While last week’s symposium at Jackson Hole was all about inflation, the mood of investors across the world in the aftermath of Powell’s speech, was one of deflation. The stock market rally of 17.7% that began on June 16 pivoted to recession anxiety. Market reactions were somewhat sharper than we had expected, as central bank policymakers really only reinforced messages that were signalled by their colleagues prior to the symposium.
The noteworthy takeout from Jackson Hole is that global inflation – and implicitly interest rates – are forecast to stay higher for longer. As a result, the interest rate curve is pricing in future rate hikes of 148bps one year out from the current 2.38 level, bringing the Fed rate to 3.85%, but still priced at 2.85% three years out.
Of key concern to investors is how much of this bad news is priced into equity markets: The US market as measured by the S&P has declined by 15.9% from early January highs, but underlying forward earnings have risen by 7%. The forward P/E of this index has plunged from 22X since the peak at the beginning of the year to 16X, with the forward multiple now slightly below the long-term average of 16.5. The second quarter’s reporting season is almost complete and is now the third successive quarter where companies have overwhelmingly beaten their earnings estimates. Although there is a school of thought that corporate earnings guidance may now be behind the curve, we believe that quality companies that have pricing power in defensive sectors will continue to show earnings growth, albeit at a slower pace. A recent research note by MRB Partners concludes that although the global economy continues to face several headwinds, US equity prices have already discounted a mild recession and that “a considerable amount of bad news is now discounted in financial asset prices.”
On balance, it seems in our view, that there is sufficient information priced into the markets to mitigate the risk of the Powell-induced hangover being enduring. Should forward corporate earnings (the ‘E”) hold up per consensus forecasts, equity market prices (the “P”) should be revised upwards. We do however add the caveat (consistent with Powell’s on the rate hike trajectory!), that the path of equity market recovery will be data dependent.
“While higher interest rates, slower growth and softer labour market conditions will bring down inflation, they will also bring some pain to households and businesses.”
– Jerome Powell (Chair of the Federal Reserve of the United States)
“In essence, Powell is clearly stating that right now, fighting inflation is more important that supporting growth.”
– Jeffrey Roach (chief economist at LPL Financial)
Global News
- Investors doubting Federal Reserve Chair Jerome Powell’s resolve to fight inflation, have been warned that interest rates are heading higher and will stay there “for some time.” He delivered a terse five-page speech last Friday saying that the central bank will not blink in the fight to cool prices.
- His speech, which lasted just eight minutes, sparked a market rout that slashed the fortunes of America’s richest people by $78 billion. Billionaire Elon Musk lost $5.5 billion, while Jeff Bezos lost $6.8 billion.
- Last month, bulls were starved in the biggest cross-asset sell off since 1981. From stocks to bonds and commodities, every major asset slid. The least-atrocious return was a 1.9% loss as shown in a Bloomberg index tracking high-yield corporate bonds. Worse was a 2.2% drop in Treasuries, a 3.9% decline in commodities and a 4.2% slide in the S&P 500.
- Emeritus professor of finance at the University of Pennsylvania’s Wharton School, Jeremy Siegel, who called the inflation uptick as early as 2000 is now saying he wants the Fed to take it slow with interest-rate hikes as the central bank seeks to rein inflation back in.
- The dollar has continued to strengthen against the Euro, having gained 14.4% against this currency since the beginning of the year. Consequently, the US dollar ended August at its strongest level since late 2002, which is a significant concern, especially within emerging markets. As mentioned in our opening paragraph, the rate hiking cycle in the US is forecast to last longer than expectations prior to the Jackson Hole Conference, thereby providing support for the dollar.
- In the UK, soaring inflation is driving sterling to a near 37-year low. There is talk about inflation surpassing 18% next year, with many families across the country likely to be pushed into energy poverty this winter as prices are set to nearly double next month. According to Bloomberg News, the prospect of the pound reaching parity with the dollar is becoming ever less outlandish. “The implied probability of it hitting an all-time low of 1.05 by the end of the year is now 1-in-7”.
- Liz Truss is widely expected to be named Britain’s next prime minister on September 5. She is currently Secretary of State for Foreign, Commonwealth and Development Affairs of the United Kingdom.
- Gas prices in Europe have rocketed recently, with significant implications for inflation and economic activity not only for the region, but also around the world. This will further undermine the value of the Euro, while increasing global risk aversion.
