August 2020 economic review
Disconnect between real economies and financial markets
Most economies appear to have banked the easy gains from the relaxation of containment measures, but progress will remain slow and output will continue to fall short of potential. More importantly, among the many unusual features of the pandemic-induced downturn is the disconnect between depressed real economies and buoyant financial markets. As such, the appetite for risk assets has remained strong over the last few months. August saw equity markets from New York to Tokyo push higher, and the S&P 500 posted its strongest rally for August since 1986. Also, a weaker dollar has, in combination with fiscal and monetary stimulus, helped to ignite a global equities rally during the month. The rand-dollar exchange rate strengthened some 0.52% for the month of August.
Continued cautious outlook
With that said, the outlook remains cautious given COVID-19, lower-for-longer interest rates and geo-political uncertainty. Even though inflation is far below central bank targets almost everywhere, its potential resurgence tops investors’ worry lists. Furthermore, high-frequency data suggested economic activity in some parts of Europe slowed amid renewed, localized flare-ups in the virus. Japanese Prime Minister Shinzo Abe stepped down for health reasons. The initial reaction in financial markets suggested investors are worried about the added risks that the sudden departure casts on an economy already in its deepest crisis in decades and which is facing a range of policy challenges, from trade to defence.
The Fed announced a major policy shift, saying that it is willing to allow inflation to run hotter than previously to support the labour market and broader economy. Fed Chairman Jerome Powell said the central bank will adopt average inflation targeting, one of the biggest policy changes introduced since the 2008 global financial crisis. The move, which was cheered by the market, effectively means the Fed will be less inclined to hike interest rates when the unemployment rate falls as long as inflation does not creep up as well. The significance of these changes to the Fed’s longer-term goals and policy strategy will likely not amount to much change in what the Fed is currently doing. Also, this approach de-emphasises previous concerns that low unemployment can lead to excess inflation. As such, the policy framework changes signal a more dovish approach to monetary policy than in the past.
Ongoing US China tension
US President Donald Trump unveiled executive orders targeting popular social media apps TikTok and WeChat. The Trump administration issued its recommendations to ban Chinese companies that do not comply with US accounting standards from listing on American stock exchanges. The SEC must engage in a rulemaking process before the proposals can come into force. It is unclear how quickly it could do so. China’s Ministry of Foreign Affairs said it required its companies to comply with laws and regulations of the locations in which they were listed. The US action alone won’t amount to a major blow to China’s economy. What this represents, though, are risks in the medium to longer term given that information technology services make up a sizeable contribution to the current account surplus. Furthermore, increasing global segmentation in the technology sector poses a risk that could impede China’s technological advance.
Globally risk assets continue to rally
As such, central banks continue to drive up stock prices by committing to keeping interest rates low for longer. The strong performance of risk assets in August shows that markets ‘accounted for the willingness of policymakers to deliver on their responsibility to support economies’. Furthermore, technology-related companies like Apple, Microsoft, Amazon, Alphabet and Facebook, the top five companies in the S&P 500, account for more than a quarter of the rally since late March. The quintet now has a market capitalisation of $7 trillion – more than the entire Japanese TOPIX index of about 2 170 companies, according to Bloomberg.
As such, the MSCI World index rallied some 6.68% in dollars and 6.13% in rands. The MSCI EM index lagged its developed market counterpart, delivering some 2.24% in dollars and 1.71% in rands. As risk assets rallied, global bond markets were softer for the month of August, and the Bloomberg Barclays Global Aggregate index declined some 0.15% in dollars and 0.67% in rands. Emerging market bonds fared better than their developed market counterparts, delivering some 0.54% in dollars and 0.03% in rands. The pandemic has had disparate short-term effects across property sectors, and will similarly have disparate long-term effects. It therefore remains important to differentiate between transitory and permanent changes in consumer behaviour and the use of real estate. Furthermore, as risk assets rallied, developed market property rallied some 2.57% in dollars and 2.05% in rands.
SARB faces pressure to adopt QE measures
Locally, the latest production data suggest that the blow to output in the second quarter will be deep given that South Africa’s lockdown was one of the most draconian in the world, which will result in a huge economic cost. Furthermore, the SARB came under pressure from politicians to take a more direct role in stimulating the economy. There have been calls from unions and some economists for the bank to adopt quantitative easing – buying government bonds directly to stimulate the economy. With that said, the SARB has already cut its benchmark rate by 300 basis points to 3.5% over the course of this year. The FRA curve below indicates that the market does not expect any further interest rate cuts from current levels in 2020.
Local equity lagged global rally
The local equity market lagged the strong rally in developed markets and kept pace with the broad emerging markets index. As such, the ALSI delivered some 0.26% in dollars and -0.26% in rands. The Resi-20 and Indi-25 indices delivered marginally positive returns for the month, and the Fini-15 declined some 3.97%.
For the month of August, fixed coupon bond yields were relatively unchanged with some marginal flattening of the yield curve from 10 years out. The ALBI delivered some 1.41% in dollars and 0.89% in rands. Inflation-linked bond yields fell sharply as inflation prints have started to rise, and local inflation-linked bonds delivered some 4.46% in dollars and 3.92% in rands.
Excess supply and weak demand in the SA property sector look likely to drive a long and painful reset of market rentals. Valuations remain supportive for long-term gains in the property sector, but visibility is low and high levels of uncertainty support a defensive stance. As such, the SAPY declined some 8.12% in dollars and 8.59% in rands.
The rand strengthened as a function of a weakening US Dollar to a rate of R16.94/US$1 and considering where it was in April at R19/US$1, this is a discernible difference although it is still 17.46% lower against the US dollar on a YTD basis.