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Market Overview - February 2024

Market Overview

Positive momentum in global equities (MSCI World Index: +3.7%) continued into February, with the tech sector still being a dominant force but gains broadening to other markets as well. Emerging markets (MSCI Emerging Markets Index: +4.4%) saw a robust recovery on the back of a solid rebound from Chinese equities (MSCI China Index: +5.9%) after Chinese authorities introduced additional stimulus measures to boost economic activity. Central bank activity continued to dominate the headlines, with investors now more realistically factoring in rate cuts towards the middle of the year as opposed to prior expectations for cuts as early as March. Geopolitical tensions across the globe continued to create some angst among investors.

The US market continued to gain with the S&P 500 Index adding 4% at the time of writing. While green shoots are now visible across the broader market, the leaderboard was once again driven by the "magnificent seven" (i.e., Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla) as the artificial intelligence (AI) theme continued to drive investor enthusiasm. Nvidia was at the helm of the advance on the back of a blockbuster fourth quarter result underpinned by relentless demand for AI-enabling processing units. The group's success serves as a barometer for the strength of the AI boom, as it fulfils a fundamental role in supporting big tech firms including Microsoft (ChatGPT), Google (Bard now Gemini), and Apple (Siri 2.0) in their ambitious AI endeavours. Recent commentary from US Fed members has resulted in market participants trimming back the number of rate cuts expected for the year, with the start of these cuts also being pushed out to later in the year. The market shifted rate cut expectations to July - closer to the Fed's own expectations - after having kicked off the year on an overly optimistic note, with cuts having been priced in for the first half of the year already.

The European Central Bank (ECB) maintained its "data-dependant" approach to monetary policy - ECB Vice President, Luis de Guindos, noted that the recent inflation outlook is very positive, however, any changes to monetary policy will be dependent on whether upcoming economic data confirms this. Market participants downwardly revised expectations for aggressive rate cuts, with recent forecasts pricing in less than four 25 basis-point cuts for 2024. The odds of a first rate cut in April are now being placed at only 30%, with the new target being June. The Euro Stoxx 600 Index was up 2.7% for the month.

The local bourse was unable to maintain upward momentum, bucking the positive trend seen offshore, with the All Share Index trading down around 2.6% towards month end (USD terms: -4.2%). The Budget Speech garnered attention and was decent from a market perspective - decidedly bond-friendly and on balance more equity-friendly than what was expected prior to its tabling. Again, execution risk remains both on sticking to the budget and government executing vital reforms to ensure an uplift in growth longer term. While investors cheered the exclusion of SOE bailouts from the budget initially, it has been touted as a potential issue if more money is required to support key network industries. It also appears that market participants (particularly offshore investors) have adopted a highly cautious stance ahead of the 2024 general election - likely a key factor contributing to the underperformance of the local market.

Economic data overview

Market participants now expect the US Fed to start cutting rates later in the year

Flash estimates showed that the S&P Global Composite PMI for the US declined to 51.4 in February from 52 in the previous month, below expectations. Output increased slightly, but a softer uptick in services activity hindered overall expansion. Retail sales in January increased 0.6% y/y - this was lower than expectations. In December 2023, the deficit was little changed at $62.2 billion from a downwardly revised $61.9 billion in November 2023, and matching forecasts, as exports increased 1.5% and imports rose 1.3%. The unemployment rate in the US was 3.7% in January, unchanged from December, and slightly below consensus of 3.8%. The annual inflation rate in the US fell back to 3.1% in January following a brief increase to 3.4% in December but was higher than forecasts of 2.9%. Fed policymakers confirmed the policy rate was likely at its peak but noted that it would not be appropriate to reduce rates until they had gained greater confidence that inflation was moving firmly toward 2%, minutes from the January FOMC meeting showed.

