Many of the gains of January have been eradicated during a risk-off environment in February. It was a case of Dollar strength straight through and it affected global markets considerably. Most global equity markets ended the month in the red with the S&P 500 ending 2.49% down, the MSCI World lost 2.40% and the MSCI EM the worst off at -6.48%. [All in USD terms].
The FED once again hiked rates, but to a lesser extent this time, hiking only 25bps. The general tone was still quite hawkish making future movement rather difficult to predict. This also triggered more recession fears that saw markets sell off in favour of safer asset classes. On the positive end, it seems like China is opening their economy quicker than expected. This saw markets rally briefly with the US Dollar retreating somewhat.
Our underweight exposure to most risk assets had a positive impact on relative performance, but it was still a difficult month for any asset class, bar US Cash. But looking forward, it will be difficult to gauge the direction of risk assets leading us to be cautious going into March.
We spent quite some time discussing various scenarios and themes that could play out in 2023. Our “global” base case looks at the following scenarios:
- Lower GDP growth globally affecting company earnings negatively in second half of 2023
- Mild US and European recession (short & shallow)
- Persistent inflation above 2.5% in US and globally, but disinflationary
- US Fed to continue rate hikes – between 50-75 bps more – to cut late in 2023 or early 2024
- Uneven China re-opening but improving commodity demand (a positive for the JSE)
- Prolonged Russia–Ukraine conflict continues to add inflationary pressure due to supply constraints
- Global political and economic polarization continues (West vs. BRICS)
- Oil price to trade between US$ 75-$90
We also have bear and bull cases built around the base scenarios with varying probabilities. But our main concern lies within the local landscape and the various headwinds that could still cause havoc.
A strong US Dollar and a weakening ZAR in the lead-up to the greylisting announcement made for a difficult investment environment. It was especially difficult for mining and resources counters, with commodity prices also coming down, seeing the index (FTSE/JSE Resources Index) falling by 13.23% for the month of February. This pushed the JSE All Share Index to also end in the red by 2.19%. It’s only Industrials and Financials that ended the month up 1.66% and 2.50% respectively. Our main concern, however, was that there are so many possible headwinds that are still haunting our economy:
- Less than optimistic budget with minimal action: This has become a staple of the South African government. There was lots to be positive about, but all the positivity hinges around action being taken to make it a reality, and unfortunately that hasn’t been our governments strong suit – most of all the situation around our energy crisis. Although lots of talk about “a plan” has been made with some interesting ideas being thrown around, we still have no idea what this “plan” entails and the steps in place to ensure that it will work.
- Eskom and a possible grid collapse: More and more talk about the possibility of a total grid collapse is doing the rounds and the recent interview with Andre de Ruyter dishing up some serious dirt on the ANC and the Eskom situation is not helping. It seems that markets are pricing in a heavy loadshedding schedule for the foreseeable future and do not believe the rhetoric of “we will solve the energy crisis in the next 12 months”, but the risk of a total grid collapse and being without electricity for an extended period (however low the probability might be) is something that we can’t ignore.
- South Africa being greylisted: This one is a bit more contentious, as opinions vary widely on how severe the true effect will be. Some commentators are saying that everything from interest rates to employment could be affected with FDI (foreign direct investment) drying up and global companies pulling out of their local offices. Others say that all the impact is already priced in and that most of the international transactions being made will remain unaffected because of long standing relationships. It’s still unclear which side will play out and the answer will probably be somewhere in between. We feel that not all the bad is priced in just yet, but we wait to see how this plays out.
Our base case for the local environment includes the following scenarios:
- SA recession worse than US – deeper and longer
- Load shedding to go 6-4-2 with an average of Stage 4 – larger short-term risk of black-out
- SA inflation sticky around 6% due to indirect cost of load shedding and sustained high oil price
- SA interest rates – no more than 0.25% hike from here then flat to year end with cuts early next year
- Grey listing happens – short term ZAR weakness and continued lack of FDI
- ZAR to strengthen by end 2023
At the moment the South African headwinds introduce too much risk to ignore and lead us to stay cautious on risk assets going into March.
Jacques de Kock
Quantitative Analyst & Portfolio Manager
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