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Market Overview - January 2024

Market Overview

The final month of 2023 was dominated by fluctuating interest rate expectations and investors continuing to speculate when rate cuts may begin. While this led to a relatively cautious mood at the start of the month, Federal Reserve Chair, Jerome Powell, indicated in mid-month that the Federal Open Market Committee (FOMC) had pivoted towards a more dovish stance, ending its historic policy tightening campaign. This paradigm shift ignited one of the biggest post-meeting rallies across assets in almost 15 years. The combination of pending rate cuts and recent data out of the United States (US), which showed that the economy remains resilient, bolstered expectations of a "soft landing" for the US economy. As at the close on 15 December, US markets were sharply higher for the month, with the S&P 500 Index trading 3.4% higher. The MSCI World Index (+3.5%) was able to maintain upward momentum, with the MSCI Emerging Markets Index offsetting earlier losses to trade up 1.5%.

A similar situation unfolded in Europe (EuroStoxx 600 Index: +3.3%) with investors turning their attention to monetary policy announcements from the European Central Bank (ECB) and Bank of England (BoE), both of which opted to keep interest rates unchanged. ECB President, Christine Lagarde, however, cautioned that the fight against inflation was not over despite the recent slump towards the 2% level, weighing on hopes for early rate cuts next year.

Chinese markets lagged global peers with the MSCI China Index trading down 3.1% as mixed economic data, growth concerns and geopolitical tensions seemed to have weighed on investor appetite for equities in the region. In addition, ratings agency Moody's placed the credit ratings of several Chinese local government financing vehicles (LGFVs) on review for downgrade after cutting its outlook for the country's sovereign bonds to negative from stable. The agency noted that a combination of increases in direct and indirect debt burdens, stressed liquidity conditions for some of their LGFVs and local state-owned enterprises (SOEs), and/or relatively weak economic prospects as reasons for its more wary stance. This raised further concerns and supported the continued dim outlook on the Chinese economy despite government efforts to bolster growth.

Locally, the All Share Index was able to offset earlier losses as well following the shift in global sentiment, trading almost flat at the time of writing, with the rand also seeing improved levels against the US dollar. In terms of local data, consumer price inflation fell to 5.5% y/y in November from 5.9% in October, in line with expectations. The moderation was mainly due to lower fuel prices which offset rising food prices - further improvements are expected, particularly at a headline level, with fuel prices set to decline further and supply side impacts on food prices waning into next year. Demand in the economy, however, is set to remain weak, weighing on core inflation. We also anticipate that the South African Reserve Bank (SARB) will keep interest rates on hold in January 2024.

Economic data overview

The US Federal Reserve finally pivots with at least three rate cuts expected next year

Flash estimates showed that the S&P Global Composite PMI for the US held steady at 50.7 in November, slightly higher than expectations. This indicated a marginal further expansion in private sector activity. Although manufacturing firms reported a slower pace of expansion, service providers witnessed a fractional uptick in the rate of output growth, the fastest since July. Retail sales in November increased 4.1% y/y - this was better than expectations. The US trade deficit widened to $64.3 billion in October 2023, against forecasts of $64.2 billion, as exports were down 1% and imports increased 0.2%. The unemployment rate in November fell to 3.7%, below market expectations. The annual inflation rate in the US slowed to 3.1% in November 2023, the lowest reading in five months, and in line with forecasts. The Federal Reserve kept the benchmark rate steady, as expected, for a third consecutive meeting in December 2023 but indicated 75bps cuts in 2024. Policymakers said that recent indicators suggest that economic growth has slowed, and job gains have moderated but remain strong with the unemployment rate remaining low. Inflation has eased over the past year but remains elevated.

The ECB kept rates on hold for a second consecutive meeting but warms that policymakers shouldn't become complacent

On a preliminary basis, the HCOB Eurozone Composite PMI rose to 47.1 in November, up from a near three-year low of 46.5 in the previous month and slightly above market expectations of 46.9. It was the highest PMI reading since July but still indicated a notable deterioration in economic conditions. Retail sales fell by 1.2% y/y in October, the third consecutive month of contraction and compared with market expectations of a 1.1% decline. A trade surplus of €10 billion was recorded in September, compared to forecasts of a €22.3 billion surplus, swinging considerably from a €29.8 billion gap in the corresponding month of the previous year, largely due to the stabilisation in prices of natural gas and other major resource imports into the currency bloc. The unemployment rate increased to 6.5% in October, unchanged from the prior month and matching market forecasts. Inflation for November came in at 2.4%, falling below consensus expectations. The ECB kept interest rates unchanged (as expected) for the second consecutive meeting on Thursday, amid efforts to address high inflation despite indications pointing to a slowdown in economic growth. The focus now turns to President Lagarde's comments, particularly regarding her acknowledgment of the unexpectedly rapid decline in inflation and the ECB's stance on speculations of potential interest-rate reductions.

