Investment Environment July 2019

26.07.19

2019 equity performances have proven very positive year to date, with virtually all markets achieving double digit returns (with the exception of Japan – Nikkei 225). The S&P500 graph illustrates the market confusion over the last year.

The US market, illustrated by the S&P500, has achieved new highs of late but this has not been without some testing moments in December 2018 and May 2019. The key drivers of the US market have been the uncertainty surrounding the trade war as Trump continues to knee jerk react to China’s retaliations. This has been compounded by an about turn of the Fed on interest rates. In December Powell forecast 3 interest rate rises in 2019 which have not materialised and it now appears that US interest rates will be reduced by the Fed as early as at its upcoming meeting scheduled for 31 July.

Logically, if one looks at the graph it is difficult to assume that the two largest economies in the world can continue a trade war to both of their detriments. Between China and the US the contribution to world GDP is in excess of 50% and estimated by the IMF to contribute GDP of USD35.8 trillion in 2019 and growth of USD 2.27 trillion in 2020. It is difficult to imagine how they will trade without one another’s cooperation.

Furthermore, the following facts are worth considering:

  • The US economy remains clearly dominant which probably gives it the right to perpetuate the trade war. However, it’s forecast to grow by USD830 billion which is approximately 3.5%;
  • China continues to come under scrutiny as its growth is expected to “slow” to around 6.1% next year. What everyone forgets is in absolute terms Chinese growth amounts to USD1.44 trillion whereas the US growth amounts to USD830 billion (42% less than Chinese growth), followed by the Euro area of under USD700 billion. In fact, in 1Q2019 Chinese GDP growth slowed to 6.2% which is the lowest GDP growth for the last 30 years.
  • The above two points show how important, and more so destructive, a trade war between these two economies will be. However, the uncertainty remains and as has often been said, markets don’t like uncertainty!

Subsequent to May, with the prospect of monetary accommodations from not only the US Fed but generally central banks worldwide, equity markets have taken heart. Valuations (PE ratings highlighted in green) are on the high side and will be tested with the expectation of world economic growth slowing late in the cycle. In fact, pessimists argue that the US will be dragged into recession in 2020. This is probably why the Fed has turned tail on interest rates in an effort to right the yield curve and stimulate the US consumer to prevent economic slow down.

While world economics continue to confuse equity investors, the situation is being exacerbated by politics! Today the Queen will ask Boris Johnson to form a new UK government. This compounds the uncertainty. The similarities between Tweedle-Dee and Tweedle-Dum are frightening. The world waits in trepidation as this plays out.

South Africa

With the May elections a distance memory and Ramaphosa’s government being plagued with a weak South African economy (2019 GDP <0.6%), SOE debt and in particular Eskom spiralling out of control and a good dollop of political chaos, it is difficult to reconcile the strength of the ZAR. The only explanation is that with Developed economies continuing with low/lowering interest rates that the ZAR carry trade is attractive. This will continue in the short term but is unlikely to persist as the South African Reserve Bank has started dropping interest rates in July and almost certainly will continue this trend through the remainder of the year. This has been demonstrated by the movement in the yield curve, but is also an obvious necessity with inflation expected at CPI 4.4% and is needed to spur on the economy. Politically, this is also an imperative with the extreme high rates of unemployment.

Regrettably, South Africa is banded together as an emerging market and will suffer the consequence of developed markets consumer slow down and more, with poor economics and the continual threat of a debt downgrade.

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