ANALYSIS
A last-ditch volte-face agreement by Greece to European Union austerity measures and disappointing Chinese manufacturing data, coupled with economic contraction from Russia, Brazil and South Africa, provided risk-off triggers for market participants for the third quarter of the year.
The People’s Bank of China also fired the currency war bazooka, which led to a rout in both emerging-market and commodity-producing country currencies, and a sharp retracement of the Shanghai composite by more than 22%.
Global equities experienced their worst quarter in four years, down close to 10%. Disappointing global growth, falling commodity prices, extreme market whiplash and a weakening rand all contributed to a sharp pull-back of the JSE in the last quarter, with emerging markets seeing half a trillion dollars in capital flee – the first net outflow from emerging economies since the 1980s.
Sanlam’s estimate of fair value for the rand is between 10.50 and 11.50 to the US dollar.
The South African Reserve Bank added fuel to the fire by hiking rates despite an economy that contracted in the second quarter (quarter on quarter), with macroeconomic imbalances not being helped by Âmining and manufacturing sectors hamstrung by load-shedding and labour unrest.
But what market participants are bracing for is the potential buffeting that a hike by the United States Federal Reserve would unleash towards year-end.
Gross domestic product growth in China was 7.3% last year, with concerns about this year’s 7% target, the lowest in a quarter of a century. We don’t believe that a Chinese market rout will lead to systemic risks but the structural readjustment of the Chinese economy from an investment-led to a services-led economy will be a painful metamorphosis and shock to commodity markets.
Towards quarter-end, financial markets took a further blow with the news that VW had falsified emission tests, leading to a massive collapse in its share price and shaking investor confidence. This put further pressure on the price of platinum metals used in diesel vehicle catalysts.
But the global economy survived a worse scenario four years ago. After the great financial crisis, the valuations of equities were more extended than they are now. Before quantitative easing kicked in, the equity risk premium was not as attractive as it is now and investors felt the need to degear overleveraged balance sheets. Now we have a lot of cash sitting on the sidelines and both individual investors and companies have had time to repair balance sheets.
But softer global growth has led to weak demand for our exports and the dumping of various products on our shores, ranging from steel, poultry and cement to sugar. This has forced a number of companies into business rescue, with the whole of the steel sector on the brink and the precious metals sector under huge pressure. Although this is not unique to South Africa, our small open economy with a huge unemployment problem can ill afford such a blow.
Globally, equities have pulled back from their peak of the past year, none more dramatic than the 40% pull-back in the Chinese market from its peak. Year to date, the FTSE/JSE SWIX (shareholder weighted index) remained in positive territory, up 2%, but underperformed bonds and cash. Resources had a torrid quarter, down about 18%, although Findi (financial and industrial 30 index) stocks were more resilient, ending the quarter slightly down.
The JSE’s 4% pull-back last quarter camouflages extreme volatility in some specific counters. SABMiller (overweight) was up 26% after a bid by American beer giant AB InBev. On the downside, Glencore (overweight) fell 61%, despite raising $2.5-billion of equity, equivalent to 10% of its market cap, and announcing measures to degear its balance sheet.
The JSE has been caught in the downdraft of the emerging market sell-off, with the rand weakening about 21% against the greenback year to date. And, given the many new listings on our exchange, it would appear that investor demand for risky assets has not waned. The risk of capital loss is now greater than ever and a disciplined approach to investing remains key.
Patrice Rassou is head of equities at Sanlam.