The BoE remains cautious and reiterated that monetary policy is likely to be restrictive for an 'extended period of time'

The S&P Global/CIPS UK Composite PMI rose to 50.1 in November, up from 48.7 in October and above market expectations of 48.7 according to preliminary estimates. Retail sales decreased 2.7% y/y in October, compared to forecasts of a 1.5% drop. The trade deficit widened to £4.48 billion in October 2023, compared to expectations of a £1.7 billion deficit, the largest in five months, as imports jumped 4.6% to a four-month high and exports rebounded 0.6% from an over one-year low. In line with market expectations, the unemployment rate was unchanged at 4.2%. Annual inflation in the UK dropped to 4.6% in October, down from 6.7% in both September and August, falling below market expectations of 4.8%. The BoE maintained its benchmark interest rate at a 15-year high of 5.25% (as expected) for the third consecutive time during its December meeting, aligning with policymakers' efforts to combat inflation, even in the face of indications pointing to a deteriorating economic landscape. Three members advocated for a 25bps rate hike, citing the relatively tight labour market and evidence of persistent inflationary pressures. The central bank has emphasised the probable necessity for an extended period of restrictive monetary policy to curb inflation, while also highlighting the potential requirement for further tightening should inflationary pressures persist. Despite these statements, investor forecasts anticipate a decline in UK interest rates next year. They have adjusted their bets on the extent of rate cuts, with the first fully priced in for June instead of May.

China concerns dominate sentiment once again

China's composite PMI fell to fell to 51.6 in November 2023 from 50 in the prior month. This was the 11th straight month of growth in private sector activity and the steepest pace since August, as factory activity unexpectedly expanded following a fall in October, while the service sector rose the most in three months. Retail sales surged by 10.1% y/y in November, much faster than a 7.6% increase in the previous month and compared with market consensus of 12.5%. China's trade surplus increased to US$68.39 billion in November 2023 from $66.49 billion in the same period the previous year, easily beating market forecasts of $58 billion, as exports unexpectedly grew while imports surprisingly fell. The surveyed urban unemployment was unchanged at 5% in November. China's consumer prices fell by 0.5% y/y in November 2023, steeper than a 0.2% drop in the prior month and compared with market forecasts of a 0.1% fall. The People's Bank of China (PBoC) maintained lending rates at the November fixing, as was widely expected. The decision came after the central bank held medium-term interbank rates steady as economic activity in October was mixed, with headwinds from the property sector deepening despite a slew of stimulus measures from authorities. Meanwhile, a weakening yuan continued to limit the scope of monetary easing. China remains an outlier among central banks, having loosened monetary policy to revive a faltering economy but further rate cuts would widen the yield gap with the US, risking yuan depreciation and capital outflows. Some economists expect the board to slash the lending benchmark by 20bps at the end of 1Q24.

Market participants expect the Bank of Japan (BoJ) to start unwinding its ultra-loose monetary settings as early as January

Early estimates showed that the Jibun Bank Composite PMI increased to 50.4 in December 2023 from a final 49.6 in the prior month. A stronger rise in services activity supported the upturn, offsetting a quicker fall in factory output. Retail sales rose 4.2% y/y in October, slowing for the second consecutive month following a revised 6.2% gain in September. October's figure was also the lowest reading in ten months and came in way below market expectations for a 5.9% rise. Japan's trade deficit narrowed sharply to ¥662.55 billion in October from ¥2.205 billion in the same month of the prior year, less than market estimates of a shortfall of ¥735.7 billion. The unemployment rate fell to 2.6% in September from 2.7% in August, in line with expectations. The annual inflation rate rose to 3.3% (above expectations of 3.2%) in October from 3% in the prior month, pointing to the highest print since July. The BoJ kept its key short-term interest rate unchanged in October, in line with expectations, with market forecasts guiding for a similar outcome at the final meeting for the year. In a quarterly outlook report, the BoJ revised inflation forecasts higher for FY23 and FY24. Meantime, policymakers noted that Japan's economy was likely to continue recovering moderately, supported by pent-up demand but highlighted downward pressure from a slowing global recovery. The board reiterated that it will not hesitate to take extra easing measures if needed.

