Investment Environment November 2018

07.12.18

International

In October and November markets gave back all the gains for the year and in some cases more. Using the S&P500 as an example, the year to date return is 2.4% having bounced in the last week – see the graph.

So what’s worrying markets?

Three things:

1. Has earnings growth peaked?

The graph shows a Bloomberg consensus survey showing that post 2Q2018 earnings growth is expected to slow down. However what is important to remember is earnings are still expected to grow albeit at a slower pace – pick a number between 10% and 15% for growth going forward next year. It is likely that if the oil price remains subdued as shown in the graph below that this will be supportive of corporate earnings. It appears that the hay days of 2014 where oil prices were >USD100 are over. Taking these factors on a combined basis, the market has nevertheless corrected and what is noteworthy as shown in the graph is that PE multiples are back to a bull market average and more importantly valuations are at the same levels as at the end of 2013. It is difficult to argue that the market is cheap but assuming some earnings growth remains intact, it is definitely not expensive. 

2. US Interest Rates are now a reality

For the last 10 years since the global financial crisis the monetary stimulus introduced by central banks caused interest rates to fall to near zero. However, since late 2016 interest rates have started to emerge as shown in the FED Funds Rate and 10 Year Treasury below. The equity market ignored this until Powell (Chair of the Federal Reserve Bank) became vocal on interest rates and predicted four increases of 0.25% each in 2018, of which three have occurred and the last is expected in December. What is heartening is Powell’s recent remarks that interest rates are near neutral  which might imply more subdued increases in 2019. This would be good for equity markets.

3. The US China Trade War

It is important to understand that President Trump is using the US Import Bill to negotiate the US’s relationship with major trading partners, in particular China. The graph below shows the imbalance of US imports from China relative to exports, causing a negative trade balance. This implies that any tariffs would be far more punitive on China than the US. This uncertainty has rocked markets but fortunately President Xi Jinping and President Donald Trump reached a truce that no further sanctions will be imposed for 90 days on the sidelines of the current G20 summit. This pause and the prospect of a calmer negotiated settlement should be good for equities removing the tit for tat approach and uncertainty surrounding these two major economies.

Although the three points above are causing the current market jitters and valuations could be “neutral” and not extended, things on balance look to be okay. If this is the case there will be no doubts that the US market has overreacted (which all markets always do) and we can expect reasonable equity share price growth into 2019.

South Africa

The JSE, which is representative of South Africa equities albeit >60% have ZAR hedge qualities, has shown yet again that markets hate uncertainty. South Africa suffers from political uncertainty, historic corruption – the cost of which is only being counted now, and very slow economic growth as predicted by the new Minister of Finance, Tito Mboweni, to be only GDP 0.7% for the current financial year to February 2019. Surprisingly, the GDP growth for 3Q2018 was reported as 2.2% which optimistically shows the recessionary environment but pessimistically Eskom’s load shedding will negatively affect this.

The graph of the JSE All Share Index demonstrates this.

The hope is that Ramaphosa can tackle corruption and lead the ANC as a united party (which it certainly isn’t at the moment) to a convincing victory in the May 2019 election. The importance of this cannot be underestimated as it will mean that Ramaphosa is a truly elected president and hopefully marginalize the other political parties. The assumption is that if this is achieved and the ANC appreciates and has some remorse about the “sins of the past” it will give Ramaphosa the necessary backing to introduce the reforms that SA so badly needs. In turn this should lead to business and consumer confidence which should give SA some economic uplift and improve prospects. Here’s hoping!

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