to deal with the ailing SAA.
Business and consumer confidence has been at such a low ebb for such a long time that the market has been looking for early signs of a turnaround in both Eskom’s and the country’s fortune. Interestingly, the rand has held firm all year, and rallied even more in December. The price of South African bonds followed suit as yields continued to fall. This provided another indication that the global search for yield remains high, and that the absolute interest rates on offer in rand are attractive versus the entire emerging market and developed market bond universe, despite the negative ratings outlook in place.
In a January 2020 investment note Fairtree Capital observed that South Africa’s growth rate has stagnated over the last decade. This structural decline can mostly be explained by a loss in productivity. The economy is in desperate need of both economic and political reforms. During the first fourteen months of President Ramaphosa’s term his focus has been on uniting factions within the ruling party (ANC) and strengthening his power base to win the national election held in May last year. He has been successful but one could argue that it has come at the expense of driving a much needed and urgent reform phase. Ramaphosa now holds clear power across most government and provincial structures and his recent actions (placing South African Airways in business rescue status and more recently, PRASA under administration) have been a move in the right direction to demonstrate his willingness to drive reform. Eskom, the country’s electricity utility company, remains a significant challenge for South Africa and a clear solution is still not evident. Fairtree reasons that the country is now in a political reform phase with movement being gradual and incremental. What is key is that the President has reinforced instrumental parts of government, namely the revenue services (SARS), the national prosecuting authority (NPA) and South Africa’s investigative and intelligence arm (Hawks). Constructively, and in Fairtree’s view very positively, President Ramaphosa has achieved much in the early phases of his term in office.
