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Cape Town - SA stocks appear stretched on a valuation basis relative to other global equity markets, says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.
SA equities trade on a trailing price-earnings multiple of 19.2x which is significantly above global peers and significantly above the 14.3x long-term historic average, says OAM.
"This would be warranted if companies and the economy were exhibiting above-average growth rates but this is currently not the case," according to OAM.
South Africa economic review
• Mining production contracted in August by -1.1% month-on-month while July’s previous estimate of 1.1% was revised lower to -0.8%. On a year-on-year basis mining production slowed from a downwardly revised 4.0% (previously 5.6%) to 3.8% well below the 6.5% consensus forecast.
The performance is disappointing, mining output declined -3.3% quarter-on-quarter in the three months to end August. The outlook remains poor. The beneficial effect of the low comparative base last year will soon dissipate indicating further output declines in the months ahead amid weakening global demand and falling commodity prices.
While the demand remains lackluster domestic infrastructure constraints such as electricity load shedding will constrain supply.
• Manufacturing production increased in August by 0.4% month-on-month although declined in the three months to end August by -0.3% quarter-on-quarter. On a year-on-year basis growth in manufacturing production slowed from a downwardly revised 5.3% to -0.2%.
The main culprits were the “basic iron and steel, non-ferrous metal products, metal products and machinery” sector which fell by -8.0% on the year and subtracted 1.6 percentage points from annual growth. The vehicle, parts and accessories sector also fell -4.4% on the year subtracting 0.4 percentage points from overall manufacturing output.
The Steel and Engineering Industries Federation of SA warned that the contraction in the iron and steel sector is likely to continue further clouding the outlook for manufacturing in the months ahead. The outlook remains poor amid weak external demand and subdued domestic business confidence while supply will continue to be constrained by energy outages.
• In a speech in New York SA Reserve Bank Governor Lesetja Kganyago said that while weak the economy will not go into recession. Kganyago also indicated that inflation expectations will rise above the central bank’s 3-6% target range but it was unlikely this would prompt monetary tightening: “Our expectation is that next year, in the first quarter, inflation will be outside of our target range. We think that is temporary.”
Kganyago also outlined the substantial benefits of SA’s macroeconomic structures including transparent fiscal policy, credible inflation targeting, and a free-floating exchange rate, which he argued helps unwind economic imbalances.
• Foreign investors bought a net R7.3bn worth of domestic bonds in the past week almost reversing the substantial –R9.3bn net selling during the month of September. The inflow is attributed to greater risk tolerance following the release of “dovish” Federal Reserve policy minutes.
However, foreign investors remained substantial sellers of domestic equities, selling a net –R4.7bn in the past week following net sales of –R4.5bn the previous week. While net foreign equity purchases for the year-to-date remain reasonably healthy at R25.03bn the heavy –R9.2bn net selling over the past fortnight lifts the chances of a market correction in the near-term.
South Africa political overview
The ANC’s National General Council conference, which traditionally assesses the success of policies endorsed at the previous national elective conference, shed little light on the party’s succession. However, this fact alone seems to support the ascendancy of Cyril Ramaphosa since he is the assumed successor.
Key decisions taken by ANC conference members are likely to foster concern and will most probably be watered down at government level: First, the decision to “fast track” the National Health Insurance in spite of lacking detail on the costs involved and an already strained state budget.
Second, the party’s official endorsement of the 50/50 proposal that all farm owners should give 50% of their equity to farm workers. Third, the decision to consider a “wealth tax” as a means of financing the state’s development costs.
The week ahead
Nil this week.
Technical analysis
• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. Although the rate of the rand’s depreciation is accelerating there is no sign yet of panic selling or capitulation. This stage needs to be reached before a reversal in the rand’s move can occur.
• The US dollar index is testing a major 30-year resistance line, which if broken will pave the way for further strong gains in the currency.
• Despite the recent uptick in bond yields the long-term JPMorgan global bond index bull trend remains intact, with the yield targeting a new low during the fifth and final wave.
• The US 10-year Treasury yield has broken above key resistance levels of 2.0% and 2.2%. However, there is unlikely to be a major bear trend in US bonds as the deleveraging phase is still in its early stages.
• The benchmark R186 SA Gilt yield is testing support at 8.70% which if broken could open a new target of 9.5%.
• The MSCI World Equity index has broken downward from a rising wedge formation which has been intact since the 2008/09 global financial crisis. It is unlikely that the downward move is over as the correction so far is too small for a bull market of the magnitude and duration of the 2009-2015 bull market. The downside target for the MSCI World Equity index is 1 400.
• Since the 1950s the Dow Jones and S&P 500 have displayed 7-year up-cycles and the top of the current US equity cycle can be expected in the next year. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur around June 2016.
• The S&P 500 has broken down from a rising wedge pattern, which is traditionally a trend-changing pattern. The break below the 2070 level confirms a reversal of the upward trend. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is leading the broader market lower on the downside.
• Brent crude’s break below the key $50 support level suggests a continuation of the weakening long-term trend. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the key $5 300 support level suggesting further downside ahead.
• Despite recent advances Gold is in a protracted bear market signalled by rapid declines through successive support levels at $1 300, $1 250 and $1 100. Gold’s next target is $1000 which is likely to be breached before the bear market ends.
• The All Share index has broken below its bull market support level which has been intact since 2009. The downside target for the All Share index is 41 000.
Bottom line
• In its latest World Economic Outlook (WEO) report, the IMF lowered its GDP growth forecasts for SA from 2% to 1.4% in 2015 and from 2.1% to 1.3% in 2016. The IMF cited electricity load-shedding and other supply side bottlenecks for the downward revision, in addition to lower commodity prices and increased import competition in sectors such as steel manufacturing.
• The World Bank downgraded its SA growth forecasts for 2015 and 2016 to 1.5% and 1.7% from its earlier forecast of 2% in each year. The Bank cited the country’s electricity challenges, high unemployment, a volatile currency and poor business and consumer sentiment.
• At its latest policy meeting in September the SA Reserve Bank (Sarb) marked its GDP forecasts substantially lower from 2% to 1.5% in 2015, from 2.1% to 1.6% in 2016, and from 2.6% to 2.1% in 2017.
While leaving the repo rate unchanged at 6% the central bank stated that “it remains on a gradual policy normalization path” citing upside risks to the inflation outlook. The policy statement suggests the current interest rate hiking cycle has further to go in spite of slowing growth.
• Slower GDP growth goes hand-in-hand with declining corporate earnings growth, which accompanied by prospects of rising interest rates makes it difficult to justify the massive +8.20% rally in the JSE All Share index over the past month.
• SA stocks appear stretched on a valuation basis relative to other global equity markets. SA equities trade on a trailing price-earnings multiple of 19.2x which is significantly above global peers and significantly above the 14.3x long-term historic average. This would be warranted if companies and the economy were exhibiting above-average growth rates but this is currently not the case.
• Foreign investors’ contribution to total market traded volume has been higher than average over the past fortnight which combined with the hefty net selling by foreigners lifts the chances of a market correction in the near-term.
For the full report, including a look at international markets, click here.
* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
