I often find myself referring back to theory studied at university, trying to rationalise movements in the market, and at the start of each year I can’t help but recall a theory known as the January Effect. This effect relates to a general increase in stock prices during the month of January attributed to an increase in stocks bought after a price decline in December. The decline is a result of a general sell-off from investors trying to create tax losses to offset against capital gains realised during the year. Theoretically speaking this would mean that January should be a relatively good month for shareholders assuming the theory holds true. Unfortunately when we consider the figures below for January 2016 it is clear that there was no sign of the January Effect and on average it was a really tough time locally and abroad for shareholders.
Here’s the usual summary of some of the major indicators for the periods ending January 2016:
||Local listed property
|Rand / Dollar
|Rand / Euro
|Rand / Sterling
January was not only a trying time for shareholders with the All Share Index down 3%, local listed property also delivered a negative return of 3%. Fortunately local bonds and cash provided a degree of protection but I think you will agree that overall it was a tough start to the year. We can’t however dwell on the past and we need to look at the year ahead. I must proclaim we don’t have a crystal ball and we steer well clear of trying to predict the future, but in order to manage client portfolios we need to be observant of economic conditions. In our minds it is clear that a few key themes have started to rear their heads which we think could become relevant for 2016.
South African consumers should continue to feel inflationary pressure on the price of goods and services during 2016. One driver of inflation is the price of imported goods and services, keeping in mind that the cost of imports increases as the value of your currency decreases, generally referred to as imported inflation. A further driver of food inflation is the effect of the current drought, which is wreaking havoc on the supply of South African produce. Other factors include Eskom’s announcement that the cost of electricity is expected to increase by about 17%, and the Ministry of Water and Sanitation’s expectation that the cost of water will increase by roughly 11%. It is clear when we consider these factors, that the headline inflation rate is a concern. Market sentiment is that inflation could reach a level of around 7.5% or higher towards the end of 2016.
The US Fed indicated plans to hike US interest rates during the course of 2016. The extent of the increases is still unknown and dependant on macro-economic conditions but any changes to US interest rates will force the South African Reserve Bank (SARB) to relook at local rates. The impact of an interest rate hike is a higher cost of debt, which could dampen earnings growth for local producers of goods and services. Traditionally, increases are also negative for growth expectations on equities. At the end of January the SARB Governor, Lesetja Kganyago announced that the repo rate would increase by 50 basis points to 6.75% from 6.25%. This further meant that the prime lending rate charged by banks to consumers increased to 10.25% from 9.75%. The main contributor to this rate hike was the concern over rising inflation.
Chinese GDP Growth
China continues to be the economy that most investors are watching with bated breath. China has published lower GDP growth figures for 2015 compared to previous years, and this growth is expected to slow down even further in 2016. Other interesting developments are starting to take place in China which should be noted. Historically, China has been a producer of goods and services, therefore exporting countries such as South Africa were significant benefactors of their growth. The last two decades of growth in China caused the Chinese population to accumulate immense wealth and now the market is showing signs of a shift away from production towards consumption. It is still very early days but we are keeping an eye on the development of these changes.
The South African Rand
In terms of our expectations for the Rand during 2016, your guess is probably as good as ours! Predicting currency movements are a lottery at best. However, at current valuations against other major currencies, the Rand is statistically undervalued, in other words; oversold. Does this mean that the currency will strengthen over time? Probably. However, we don’t know when or by how much and, to be honest, the absolute level of for example R17.50 or R19.00 is rather misleading, so we don’t get fixated on that. We prefer to look at the currency on a relative to par value basis over the long term, which provides for better positioning and decision making.
In closing, it is clear that there are currently a number of economic factors at play that could impact the short-term direction of the South African market for 2016. What does this mean for your investment portfolio? The short answer is a focus on diversification and preservation of capital. We aim to provide investors with access to multiple asset classes in order to diversify risk and increase their possible opportunity set. This will allow us to take advantage of any mispricing which we believe will be a key driver of returns during 2016. You might feel slightly pessimistic when reading about our current economic state of affairs but remember that each of these economic factors in itself also provides investment opportunities. Lastly and arguably the most important point, we would like to encourage all of our South African clients to vote during the upcoming municipal elections. Remember your vote is your democratic voice and a driver for change in South Africa.
For a full breakdown of fund and individual share movements, kindly click on the links above to access the January 2015 Local and Offshore Watchlists.