ECB's inflation outlook remains positive, but policy action remains data dependant

On a preliminary basis, the HCOB Eurozone Composite PMI rose to 48.9 in February, up from 47.9 in January and above the market consensus of 48.5, a preliminary estimate showed. The latest reading signalled a ninth consecutive month of falling output, although the contraction was the weakest since last June, as a stabilisation in the service sector offset a deeper downturn in manufacturing. Retail sales fell 0.8% y/y in December, a touch better than market expectations of a 0.9% decline, marking the 15th consecutive month of contraction in retail trade. A trade surplus of €16.8 billion was recorded in December against market expectations of a €21.5 billion surplus. The unemployment rate was unchanged at 6.4% in December, aligning with the market forecasts and remaining historically low. Inflation for December came in at 2.8%, matching consensus. At its most recent meeting, ECB officials agreed that it was too early to discuss interest rate cuts, despite recent indications of cooling inflationary pressures across the Eurozone. They expressed concerns that such a move may be premature and could potentially hinder or delay the timely return of inflation to target levels. In January, the ECB kept interest rates unchanged, as expected, at record-high levels and pledged to maintain them at sufficiently restrictive levels for as long as necessary to bring inflation back to its target in a timely manner.

Bank of England (BoE) sees inflation below 2% in a few months, supporting rate cut expectations

Initial reports showed that the S&P Global UK Composite PMI for February increased to 53.3 from 52.9 in January, surpassing the expected 52.9. Retail sales rebounded by 0.7% y/y in January, following a sharp fall of 2.4% in December and surpassing market expectations of a 1.4% decline. The UK's trade deficit narrowed to £2.6 billion in December, from a revised £3.7 billion in November, as imports fell 3.4% and exports declined 2.0% - this was softer than expectations of a deficit of £1.9 billion. The unemployment rate declined to 3.8% in 4Q23, down from 4.0% in 3Q23 and slightly below the market consensus of 4.0%. The BoE maintained its benchmark interest rate at a 15-year high of 5.25% for the fourth consecutive time during its first meeting of 2024, in line with market expectations. The central bank said monetary policy will need to remain restrictive to return inflation to target sustainably, but dropped a reference to further tightening and acknowledged that the risks to inflation are more balanced. Still, key indicators of inflation persistence remain elevated although services inflation and wage growth have fallen by more than expected. Policymakers expect GDP growth to pick up gradually during the forecast period, in large part reflecting a waning drag on the rate of growth from past rate increases.

Additional stimulus plans from Chinese officials bolstered sentiment

The Caixin China General Composite PMI was at 52.5 in January this year, edging lower from December's seven-month high of 52.6, while marking the 13th straight month of growth in private sector activity. Retail sales increased by 7.4% y/y in December, missing market consensus of 8.0% and slowing from a 10.1% jump in November. China's trade surplus increased to $75.3 billion in December, surpassing market forecasts of $74.8 billion. The surveyed urban unemployment rate increased to 5.2% in January from 5.1% in the previous month. Consumer prices fell by 0.8% y/y in January 2024, the most in more than 14 years and worse than market forecasts of a 0.5% fall. It was the fourth straight month of decline in CPI, marking the longest streak of drops since 2009. The reference for mortgages, the five-year loan prime rate, was slashed by 25bps to 3.95%, more than market forecasts of a reduction of 15bps. It was the first rate reduction since June 2023 and the largest since that rate was introduced in 2019, as the board ramped up efforts to spur credit demand and reverse a property downturn. Meanwhile, the one-year rate was kept at 3.45%, defying consensus of a drop of 15bps. Both key lending rates are at record lows. Earlier in the month, the central bank unleashed CNY 1 trillion of liquidity into the banking system by trimming the reserve requirement ration for commercial banks by 50bps and reducing interest rates on re-lending funds aimed at promoting loans to agricultural and small firms.

