Investment Environment February 2017

03.04.17

In November we indicated that the Trump presidential victory was probably good for US equities and the US dollar. In January this year we reinforced this belief in a paper entitled “Investments and Politics”. To date we are very pleased that the US market and the USD have endorsed these views as shown in the graphs.

This trend has been assisted further by the FED pausing on interest rate increases, but as we write, markets are expecting US short term interest rates to be increased by 0.25% on 15 March. Although the magnitude of an interest rate increase is not significant, the trend is important as it indicates the FED has a reasonable conviction that US GDP growth is intact. Further support also comes from the US unemployment figures that in February dropped to 4.8%. The significance of this is that if unemployment is < 5%, economically this is regarded as operating at full employment and all the benefits associated with that, not least of all improved consumerism. On top of this equity markets are assuming that the Trump administration will embark on significant fiscal spend; this will inject growth into the US economy. The recent presentations to congress by Trump have been short on detail, but kept the hope of this fiscal stimulation in Investors’ minds.

It would appear that on balance Trump policies are positive for the next couple of years and sufficient to overcome the negativity associated with proposed trade policies. The engine of growth in the US economy is significant enough to imply global economic growth, particularly if the Chinese economy stabilises at growth rate of GDP +6% and the Eurozone continues to produce meagre but steady positive GDP growth. This cocktail is very good for equity markets.

Since mid 2016 the JSE has grossly underperformed and the reconciling factor between the positive story above and South African equities is the ZAR. As shown in the graphs, the strengthening ZAR/USD is attributable to the equity underperformance.

The question that consumes South African Investors’ minds is “What is the price direction for the ZAR?” and related thereto, interest rate and fiscal policies. The easiest question to answer is that there is unlikely to be any fiscal stimulus from Treasury as we were told in Pravin Gordhan’s February budget. However, with the improving trade balance, fragile GDP growth forecast at 1% and efforts to keep rating agencies from downgrading South Africa, it is likely that interest rates have peaked and could potentially decline into 2018. This alone could help equity markets but might also discourage foreign Investors from seeking yield in emerging markets and potentially unwind carry trades. The net outflow of ZAR could weaken the Rand towards the end of 2017. There is always a risk that politics, which is focused on upcoming leadership challenges and consequent lack of policy implementation, could have an extraneous effect of weakening the Rand – but who knows?

What has been interesting, although unfortunately a far less significant contributor to GDP (5–6%), is the South African mining industry. Mining and Material Stocks showed considerable performance after January 2017 and one wonders if this troubled industry could re-emerge as a significant investment theme. While US consumerism is undoubtedly positive, mining requires: 1) commodity prices to be maintained and improve (obviously!); 2) no labour disruption in the upcoming wage negotiations (political effect?); and 3) the services infrastructure (eg electricity) to remain stable. If 2 out of 3 of these are positive mining will return as an attractive investment sector.

In conclusion, Douglas Investments remains positive on US equities for the time being and patient as US interest rates rise, hopefully to the extent that an interest yield can be introduced into portfolios going into 2018. The South African market is very much in the balance, but will probably be supported by Reserve Bank monetary policy in the absence of fiscal expenditure which will be positive for equities, particularly if the Rand has a weakening bias. While politics can cause short term negative blow outs, these cannot be used to invest on a long term basis and are usually detrimental over time.

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