- German inflation has hit its highest level in almost five decades, outpacing a high set three months earlier. This has strengthened the case for the European Central Bank to go for a larger basis point interest rate increase next month. Consumer prices, harmonised to make them comparable with inflation data from other EU countries, increased by 8.8% on the year.
- Growth in China is under threat, as economists turn more bearish on their economy, downgrading their growth forecasts further for 2022 and seeing lingering risks into next year as turmoil in the property market and Covid outbreaks persist. GDP is projected to grow just 3.5% this year, down from a previous forecast of 3.9%.
- Ride sharing company, Uber Technologies, is set to partner with financial technology start-up, Moove, to boost the number of electric vehicles in London by an additional 10,000 over the next few years, according to a statement. Moove is already Uber’s largest vehicle supply partner across Europe, the Mideast and Africa.
- Chipmaker ASML Holding, in the Netherlands, makes bus-size advanced semiconductor manufacturing devices, which cost more than $150 million to produce and consist of 100,000 separate components. Yet to manufacture them takes as much power as what an entire country would, and ironically they therefore have no choice but to push back against the move away from fossil fuels.
- At the time of writing, the S&P 500 was down 2.5% for the week based on Thursday’s close.
Local News
- The South African Reserve Bank has given President Cyril Ramaphosa until next week to provide details of the theft of millions in forex from his Phala Phala farm. He did not report the incident at the time and has also yet to respond adequately to the central bank, which has written to his lawyers asking for details of the forex transactions.
- After a series of high-profile Gupta-linked arrests, the apparent success of the Special Investigating Unit, and the South African Revenue Service investigation into the Gold Leaf Tobacco Corporation’s almost R3 billion tax evasion, should bring hope to a country besieged by tax evasion.
- On Monday, it was confirmed that the Hawks had arrested Brian Molefe and Anoj Singh. Both were found by the Zondo Commission to have been involved in State Capture and to have manipulated massive contracts for locomotives.
- Meanwhile, former Transnet CEO Siyabonga Gama was in court on Monday, where he and other former top executives and businessmen appeared on corruption charges. They were released on R50,000 bail. Their arrests were related to a R93 million train purchase tender. Gama was joined by former CFO Garry Pita and Treasurer Phetelo Ramosebudi as well as Eric Wood, from Gupta-linked companies Trillian Capital Partners and Regiments Capital.
- As South Africa faces being grey listed by Paris-based Financial Action Task Force, National Treasury has said that it will be difficult to demonstrate to the world that South Africa has sufficient measures in place to combat money laundering and terrorist financing activities and avoid being ranked alongside high-risk countries such as Syria and Turkey. South Africa has until the end of October to present a solution to the issues.
- Government debt has soared to 70% of GDP from just 24% in 2007, with debt costs now consuming one-fifth of all the revenue the government collects. February’s budget projected the debt would stabilise at 75% in 2024/2025, and the economy and revenues have done somewhat better than expected since then. We should get a clearer picture when the medium-term budget policy statement is released towards the end of October.
- The rand weakened to a two-year low against the dollar on Thursday and remains vulnerable to its own unique set of domestic economic factors, such as the fact that July and August are a time of seasonal weakening for the rand as many South African companies place import orders with foreign companies ahead of the end-of-year festive season. Moreover, the country is currently experiencing net portfolio outflows. For example, according to the Reserve Bank, foreign investors sold a net $0.46 billion of SA bonds as well as a net $2.52 billion of SA equities in the first seven months of 2022.
- It appears likely that South Africa will go ahead with plans to secure at least 3GW to 6GW of gas-powered electricity generation capacity within the next few years, despite criticism and objections from activists and researchers. There is an urgent need to secure additional gas supplies for industrial users. Read more here.
- Walmart is prepared to spend R6.4 billion for minority holdings in Massmart, which has sent shares in the struggling South African subsidiary skyrocketing and underlining its renewed commitment to one of Africa’s most lucrative retail markets. Walmart will pay R62 a share for the 47% stake in Massmart it does not already own, a 53% premium to the closing share price last Friday.
- Woolworths Holdings, facing fierce competition from rivals Pick n Pay and Shoprite-owned Checkers, plans to open more stores and ramp up its on-demand delivery service as it steps up a turf war for South Africa’s affluent shoppers.
- At the time of writing, the JSE All Share was 4.2% lower for the week, while the rand was 2.6% weaker against the US dollar.
Sources: Dynasty, Bloomberg, BusinessLIVE, Reuters, Daily Maverick, The Economist, Analytics Consulting, CNBC, ENCA, etc.