Bank of Japan (BoJ) officials grow increasingly confident about imminent exit from negative rates

Early estimates showed that the Jibun Bank Composite PMI fell to 50.3 in February from a final 51.5 in January, which was the highest figure in four months. Retail sales rose 2.1% y/y in December, slowing from a 5.4% gain in November and missing market expectations for 4.7% growth. Japan's trade deficit narrowed sharply to ¥1.8 trillion in January from ¥3.5 trillion in the same period last year and compared with market consensus of a gap of ¥1.9 trillion. The unemployment rate fell to 2.4% in December from 2.5% in the previous two months, which was also the consensus forecast. The annual inflation rate dropped to 2.2% (higher than forecasts) in January from 2.6% in December, the lowest figure since March 2022. At its January meeting, the BoJ kept its key short-term interest rate unchanged, in line with market expectations. After the decision, BoJ Governor Ueda commented that any potential rate hike would initially seek to maintain BoJ policy in support of the economy and would strive to minimise disruptions. Expanding on the newly incorporated language in the central bank's quarterly outlook report, the governor noted that the confidence in achieving the BoJ's projections has steadily grown.

Local Budget Speech appeared to be market friendly as heightened political risk remains a concern

In December 2023, the leading business cycle indicator contracted 0.8% m/m (following a decrease of 0.4% a month prior), marking a second consecutive decline. In contrast, the SACCI Business Confidence Index recovered to a reading of 112.1 (from 108.6 in November) and improved further in January to a reading of 112.3. Sentiment was driven by increased merchandise exports, higher new-vehicle sales, a rise in tourism, as well as an uptick in retail sales (+2.7% in December). The trade balance in December amounted to a surplus of ~R14 billion (slightly below expectations of ~R15 billion) as exports decreased 11.5%.

Local mining production edged 0.6% higher in December (well below forecasts of 4.9% growth) due to significantly lower output of iron ore (-18%), manganese ore (-13.1%) and other metallic minerals (-16.9%). Manufacturing production increased 0.7% y/y, marking the slowest increase in three months due to weaker contributions from motor vehicle parts and accessories (-7.1%), other chemical products (-10.2%), as well as textiles, clothing, leather, and footwear (-4%). In January, composite PMI edged up to a reading of 49.2 (vs a reading of 49 a month before), as private sector activity remained soft. Manufacturing PMI, however, dropped to 43.6 (December 2023: 50.9), pointing to a renewed contraction in the manufacturing sector amid a sharp decline in new sales orders.

Consumer price inflation (CPI) rose to 5.3% in January (against expectations of 5.4%) amid a slight uptick in prices across restaurants & hotels, food & non-alcoholic beverages, health care as well as transportation. This is trending towards the top- end of the South African Reserve Bank's (SARB) target range of 3% to 6%. Core inflation (which excludes the price of food, non-alcoholic beverages, fuel, and energy) increased to 4.6%, slightly above forecasts of 4.5%.

On 21 February, Finance Minister Enoch Godongwana delivered the 2024/25 Budget Speech.

A few key highlights included:

• No major tax or VAT increases (apart from the usual increase in sin taxes). The budget, however, proposed a net tax revenue increase of ~R15 billion through non-inflationary adjustments to personal income tax brackets, rebates, and medical credits
• National Treasury has planned R150 billion in transfers from the Gold and Foreign Exchange Contingency Reserve Account (GFECRA), which will be used to rein in debt, provide for public wage increases and maintain the budget deficit at 4.9% of GDP.
• As a result, gross government debt is anticipated to reach its peak at 75.3% of GDP in 2025/26. This projection is 2.4ppts lower than the 77.7% projected in the Medium-Term Budget Policy Statement (MTBPS) but still higher than the 73.6% peak that was projected at the 2023 Budget.
• The consolidated budget deficit is projected to narrow from 4.9% of GDP to 3.3% by the end of the 2024 Medium-Term Expenditure Framework (MTEF) period.

