Emerging markets have had a significant lower performance since the beginning of the year, despite an economic context that supports the actions of emerging markets. According to Overberg Asset Management, this seems unreasonable.
OAM said the blame for the low performance in emerging market equities is attributed to the strengthening of the dollar and the unpredictable US trade policy. UU
"A stronger dollar reflects a tightening in global financial conditions, which causes a low return on riskier assets, such as emerging market equities."
According to OAM analysts, a turning point in the appreciation of the US dollar and the deterioration of US trade relations should pave the way for a reclassification in emerging market stocks.
"What is good for emerging markets, as an asset class, is also good for the rand and South African stocks."
Economic review of South Africa
• The ABSA / BER Manufacturing Purchasing Managers Index (PMI) collapsed in October from 43.2 to 42.4, its lowest level since 2009 and substantially below the neutral level of 50 that separates the expansion from contraction. All the sub-indices were below 50, with the index of new prospective orders decreasing from 39.6 to 39.0, the employment index lost ground from 44.3 to 44.2 and, what is more worrying, the index of future conditions measures the expected conditions in a period of 6 months. 45.8 to 41.7.
The only bright spots were the index of commercial activity that improved from 38.7 to 40.3 and the price index that decreased from 85.9 to 84.7, indicating a decrease in inflationary pressure. While the PMI data indicate a recession in the manufacturing sector, it has tended to overestimate the disadvantage. The PMI incorrectly predicted a recession in August, while, in fact, manufacturing output increased that month by 1.30% year-on-year. PMI data measures confidence in manufacturing, which may differ from strict production numbers.
• Total sales of new vehicles unexpectedly increased in October by 1.7% year-on-year, recovering from the 2.0% contraction in September. The result was better than the consensus forecast, which predicted a decline of 1.7%. While new vehicle sales for passengers continued with their contracts, 0.7% in the year after a 2.6% drop in September, sales of new commercial vehicles increased a solid 7.0% in the year compared to a decrease of 0.5% from the previous month.
The National Association of Automobile Manufacturers of South Africa (NAAMSA) noted that the strengthening of sales of new commercial vehicles suggests an improvement in capital investment. Sales of light, medium, heavy and extra-heavy commercial vehicles increased year-on-year by 5.9%, 15.3%, 9.0% and 18.8%, respectively. In other good news, total export sales of new vehicles increased by 20.9% in the year, compared to 1.1% in September. NAAMSA expects export sales to maintain a strong momentum in 2019.
• The trade balance unexpectedly returned to a deficit in September with an increase in imports of 19.3% year-on-year faster than the 11.2% increase in exports. On a month-to-month basis, imports increased 7.9% while exports fell 2.7%. The trade deficit in September measured R2.95bn, a sharp deterioration in the surplus of R8.79bn registered in August.
So far this year, the trade balance shows a lower deficit of R330m compared to a surplus of R44.9bn in the same period of 2017. The rise in the price of oil is one of the main culprits, causing the importation of mineral products Increase a massive 99.6% in the year. The rand price of crude oil in September increased 55.7% in the year. Meanwhile, improving political and political security is reviving business confidence, which is raising the demand for imported fixed capital investment goods.
• The Third Quarter Labor Force Survey (Q3) confirms that the unemployment rate increased from 27.2% in Q2 to 27.5% in Q3. In the third quarter, non-agricultural employment in the formal sector decreased by 65,000 quarterly and by 125,000 compared to employment in the non-agricultural informal sector, which increased by 188,000 in the quarter and 327,000 in the year
Despite net employment growth, the unemployment rate increased due to the expansion of the labor force by 219,000 in the quarter and 187,000 in the year. Encouragingly, the labor force participation rate improved slightly from 59.1% to 59.5%, indicating an increase in the number of people actively seeking employment.
During the third quarter, employment in agriculture, mining and manufacturing contracted by 1,000, 29,000 and 25,000, respectively, while employment in the financial services sector and other business services increased by 102,000. Employment in the construction sector increased by 26,000 in the quarter and 137,000 in the year.
Employment growth, traditionally a lagging indicator in the economic cycle, should accelerate as the economy recovers from the recession suffered in the first half of the year. Increased political security and targeted policy initiatives, including the recent Employment Summit and the Investment Conference, should encourage employment growth in the coming months.
The week ahead
• Mining production: departure on Thursday, November 8. After a horrendous reading in August, when mining production fell by 9.1% year-on-year, production in September is expected to stabilize, according to consensus forecasts, with a moderate increase of 0.30% in the year. A weak comparative base should boost the reading year after year. Mining production should accelerate amid better political security and continued strength in the international prices of mining products.
• Manufacturing production: departure on Thursday, November 8. Despite data from the survey of the depressed purchasing managers' index (PMI), the third quarter is expected to close with a slight pick-up in manufacturing production growth in September. The manufacturing output is expected to have increased 1.80% year-on-year, according to the consensus forecast, an increase of 1.30% in August.
• The increase in the rand / dollar rate to R15.50 / $ in the first week of September may mark the peak in the recent decline of the currency.
• The increase in the US dollar index has reached its medium-term objective, which suggests a correction of current levels. The dollar remains below the main 30-year resistance line, suggesting that the bull run on the dollar may have ended.
