Market and economic outlook – July 2024
11 Jul, 2024

 

Sanisha Packirisamy, Economist at Momentum Investments

 

Markets

 

  • For South African (SA) investors, our preference remains biased towards domestic asset classes over global counterparts for the upcoming year, driven by more attractive valuations and the potential for rand strength.

 

  • Although slowing United States (US) growth into 2025 could underpin both global bonds and equities due to the associated more positive rate cut expectations, it will be less supportive for equities should profit fears emerge.

 

  • Historically, global equities have performed robustly when the US rate-cutting cycle was not accompanied by a recession, whereas they tend to decline somewhat during recessions.

 

  • Expensive US valuations are the main return risk for global equities going forward. US bonds are presently trading at a discount to US equities, a situation seldom witnessed in the 21st century. An examination of the ratio between the current US bond yield and the through-the-cycle US equity earnings yield demonstrates that equities are currently priced almost two standard deviations expensive relative to US bonds.

 

  • With less than half of the SA equity market’s production, revenue or earnings generated within the borders of SA, the aggregate SA equity market is not overly sensitive to local developments or the rand. The valuation metrics of the SA equity market have reset to consistently lower levels since the pandemic. SA equities remain very underowned by local and global portfolio managers, enhancing their rerating potential should there be positive surprises on the domestic economic growth front or if a global risk-on environment takes hold.

 

  • SA bond yields are attractive against their history in real terms, as well as relative to those in developed markets (DMs) and emerging markets (EMs), with part of the high real yield differential due to a high fiscal risk premium. Sharp break-even tightening and mostly lower-than-average accruals in 2025, as inflation falls, should be less favourable for inflation-linked bonds (ILBs) from later this year. The prospective SA real cash yield has been rising from a low level in line with policy rate increases and has stabilised around 0.7 standard deviations above its historical average.

 

  • Strong recent returns from the listed property sector should constrain future returns.

 

  • Ongoing central bank gold purchases, associated with geopolitical risks, are expected to support the US dollar gold price in the near term.

 

Economics

 

  • Barring a sharp rise in geopolitical tensions, the global economy appears increasingly likely to avoid a hard landing.

 

  • Despite more muted expectations for policy easing relative to the start of the year, global economic activity is still expected to continue expanding, albeit at a slower pace and below historical averages. The durability of the recovery, we believe, does not depend on significant policy easing but will be supported by still-robust wage growth, declining inflation and ongoing tightness in labour markets.

 

  • Regional disparities in inflation and output gaps have resulted in different central bank strategies, with some countries in a position to ease interest rates earlier than others.

 

  • By 2025 and 2026, central banks are expected to edge towards their neutral rates, which may have increased due to structural changes such as fiscal dominance and demographic trends.

 

  • A decade-long trend of rising protectionist measures, escalating social unrest and geopolitical instability appears likely to gather momentum as this year witnesses a record number of national elections, offering populist movements a chance to solidify their influence.

 

  • Global proxy wars continue to raise risks of volatility and inflation, posing significant threats to economic growth and global cooperation efforts as relations between major superpowers become strained. As the Russia-Ukraine war reaches the two-and-a-half-year mark, the conflict is stuck in a political and military impasse. The looming year of elections in Europe may deepen rifts over aid to Ukraine, and a second Trump administration could disrupt the cohesion of the Transatlantic Alliance. Meanwhile, Israel’s bombing campaign in Gaza raises the potential for wider regional wars and threatens regional stability.

 

  • SA has now entered a phase where collective decision-making is crucial for effective governance. As such, the stability of the incoming government will hinge on the political maturity of the represented parties in parliament.

 

  • We anticipate that business and consumer confidence will rise in hopes of continued structural reforms, leading to a better economic path. There is potential for growth to exceed our base case of 1% this year and 1.7% next year as accountability and governance improve and policy and reform continuity prevail.

 

  • Further rand strength could result from DM central banks lowering interest rates in response to disinflation, though significant appreciation will depend on empirical growth evidence.

 

  • As tail risks to the currency recede, upside threats to our inflation view of 5.3% this year and 4.5% next year are likely to wane. Should growth outperform expectations, there could be room for more significant rate cuts than the 100 basis points we currently forecast over the next year.

 

ENDS

Author

@Sanisha Packirisamy, Momentum Investments
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