Market Outlook in a nutshell

Local

• The global economy is still expected to perform poorly relative to historic averages. This is even with the IMF's most recent upward adjustment to the 2024 forecast, from 3.0% to 3.2%, that was primarily driven by starting point gains. This highlights headwinds from tighter monetary policy, fiscal policy neutralising, and continued geopolitical tensions.
• Meanwhile, South Africa's economy is expected to slowly start recovering from a decade of materially weak growth and currently binding structural constraints. Downside surprises will be driven by political outcomes that allow rent-seekers to divert policy away from the structural reform agenda and adversely affect investments. We forecast growth of 0.6% in 2023, lifting to 1.2% in 2024, 1.6% in 2025, and 1.8% by 2026.
• Falling inflation remains a key feature of the outlook, globally and locally. This will allow a modest lowering of nominal interest rates and support a gradual recovery in household spending growth. Unfortunately, tensions in the Middle East pose significant upside risk to oil prices and logistics costs, and this could keep goods inflation sticky at a time when local services inflation is recovering from pre-pandemic lows.
• Should this affect the disinflation trend in the medium term, it would be troubling for the central bank - compounding the prevailing cost of funding risks. We currently project headline inflation to average 5.2% this year, before falling towards target in 2026. Such a profile is necessary to support a moderation in the nominal repo rate to 7% in 2026.
• Fiscal policy was more positive than feared before the 2024 Budget. Despite modest revenue increases and persistent spending pressures, Treasury expects the fiscal deficit to narrow over the period to 2026/27 and debt to stabilise at a lower level. This is a function of employing valuation gains from GFECRA to reduce the debt and interest cost profile, which should also be positive for the risk premium in the near term. This would ease funding cost pressures but given budget implementations risks, both monetary and fiscal policy should only aim at being neutral, rather than accommodative.

Global

• US growth has held up very well over the last few quarters despite a very aggressive interest rate hiking cycle. In the last Bank of America survey, participants stopped predicting a global recession for the first time since April 2022.The long and variable lags of monetary policy are in progress, but thus far the impact has been relatively small (as most companies/ individuals have locked-in low rates). We expect this "soft" vs "hard" landing rhetoric to continue throughout the year as new data becomes available. Our house view is for US growth to underperform consensus in 2024.
• Inflation has peaked and is trending lower. We are now in the 'last mile' (to get inflation from 3% to 2%), and many economists expect this to take some time. However, shelter inflation should continue to trend lower, causing inflation to continue its downward trend.
• The Fed's interest rate hiking cycle is over. The question for 2024 now becomes the pace and quantum of these cuts. Markets are now pricing in about three-and-a-half interest rate cuts by the Fed for 2024 and is much closer aligned to the Fed, versus the six cuts priced into the market just one month ago. The 'soft' landing narrative is based on the Fed cutting rates fast enough, so real rates don't become too restrictive on the economy.
• In emerging markets, it is certainly encouraging to see the PBoC maintaining loose monetary policy and further injecting liquidity into the banking system. However, the recovery will remain fragile in the absence of fiscal stimulus targeted at restoring confidence to the consumer and addressing the property sector issues. With low levels of inflation and notable excess savings combined with attractive valuation multiplies, we are of the belief that selected opportunities remain in the Chinese economy and will be on the lookout for more palatable policy responses from fiscal authorities. This month, commercial banks lowered their five-year loan prime rates to 3.95%, the biggest cut on record.
• Geopolitics are always important for asset markets, but the election calendar for 2024 is exceptionally busy. This year 76 countries will be voting, representing more than half of the world's population and over 65% of global GDP. This, together with two major ongoing wars, could exacerbate uncertainty and volatility over the next few months. The impact from these developments, especially on oil, should be monitored very closely.
• Given all the above uncertainties, we are closely aligned to our strategic asset allocation benchmarks, with a slight defensive twist. We slightly favour fixed income over equities.

China: Signs, symptoms, and a possible diagnosis

By Jalpa Bhoolia

They say that when America sneezes, the rest of the world catches a cold. But what do we do when China is unwell?

The year of the dragon was ushered in this month, symbolic of luck, power, and strength - which seems a little ironic considering the state of China's economy. Following years of breakneck growth, the world's second largest economy appears to be losing its steam, plagued by an underwhelming post-Covid-19 recovery, a protracted property rout, regulatory uncertainty in the tech-sector and increasingly unfavourable demographics.