• The British pound has recovered below the key resistance at £ 1.35 / $, suggesting a trading range of £ 1.30 / $ to £ 1.35 / $. The level of £ 1.28 / $ is expected to provide strong resistance.
• JPMorgan's global bond index is testing the bull market support line dating back to 1989, which if broken will project further increases in bond yields.
• The performance of the US Treasury UU At 10 years it has surpassed the resistance at 3.0% and 3.20%, paving the way for a new trading range of 3.20-3.30%. However, any additional high movement is likely to encounter strong resistance, especially at the key level of 3.50%.
• The benchmark yield of R186 2025 SA Gilt has risen to 9.30%, but it is expected to find strong resistance at this level, which limits any possible additional rise. The R186 can retrace a part of its upward movement bringing the performance back to the 8.80% level and then 8.60%.
• The indexes of key EE shares. US, including the S & P 500 index, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have set new historical highs at the same time, confirming a bullish outlook for the US stock markets. UU
• The price of Brent crude could not sustainably stay above the key resistance at $ 80 per barrel, suggesting a new trading range of $ 65 to $ 75. The outlook for base metals prices is less safe after the price of copper sharply retreated from the key level of $ 7,000 per ton. A decisive break below $ 6,000 per ton would announce a bear market in copper and base metals prices.
• Gold has developed a reverse "head and shoulders" pattern, which indicates a price recovery and a test of the target level of $ 1,400.
• Despite the consolidation since the beginning of the year, the break in the JSE All Share index above the key resistance level of 60,000 in December marks the first stages of a new bull market.
• Emerging markets have performed significantly less since the beginning of the year. This seems anomalous in the context of strong synchronized global growth and high international commodity prices. Despite an economic context that supports emerging market equities, the MSCI Emerging Market Index has fallen -13.96% so far this year (until November 5) compared to a much softer fall in the MSCI. World Index of -3.17%.
• This seems unreasonable. Emerging market economies are enjoying greater GDP growth. In its last semi-annual report on the world economy, the IMF forecast global economic growth in 2018 and 2019 of 3.7%. United States growth, which has reached 4.2% annualized in the second quarter, is expected to slow to 2.5% in 2019. On the other hand, it is expected that the GDP of emerging markets will grow by 4.7% in both 2018 and 2019.
• In addition, emerging market companies are showing higher revenue and earnings growth than their counterparts in developed markets. It is expected that the median of emerging market equities will increase revenues by 11% in 2019 compared to growth of less than half that of developed market equities.
• Capital valuations in emerging markets have been significantly reduced. Now they offer considerable value in relation to the developed equity markets. Despite higher revenue and earnings growth, the MSCI Emerging Market Index trades at a much lower price-earnings of 11.7x, compared to a multiple of 17.9x for the MSCI World Index. The valuation gap is equally compelling in other measures.
The two indices are traded in book price multiples of 1.5x and 2.4x and Enterprise Value in multiples of EBITDA of 7.8x and 11.4x, respectively.
• Blame for underperformance in emerging market equities is attributed to the strengthening of the dollar and the unpredictable US trade policy. UU However, these key market forces may be near a crucial turning point. As background, most fund managers cite trade conflict as the biggest risk to global financial markets. Meanwhile, a stronger dollar reflects a tightening in global financial conditions, which leads to a low performance in higher risk assets, such as emerging market equities.
• The Fed has carefully navigated a standardization in the interest rate policy. For the first time in a decade, the federal funds rate is now positive in real terms, surpassing the inflation rate and rapidly approaching the neutral rate where it is no longer accommodative.
Fed Chairman Jerome Powell's speech at Jackson Hole's annual central bank conference hinted at a more cautious approach to interest rate hikes now than US rates. UU They are close to the neutral rate. The fading of the fiscal stimulus and the expected slowdown in the growth of EE. UU In 2019 they will give the Fed even more reasons to pause. As a result, it is likely that the upward pressure on the US dollar will decrease.
• In the last three months, the EE. Although they increased their participation in their commercial relations with China, they have successfully concluded the Agreement between the United States, Mexico and Canada (USMCA), suspended the euro zone automobile tariffs and finalized a free trade agreement with South Korea. and agreed to hold bilateral trade talks with Japan. As long as the commercial conflict does not extend beyond the USA. UU And China, which seems unlikely, given the positive developments elsewhere, the effect on world trade and world GDP will be negligible.
The worst effect in China and the United States will also be slight, since bilateral trade between the two countries will represent a modest 2.5% and 1% of their respective GDP.
• A turning point in the appreciation of the US dollar and the deterioration of US trade relations. UU They should pave the way for a reclassification of emerging market stocks. What is good for emerging markets, as an asset class, is also good for rand and South African equities.
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* Overberg Asset Management (OAM) is a licensed financial services provider No. 783. Overberg specializes in the private management of local and global discretionary portfolios, as well as pension products.
Resignation: The information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes to be reliable, but makes no representations as to its accuracy or completeness. Any opinion, forecast or estimate here constitutes a judgment as of the date of this Report and should not be invoked. It can not be guaranteed that future results or events will be consistent with such opinions, forecasts or estimates. In addition, Overberg Asset Management accepts no liability or obligation for any loss arising from the use or trust placed in the material presented in this report.
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