US CPI data release drives a strong rally in markets in June 2024, and SA’s GNU is well received by local markets.
SA inc stocks jumped although there was some retracement as there is still uncertainty as to how effectively the political parties will work together. Big tech continued to be a driving force for markets, and while AI remains a clear tailwind for the technology sector there are some questions around which players will truly unlock value.
Introduction
June has been a good month for markets although volatility ticked up. The main offshore themes continued with a lower-than-expected inflation reading being the catalyst for bullish sentiment. Locally the Government of National Unity (GNU) saw SA inc stocks jump although there has been some retracement as there is still uncertainty as to how effectively the political parties will work together.
Big tech continued to be a driving force for markets with Nvidia temporarily becoming the largest company after surpassing both Microsoft and Apple. This was followed by a steep sell off driven by a number of technical factors although the fundamentals still look strong. While AI remains a clear tailwind for the technology sector there are some questions around which players will truly unlock value.
The June Fed Meeting and CPI data release coincided with CPI coming in slightly softer than expected which drove a strong rally in markets. This strength was unaffected by a more hawkish dot plot put forward by the Fed. Other macroeconomic data has remained fairly mixed with the labour market softening but other areas still showing underlying strength. The market continues to adjust expectations for a rate cut with the majority of economists expecting a cut in November although some believe it might come earlier than that. The ECB has already made the first move by cutting by 25bps although it has indicated it still remains data dependent and a fast-cutting cycle is unlikely.
Locally the main focus has been on the political front following the outcome of the National election. There has been significant political jostling creating a fair amount of uncertainty which is fairly clear from the movement in the Rand. The resulting GNU has been well received by the market as it is seen as the best outcome and there is hope politicians will now focus on putting the country first. During the election of Speaker and President it appeared the Party Members were voting in line with their Party stance without any major upsets taking place. President Ramaphosa announced a cabinet that while bloated appears to be a true outcome of the GNU where representatives of parties have been considered. Although the negotiation had a number of moments where it nearly collapsed in the end we have a new cabinet under the GNU. There is a long road ahead but it appears as a country we are moving in the right direction and if all these leaders can find a way to work together it will likely be the best outcome that we could have hoped for.
Macro Environment
US Inflation continued the disinflationary trend in June which provided the markets comfort that the high interest rate environment is doing its job. The sideways movement from earlier in the year appears to have abated. The May CPI levels came in lower than expected with headline coming in flat Month on Month (MoM) and core (excluding food and energy) rising 0.2% MoM. This is the lowest monthly reading since August 2021. Shelter which has been a key inflationary issue continued to rise but new vehicles and airfares both saw a decrease. In a unique timing overlap the release of CPI coincided with the Fed’s latest meeting where they kept rates on hold. This was largely expected by the market with a 98% chance of rates remaining unchanged being priced in. The June meeting did provide us with an updated dot plot (Summary of Economic Projections) which did see a significant change with the median expectation now sitting at a single 25bps cut in 2024.
This is a significant shift from the 75bps worth of cuts that were previously forecast. However, looking longer term there was a more dovish shift as both the 2025 and 2026 dots indicated additional easing and the general language was interpreted as more dovish. Chairman Powell reiterated the view that the Fed needs more confidence before they can begin cutting. Recent commentary from Fed speakers has varied with those leaning more dovish indicating they are getting closer to a cut while the more hawkish don’t see any cuts this year and have even touted a possible hike although the market is not giving this any weight.
The Fed’s preferred method of inflation (PCE) was released on Friday (28 June) and showed a 2.6% increase which was in line with expectations. As outlined by the chart below, the PCE measure continues its disinflationary trend which is positive for rate cut expectations.
Asset Allocation
Our asset allocation remains largely unchanged as portfolios are well balanced for the current market dynamics. We have had a number of our Structured Notes mature and have been rolling positions into new notes in order to keep our asset allocation in line. Locally we continue to watch the political landscape and the progress on the GNU to assist in our discussions about potentially upweighting the exposure to SA Inc companies. For now, we remain patient as there are a lot of negotiations taking place and these need to unfold.
Market Performance
June was a good month for local and offshore markets. During the month of June, the S&P500 ended up 3.47%. The MSCI World index was up 3.91% for the month and the JSE saw a positive return of 2.22%. As per chart below the YTD performance of the JSE is up 3.66% (in ZAR), while the S&P500 is up 14.48% and the World index is up 12.48% (in USD), respectively.
Bonds
Bonds play an important role in the portfolio as we seek to lock in the attractive yields on offer while limiting the credit risk. The yield curve continues to move around as markets are seeking to digest the latest macroeconomic data. South Africa has seen positive moves in the bond market as the announcement of the GNU was well received by the investing community although volatility remains as outlined by the 10-year chart below. SA yields continue to look very attractive, and should the positive political momentum continue then we could see further yield correction and some much needed capital uplift in our bond market. While we remain an equity focused house in a higher yield world, we use bonds in portfolios as a diversifier and a benefit to the portfolios risk adjusted return.
Equities
There has been a lot of discussion around equity valuations and whether they have gone too far. While we acknowledge that some valuations do appear to have got ahead of themselves, we believe valuation cannot be viewed in isolation and there are a number of factors to be considered. An example of this is the impact of earnings and expectations thereof. An easy way to view this is the PEG ratio which compares the PE (valuation) to the earnings growth. The lower the PEG ratio the better. If a company with a PE of 20x has earnings growth of 10% their PEG ratio is 2. Whereas if that same company has a PE of 20x but achieves earnings growth of 20% then the PEG ratio is 1. Thus, the lower the PEG ratio the better the valuation is relative to growth prospects. The below chart reflects the PEG ratio for the S&P500 which has been decreasing so despite high valuations this is a good trend and shows the earnings growth under pin that is backing up the valuations.
Looking forward earnings expectations for the S&P500 are high with analyst projecting earnings growth for 2024 of 11.3%. Then further growth of 14.4% in 2025. Should these projections unfold then it would be the third time in 15 years that that the S&P500 has reported back-to-back double-digit growth. Current projections reflect broad based earnings growth although technology remains a key driver. The high interest rate environment naturally makes earnings growth more challenging so the path of the Fed will have an impact on achieving this. Earnings are always critical to the investment thesis, and we are watching it closely as the current lofty valuations require this growth to come through to avoid a multiple correction. We are a couple weeks away from Q2 earnings season and current projections are for 8.8% earnings growth for the quarter from the S&P500. This is despite the mixed guidance provided by companies in their Q1 earnings report, but the US economic strength supports good earnings.
Conclusion
June has been another strong month for offshore markets while the local market is trying to digest the uncertainty around the GNU. Macro data remains a key driver of the market although as we head into earnings season with fairly high expectations, we will be monitoring results closely to ensure the company’s fundamentals continue to stack up. We are comfortable with our portfolio positioning and believe that performance will benefit from further earnings growth while managing the risk of the high valuations and expectations. Should you wish to chat through any of the detail please reach out to the team.
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