From 1978, China's export and investment-led model resulted in it growing rapidly (at around 10% per annum on average till 2005) to become one of the world's strongest global economies. China eventually outgrew this model, transitioning more towards a consumption-led economic model in the late 2010's. The Covid-19 pandemic somewhat derailed the shift, as consumer confidence suffered leading to a marked step down in China's growth. In fact, consumer confidence has still not recovered after the initial Covid-19 slump.

China consumer confidence index

Property - boom to bust?

Part of the fundamental problem facing the country is a major supply-demand mismatch in the property sector - resultant of overdevelopment and dependence on housing as an investment strategy. Pre-pandemic, the property sector played an outsized role in the economy, accounting for as much as 30% of GDP. There was substantial investment in property across China as property prices went up considerably and speculative development and buying became commonplace. There were already signs of trouble in 2015 when property prices began sliding. Despite a few scattered periods of growth since - the dominating trend in property prices has been down. Now, big property developers, Evergrande and Country Garden (among others), are burdened with debt, leaving behind numerous unfinished projects, and "ghost cities" in many parts of the country become the norm. In addition, many families pumped their savings into real estate, and when property prices started to decline, so did family wealth.

Waning birth rates

China's one-child policy, implemented in 1980s, formally ended in 2016. But that was too late to save it from a demographic nightmare. In fact, according to China's Population and Development Research Center, population decline has accelerated more recently. In 2023, birth rates fell to record lows (2023: -0.15%; 2022: 0.0%), which means that China is now dealing with an aging population and less job creation, and this can have major economic and social consequences down the line

China's population shrinkage (in millions)

Casualties of a regulatory crackdown

In November 2020, Ant Group was planning to list on the Shanghai and Hong Kong Stock Exchanges when Chinese authorities stepped in and began wide-ranging probes into not only that company but several other tech and tech adjacent companies doing business in the country. Sectors targeted were fintech, e-commerce, education, ride hailing, social media, music, gaming, e-cigarettes, and insurance, with investigations centred on data security, antitrust (competition), financial risk, market deception, worker's rights, content regulation and "burden on children".

Since then, trillions of dollars in company market values have been erased, with the uncertainty related to the next probe or fine being enough to keep investors at bay.

Chinese stock market performance

Is there light at the end of the tunnel?

Near term, we believe that the Chinese economy will continue to slow amid rebalancing from an export/investment-led growth model to a consumption-led model, high debt, and misallocation of capital. Longer term, the multi-faceted issues facing China will certainly lead to structural changes, however, we believe that a lot of the negative sentiment is currently overpriced into the market. While there is not much China can do to stem its demographic issues in the immediate term, so far, the property sector contagion has been limited, and we have seen signs of a softening on the regulatory front as it relates to the major tech players.

• When Japan was hit by a property crisis in the 1980's, the country's banks were extremely hard hit. In contrast, banks in China are faring well and holding their ground. We therefore don't view the collapse of Evergrande and Country Garden as China's Lehman Brother's moment, however, the turnaround of the Chinese property market will surely be a long and bumpy road.
• In mid-2023, two-and-a-half years after the government killed its IPO, financial regulators fined the Ant Group a total of 7.1 billion yuan ($999 million) for breaking rules related to "corporate governance and financial consumer protection". The wrapping up of this investigation was widely considered to signal the end of China's crackdown on the tech sector. This was confirmed towards the end of last year as Chinese Premier Li Qiang offered support to major tech companies at a symposium and the economic planning agency praised Alibaba, Tencent and Meituan for their contributions to the country's growth and technological progress.

In recent months China has rolled out a wave of policy measures to shore up economic recovery and boost market confidence. While Chinese authorities have dragged their feet in implementing meaningful stimulus measures, we note that the government has picked up the tempo recently and has implemented more aggressive and meaningful measures, the latest (implemented in February 2024) being the sharp reduction in the five-year loan prime rate to 3.95% - the first cut since June and the largest since its new rate regime came into existence in 2019. This will hopefully enable more cities to reduce minimum mortgage rates, and in turn, entice homebuyers as prices fall. In October last year, the country also announced the issuance of CNY1 trillion of additional sovereign bonds, aimed at supporting economic recovery. In January this year, Chinese regulatory authorities tightened the reins on short selling in a move to support the country's slumping stock markets.