Local inflation eased in November with expectations of interest rates remaining on hold

The SACCI business confidence index for November increased to a nine-month high of 111.5 (compared to a reading of 108.6 in the previous month), with sentiment driven by a more positive outlook on tourism and foreign trade relations (including merchandise volumes). Mining production recovered almost 4% y/y in October (against expectations of a 1.5% increase), marking the first uptick in activity after more than three months, as output for PGMs, manganese ore and chromium ore improved. Manufacturing production grew 2.1% y/y, ahead of the expected increase of 1.8%, signalling a swift rebound in activity, with strong contributions from petroleum, chemical products and rubber & plastic producers. The composite PMI improved to 50 in November (compared to 48.9 a month before), pointing toward a stabilisation in private sector activity amid robust domestic demand. This was evidenced by an uptick in manufacturing PMI to 48.2 (October: 45.3). Total new vehicle sales decreased to 45 075 units (October: 45 460 units) as buyers remained under pressure due to tight economic conditions.

Consumer price inflation (CPI) eased to 5.5% in November (against forecasts of 5.6%) amid moderating transport (fuel) costs, notwithstanding sustained pressure in food & non-alcoholic beverage prices. This remains within the SARB's target range of between 3% and 6%. Core inflation (which excludes the price of food, non-alcoholic beverages, fuel and energy) was slightly higher at 4.5%.

During its November meeting, the SARB left its benchmark interest rate unchanged at 8.25% (in line with expectations) and emphasised that inflation risks remain elevated though the risks for medium-term domestic growth appear balanced. The SARB's main goal remains to firmly anchor inflation expectations around the midpoint of its targeted range.

Market Outlook in a nutshell

Local

• We predict growth of 0.8% in 2023, lifting to 1.2% in 2024, 1.6% in 2025 and 1.8% by 2026. The near-term growth projection has improved on a lower intensity of load-shedding, while growth in the medium term continues to rely on the structural reform agenda and improving external demand. We remain concerned that further escalations in geopolitical tensions will hinder improvement in global trade and the reversion of inflation to central bank targets.
• Furthermore, we are worried about mounting stress for vulnerable households. Cost-of-living pressures and failing service delivery have likely pushed many households into distressed borrowing, which will have implications for borrowing costs as a proportion of disposable income and the overall health of balance sheets. The next year will likely remain challenging but as inflation slows and economic growth gains momentum, we are likely to see more pronounced and broad-based employment and real wage growth.
• Slower inflation is a key feature of the medium-term outlook but the risk that it is more sticky than projected is material. Currency and supply-side pressures continue to manifest themselves in elevated goods inflation, albeit to a lesser extent with the unwinding of international supply chain bottlenecks, but services highlight weak consumer demand. In line with this, core inflation generally underwhelmed expectations this year, indicating that the passthrough of elevated input costs has been constrained. This supports average annual headline inflation slowing to 5.9% in the current year, from 6.9% last year, before falling to 4.7% in 2026.
• Weak demand-driven inflation is consistent with restrictive monetary policy. With nominal interest rates at 8.25%, and inflation falling towards 5% by year-end, real interest rates should climb above 3% and exceed the estimated level of neutral by 0.5 ppt. With policy becoming more restrictive as inflation slows and after three consecutive holds by the MPC, we are more confident that we have reached the peak in nominal interest rates. The next major risk event in the calendar is the 2024 elections, after which the MPC should be able to consider cutting rates. Ultimately, the MPC should only look to remove excess restrictiveness but not necessarily shift to an accommodative stance. This will be key to catering for funding risks while ensuring that financial conditions are consistent with inflation slowing to target sustainably.

