South African investors should brace themselves for considerable market volatility in the months ahead, on the back of rising concerns over fiscal contraction in Europe, budget clashes and slow growth in the US, and slowing growth in China, among other issues, according to Rian le Roux, chief economist at Old Mutual Investment Group South Africa.
Le Roux cautions that it is investors’ negative perceptions around these issues that are dominating equity and bond markets around the globe, and will continue to do so for some time. “This will favour emerging markets, including South Africa, as investment destinations, but the local market is still likely to suffer from big swings driven by this newsflow for the rest of the year,” he says. “Investor sentiment is particularly fragile right now and we certainly won’t escape it.”
With fiscal tightening looming large in many big economies including the US, UK and most of Europe, and the global recovery having lost momentum (again), it is the combination of slowing growth and the acute debt problems in Europe and the USA that is causing the most worry. Political brinkmanship in the US is threatening the triple-A rating of US Treasury bonds. Failure to raise the debt ceiling and/or to effect a meaningful reduction in the budget deficit over the medium term could cause considerable turmoil in global financial markets.
“While neither of these two scenarios is likely to materialise, it is simply the fact that they are being debated that is sparking increasing investor unease,” notes Le Roux.
“Just look at the price of gold, which is at an all-time record above $1 600/oz — there seem to be very few safe-haven investments out there right now. The US economy is stuttering, China is slowing and Europe is overwhelmed by debt, while emerging markets are still perceived to be risky.”
The implications of these deteriorating conditions, he says, are that the developed world is likely to maintain expansionary monetary policies for longer, and will continue to underperform developing countries, where inflation is the primary risk. This will maintain the attractive interest rate differentials in developing countries, lending further support to developing country currencies at the expense of the euro and US dollar.
“For South Africa, this means the rand could well stay stronger for longer, which will help keep inflation under control and probably delay any interest rate hikes until late this year or early 2012. At the same time, though, it continues to undermine our exports. So although we’re experiencing a moderate recovery led by consumer spending, it remains uneven — investment and export growth are lagging so that we’re only likely to reach 3.7% GDP growth this year.”
Le Roux believes inflation is not a significant threat to the economy, even though it is on the rise. “Over the next few months we do expect CPI to rise from 5% year on year currently to around 6% at year-end, but core inflation (excluding food and petrol costs) remains relatively subdued at 3.5% year on year. We’re likely to see only a moderate up-cycle in inflation and interest rates ahead — barring an unexpected rand sell-off. For example, we’re pencilling in a total of 150 basis points in rate hikes through the cycle to the end of 2012.”
Risks, he says, mainly stem from the global environment, with the rand’s exchange rate remaining key. “Right now investor sentiment towards emerging markets remains relatively positive, but the fragile nature of the world economy means that sentiment could change very quickly. We aren’t immune to contagion from a worsening debt crisis in the Eurozone, for example. At the same time, conflicting messages we send around foreign investment in SA and government ownership policies create further uncertainty, undermining that positive sentiment and, eventually, our longer-term economic growth prospects.