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Rand and JSE show impressive gains amid bleak conditions in 2021

Since the beginning of the year, the JSE all-share index has increased dramatically by 14.6% and is one of the best performing stock markets in the world in 2021. In addition to this above-average stock market performance, the rand has outperformed most emerging market currencies and has appreciated by 13.9 % to the dollar since the beginning of 2021. All of this is happening within a negative Covid-19 economic environment, with both supply and demand sides of the economy affected on a global scale.

The South African economy has been struggling with low growth over the last decade, and in 2020 it contracted by more than 7%. The local economy is still struggling, although the first quarter of 2021 has shown some improvements. However, the real economy is only equal to 2013 levels when taking inflation into account. Also, the risk rating agencies (Moody’s Investors Service, S&P Global Ratings and Fitch Ratings) have downgraded the country’s sovereign debt to “junk“ or sub-investment status.

So what are the relationships, if any, between the JSE all-share index, the exchange rate and economic growth in South Africa? And secondly, why is the JSE booming and the rand strengthening against the US dollar? What is expected with economic growth in 2021?

Investors assess a range of economic and other indicators for guidance and predictions for stock markets. Stock market increases are also assumed to lead to a more favourable economic environment with growth and currency appreciation. So does a relationship exist between the stock market’s growth in returns and economic growth, as well as the rand exchange rate? The stock market and the exchange rate indicate how foreign investors see local economic and investment conditions. A rising stock market and appreciating currency reflect a positive sentiment towards the local economy and investment environment. But how does this relate to economic growth? Previous studies on a global scale are indecisive in quantifying these relationships as many factors affect any analysis, including political statements and decisions. The majority opinion is that past economic performance should not be used to predict future stock market performance, especially in a volatile, high-risk market such as South Africa.

Using econometric methods and quarterly data from 2008 to 2021, the three variables of the JSE all-share index, economic output (GDP) and the rand to dollar exchange rate were analysed to determine the existence of any relationships. Interesting results were found. Figure 1 is a presentation of the log differenced data for the three variables. A visual analysis indicates that if the JSE all-share index rises, there is evidence of positive economic growth periods and persistent appreciation in the currency over the study period. The JSE all-share index and economic growth trends in the same direction.

More in-depth analysis via fully modified ordinary least squares and dynamic ordinary least squares regressions, ARDL cointegration analysis, and vector auto-regression estimations indicate similar results. All the results show a positive relationship between the JSE all-share index and economic growth, while a negative relationship is listed between economic growth and the rand to dollar exchange rate, meaning that an appreciating currency is associated with economic growth. In addition, the JSE all-share index is positively related to an appreciating currency. This analysis was not an attempt to forecast changes between the variables but to determine overall relationships between the three variables. When quantifying the relationship between the stock market and GDP from 2008 to 2021, a 1% change in the JSE all-share index resulted in a change ranging between 0.2% and 0.25% in GDP growth.

A positive change in the stock market also has a positive effect on the exchange rate. A 1% change in the JSE all-share index could lead to an appreciation in the rand of approximately 0.35% with a positive outlook. A positive change in economic growth could also lead to the appreciation of the rand. In terms of causality, results indicate that shifts in the stock market instead impact GDP and not vice versa. While both changes in the stock market and GDP could cause changes in the exchange rate. Also, appreciation changes in the exchange rate cause a positive outlook for the JSE and could lead to a rising stock market.   

What are the reasons for the strength of the JSE all-share index and the local currency in the first quarter of 2021? Against all odds, these two variables are doing exceptionally well since the beginning of the year, despite recession-type conditions in South Africa. One of the main reasons is the relatively strong recovery in the commodity market prices, which are in a boom cycle with the global economy picking up after the 2020 global recession. According to the International Monetary Fund, the index of all primary commodities increased from 84.0 in the third quarter of 2020 to 141.0 at the end of the first quarter of 2021, marking an astonishing 67.8% increase. 

A second possible reason is the trade surplus in 2020, and this trend has continued into 2021. Exports have out-performed imports over the last 12 months, mainly due to weak local demand for imported products, while export demand has remained high. Exports of precious metals, minerals and steel have especially contributed to this situation leading to a net export surplus and an excellent positive trade balance. To prove this point, South Africa had its largest trade surplus ever recorded at R52.77-billion in March 2021. The last month in which SA had a negative trade balance was April 2020.

However, it should be noted that the local economy has slowly started to show signs of recovery and the pace of the recovery depends on the intensity of future Covid-19 waves and electricity supply from Eskom. As soon as the country’s economic output starts to accelerate, local demand will increase, and the trade balance could be under pressure. This could result in a weakening or depreciating currency over the next 24 months. Economists are predicting that 2021 economic growth will exceed 3% after the 7% contraction of 2020. This is possible because of the low base of 2020, but more than 3% growth is needed to create local demand and employment. 

In terms of developmental policy, the government needs to remove any policy uncertainty and formulate a favourable policy supported by the private sector. This could convince companies to stop the investment strike and start investing in the local economy, which will result in accelerated growth. 

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Daniel Meyer
Professor Daniel Meyer is from the College of Business and Economics at the University of Johannesburg

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