Global

• Our primary concern going forward is whether the resilience of company earnings can be extrapolated into the future. We believe that this may prove difficult as the lagged effect of tightening monetary policy actions will likely begin to filter through to changes in both corporate and consumer spending patterns. Higher borrowing costs for both businesses and consumers will likely suppress economic activity, particularly in discretionary related areas, as economic agents look to rein in expenditure to tighten their balance sheets and income statements. However, there is potential for fiscal stimulus in an election year (2024).
• Households will likely continue utilising various credit instruments, particularly credit card debt which is currently at all-time highs to prop up short term expenditure prospects. Moreover, the reactivation of over $1.6 trillion of student debt may well present a headwind to future earnings prospects. Nevertheless, if liquidity remains plentiful, the emergence of price discovery in the short-term could be prevented.
• In emerging markets, it is certainly encouraging to see the People's Bank of China maintaining loose monetary policy and further injecting liquidity into the banking system. However, recovery to remain fragile in the absence of fiscal stimulus targeted at restoring confidence to the consumer or 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.
• We have continued to reduce the fixed income underweight. We are taking more explicit position on the long end of the curve as inflation continues to trend down. We would look to take an overweight fixed income position when investor fears have shifted from interest rate and inflation to that of growth prospects.

2023 - The year that was

This year the markets kicked off on uncertain terms with the growth outlook marred by several unknowns and 'what ifs'. What if the Fed's interest rate hikes break something? What if we have more geopolitical drama? When will China re-open? Will we ever see the end of load-shedding in South Africa (SA)? What if looming issues at Transnet become a bigger problem?

The Fed did break something, but the regional banking crisis was contained and short lived. Conflict in the Middle East re-emerged, although the impact on global growth and importantly oil has so far been limited. China re-opened but it was with anything but a 'bang'. Load-shedding persisted and while impeding growth somewhat, industries and households have adapted well. Transnet's issues unfortunately intensified to become the dominating local economic growth constraint.

Our expectation for markets at the start of the year was again cautious with the possibility of recession in several major economies flagged as a major risk.

Several large economies, notably the United States (US), were expected to enter recessions or at least come close to entering one in 2023. We were less pessimistic on the second half of the year.

At the time of writing, the recession in the US had not materialised. Quarter after quarter, the strength of the US economy continued to surprise economists and market participants alike. The theme of 'US exceptionalism' gained traction, and in the final quarter of the year the dominating narrative shifted from a US recession to a 'soft landing'.

The advent of Chat-GTP spurred major enthusiasm in Artificial Intelligence (AI) as a thematic. Major US technology companies exposed to this theme performed exceptionally well, supporting a very strong performance from the Nasdaq and S&P 500 in aggregate. For most of the year, outside the 'Magnificent Seven', US stock market returns were notably less impressive although the emergence of the 'soft landing' as the dominating narrative in November saw more breadth emerging in the equity market uplift.

Also holding up the US economy was a US consumer remaining in a relatively solid position because of continued buoyancy in the labour market and a drawdown of savings that were shored up substantially during the Covid-19 pandemic. Furthermore, US fiscal spending remained expansive, countering the Feds restrictive path on the monetary policy front.

US recession probability forecast

Among the listed companies, Bandai Namco has comfortably outperformed the other two major toymakers over the last decade and over a five-year period. More recently, Mattel has outperformed -on the expected and realised success of the Barbie movie.

We were optimistic that China's reopening (that had not yet occurred at the start of 2023) would see the outlook improve. We highlighted, however, that haphazard policy pronouncements remained a risk.

China's reopening spurred major optimism at the start of the year but failed to provide thrust throughout the year - not because of the policy environment, but rather because of a very slow reaction from Chinese consumers to the less restrictive environment. Economic data remained mixed throughout most of the year and the external environment, while not recessionary, softened.

For SA, our economics team expected economic activity to slow significantly alongside the expected moderation in global growth.

While the slowdown did materialise, outcomes have been unusually volatile, reflecting the post-pandemic forecasting complexity and the dynamic impact of domestic infrastructure inefficiencies such as electricity supply disruptions (which we were already aware of) and logistical challenges (that emerged as a major imminent threat). In particular, the first half of the year was exceptionally positive, with the first two quarters recording 0.4% and 0.5% quarterly expansions. Meanwhile, the start of the second half has been downbeat, with growth underwhelming expectations. We think the agricultural sector may rebound strongly in 4Q23 and sharp inventory destocking in 3Q23 could propel production ramp-up by the mining and manufacturing sectors in the last quarter, but enduring growth will have to be supported by more broad-based investment. We maintain a relatively soft 0.8% GDP real growth expectation for 2023 (down from 1.9% last year) but are cognisant of the material downside risk as it relates to our network industries.