All things considered, there are still pockets of growth and value to be unlocked in the market. While stocks appear very cheap for the moment, significant upside potential does not come without risks. We think that for the time being it may be a safer bet to invest in the larger-cap stocks, which have a better ability to withstand regulatory enforcements (if any).

Tencent

• Founded in 1998 with its headquarters in Shenzhen, China, Tencent is a world-leading internet and technology company that develops innovative products and services, as well as communication and social services (WeChat and QQ) that connect more than one billion people around the world.
• The company publishes some of the world's most popular video games and other high-quality digital content, enriching interactive entertainment experiences for people around the globe. Tencent also offers a range of services such as cloud computing, advertising, FinTech, and other enterprise services to support our clients' digital transformation and business growth.
• Value-added services (gaming and social networks) make up a large chunk of revenue ~52%, followed by FinTech and business services (~33%) and Online advertising (~15%).
• The company's revenue streams are relatively well-diversified, with many of its businesses holding a market-leader position. Tencent's successful track record of product innovation and development is complemented by its strong distribution network and reliable supplier base.
• Tencent is trading near its lowest levels in years (one-year: -19.5%; five-year: -12%), but we are positive on the company's improving fundamentals (focus on cost reductions, elimination of low-margin or loss-making business lines, thus leading to further margin expansion), particularly as the regulatory environment becomes more supportive.
• Tencent is trading on a forward PE of 10.6 times, which remains undemanding relative to its average rating over time (~18 times).

Alibaba

• Alibaba is one of the largest e-commerce players in China. It provides tech infrastructure and marketing to build businesses and create value. Alibaba has numerous subsidiaries and operating segments which provides it with a diversified revenue stream.
• The company operates in seven operating segments: China commerce (~ 70% of revenue), Cloud (~ 10% of revenue), International commerce (~5% of revenue), Local consumer services, Cainiao, and Digital media and entertainment (make up ~5% each of revenue). China commerce mainly includes the China commerce retail businesses such as Taobao, Tmall, Taobao Deals, Freshippo, and Alibaba Health, among others.
• Alibaba's digital businesses have a large addressable market - China remains the most populous country in the world and boasts an internet penetration rate of 75% and growing.
• As mentioned above, the regulatory environment for Chinese internet companies appears to be easing, due to pressure on the state regarding tepid economic growth and simultaneous action being taken by companies to address regulators' concerns.
• Alibaba's recent restructuring could unlock value longer term. The company can now be valued on a "sum-of-the-parts" basis, although a holding company discount will likely apply.
• Alibaba is trading on a forward PE of 8.8 times, a discount to its peers and slightly below its long-term average valuation of 10.7 times. Notwithstanding prevailing near-term headwinds to the valuation, we continue to like the long-term prospects of the stock.

BYD

• BYD was founded in 1995 by current Chairman and CEO Wang Chuanfu. It operated primarily as a rechargeable battery manufacturer for third-party electronics brands including Nokia and Motorola.
• BYD is now known for its full range of gas, electric and hybrid automobile products, which include passenger and commercial vehicles, as well as rail transportation. Other product offerings include electronic components for mobile phones as well as nickel and lithium-ion batteries. Through a strong focus on energy generation and storage, the company has emphasised its commitment to providing emission-free energy solutions.
• The automobile business is expected to continue seeing strong demand in China (which generates ~78% of total revenue) as the economic reopening gains traction. Economies of scale will continue to bring down per-unit production expenses as volumes increase and battery material costs come down.
• BYD is trading on a 12-month blended forward PE ratio of 12.1 times, a substantial discount to its long-term average (~51.5 times), with structural and thematic growth drivers to support a strong unwinding of this rating medium to long term.

Company forward PE bands

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FNB