The rand was expected to remain volatile and undervalued as global financial conditions remained tight and economic activity slows. The rand faced pressure from an external financing perspective as the current account balance had turned into a deficit.

The rand was exceptionally volatile this year, as expected. At the time of writing, the rand had lost 7.5% against the US dollar on a year-to-date basis, the fourth weakest among the 30 major global currencies against the greenback. The US dollar remained strong in the year due to continued rate hikes by the US Federal Reserve (far more than what was predicted at the start of the year) and heightened geopolitical risk. Only eight major currencies strengthened relative to the US dollar in 2023 - the Columbian peso, Mexican peso, Polish zloty, and the Brazilian real were notable outperformers.

Outside of dollar strength, the rand was weighed on by a sharp deterioration in certain commodity prices and a weakening fiscal position, along with other idiosyncratic factors (Eskom! Transnet! Grid Collapse! Putin! Lady R! AGOA!) dampening SA's appeal as an investment destination - both in terms of foreign direct investment and portfolio flows.

We noted that the local equity market was still not expensive relative to history and its peers and regarded real rates offered from bonds as still attractive. We expected returns above inflation from local risk assets.

While the bond market staged a late recovery to provide decent returns relative to inflation and cash rates, the equity market overall struggled - particularly in the second half of the year. The weakness was, however, sector and stock specific - with underperformance from several heavyweight industrial stocks, and the Resources index dragging the market lower. The JSE All Share Index delivered a total return of ~7% but considering the SA Inc stable, the performance was notably better. The JSE Financial 15 Index returned ~18%, the small cap index delivered ~8%, and the All Share excluding Resources, secondary listed companies and Naspers showed a return of 13.7%

2024 - The year ahead

When considering our expectations and positioning for 2024, we are experiencing a pronounced sense of déjà vu. While it seems as if market participants are currently leaning more towards a soft landing as opposed to a recession at the start of the year, we are still concerned that the recession in the US has been delayed and not necessarily avoided. Regardless of severity in the US, the expectation is still for below trend growth in 2024 from most economies.

• We expect the slowdown to be consumption led as household savings in the US have become depleted and consumers gear up to cover higher living costs. The fiscal thrust seen in 2023 is unlikely to be repeated and the lagged impact of monetary policy (US monetary policy in particular) could begin to bite. The impact of higher interest rates thus far has not yet translated into clear balance sheet stress in corporates and for consumers. These balance sheets are stretched, however, and could deteriorate further next year in the absence of interest rate relief.
• Again, the second half looks more promising than the first and there may be good opportunities to add to risk exposure late in the first half. While rate cuts may work with a lag, equity markets usually recover when the first cut is confirmed. Our preference at the start of the year is for bonds over equities.
• China's 'growth interrupted' narrative may remain an issue in 2024. The property market remains a concern and has likely contributed greatly to depressed consumer confidence and weakness in that space. The expectation is that recent state intervention could see a cyclical recovery into next year, but structural issues may remain an impediment to a return to pre-Covid-19 growth dynamics.
• Global geopolitics could also again be a dominating factor next year with 76 countries (or 51% of the global population and representing 59% of global GDP) set to vote in 2024. Notably the US will elect a new president, a new House of Representatives, and will replace a third of its Senate.

In SA, we see growth lifting to just above 1% next year as network industry constraints continue to bite, but lower inflation, improving external demand, and some interest rate relief could provide support.

• The local equity market remains undervalued, and within the JSE the rand hedges are now also showing decent value. SA bond real rates are still attractive.
• We note that foreign participation is required to drive capital gains in both instances and SA specific risk remains a deterrent to participation, both in the bond market and SA Inc equities space.
• Network industry constraints and slow progress on economic reforms not only remain key inhibitors of growth, but also materially impacts South Africa's attractiveness as an investment destination.
• We could see heightened volatility in asset prices and the rand exchange rate as South Africans are also set to visit the polls in around May.
• With interest rates likely to come down towards the second half of the year, we would expect above money-market returns from local risk assets in 2024. As is the case with offshore assets, we would expect returns to be weighted towards the latter part of the year.

Disclaimer: All figures have been obtained from Bloomberg based on each company's latest financial results. Companies disclose degrees of geographic exposure in varying granularity, which may cause discrepancies, and figures obtained may be impacted by currency volatility and may not be representative of future exposures.

For more information regarding your investment, please contact your Portfolio Manager directly.

Regards

FNB