The Dichotomous Causes of Interest Rate Cuts, Weekly Update

In anticipation that the peak in the rate-hiking cycle should imminently be reached in the US, the S&P 500 continued its positive run this week, with this index now having rebounded by around 7% since the collapse of Silicon Valley Bank and Signature Bank last month.

The March inflation numbers released on Wednesday reinforced the view that perhaps only one additional hike of 25bps will be implemented by the Fed in May. However as we look past the peak of the cycle, a question needs to be posed as to whether the rate cuts later this year (as priced into the interest rate curve ), will be in response to tamed inflation signalling the Fed has induced enough monetary tightening to engineer a “goldilocks” landing for the economy, or whether the cuts will be in reaction to the threat of the US entering a recessionary environment accompanied by rising unemployment and a falloff in corporate earnings.

Either of these dichotomous outcomes will have a major impact on short-term market direction and all eyes will be on the release of Q1 2023’s results during the course of this month. Recent market movements are reflective of general optimism by participants, but of more relevance is that our most recent research indicates a large measure of forward earnings resilience from the individual holdings within our preferred offshore funds.

“Dichotomies are most mischievous when they arbitrarily separate parts of a highly interrelated and complex system.”

– David Ehrenfeld, American professor of biology

Global News

Figures released on Wednesday indicated that the core consumer price index, a key measure of US inflation, showed signs of moderating in March. The core consumer price index, which excludes food and energy rose 0.4% from the prior month following a 0.5% gain in the previous month, which was in line with economists’ estimates. Yet, key measures of housing costs posted the smallest monthly increases in about a year and grocery prices dropped, the report from the Bureau of Labour Statistics showed. Consumer prices overall increased 5% from a year earlier, down from 6% in February and a 40-year high of 9.1% last June, according to the Labour Department. The Producer Price Index (PPI) fell 0.5% in March from the prior month, the largest drop since April 2020, adding to signs of moderating inflation. However, this may not be enough to discourage the Federal Reserve from raising interest rates again next month.
UBS suggests that the demand-driven inflation cycle that commenced in 2021 is now deflationary – television prices are more than 21% below their post-pandemic high. The second inflation wave – energy supply shock – is now also disinflationary, with the oil price well off its 2022 peak. Although profit margin-led inflation from the business sector remains, this category of inflation is likely to be stronger at the very start of the year when cost increases are most frequently passed on.
The dollar is set to keep weakening regardless of inflation because investors are convinced that the Fed is close to the peak of its tightening cycle even in the most hawkish of scenarios. The Bloomberg Dollar Spot index has now tumbled almost 10% since it reached a record high in September as rate hikes slowed. On the back of the news on slowing cost pressures in the US, the dollar slumped to a one-year low in early European trade on Friday while the euro jumped to its highest level in more than a year fueled by increasing market expectations that the US Fed will cut interest rates later this year. Interest rates in Europe and the UK are boosting the Euro and Sterling, respectively.
French President Emmanuel Macron provoked a backlash in the United States and Europe earlier this week when he called on the European Union to reduce dependence on the US and cautioned against being drawn into a crisis over Taiwan driven by an “American rhythm and a Chinese overreaction”. This was seen by many as a gift to what they called Beijing’s goal of dismantling transatlantic unity. The fallout from the China trip has left the French President more isolated than at any time in his six-year presidency.
The IMF has dropped its global growth projections due to high uncertainty and risks. This is being caused by financial-sector stress and pressures emanating from tighter monetary policy as well as the ongoing Russian invasion of Ukraine. Globally, GDP will likely expand 2.8% this year and 3% next year, each 0.1 percentage point less than forecast in January, it said at its annual week-long Spring Meeting this week. This compares with the 3.4% recorded growth in 2022.
Market participants are concerned that the fallout from March’s banking crisis is not over. Smaller lenders are expected to pull back on lending, which could result in a quarter- to a half-percentage-point drag on GDP in the US; money is no longer freely available in the market, which is also adversely affecting start-ups as investors seek more security flowing from concerns that there could be more collapses in the financial sector; at the same time, bank stocks are taking strain and based on the KBW index, trading near a 30-month low after SVB’s collapse.
OpenAI has upgraded its ChatGPT with plugin capabilities that make it even more of a threat to big tech companies such as Google. It can now go from merely generating text to acting on the web, turning it into a powerful virtual assistant, which Alphabet’s Google and Apple have been trying to build for years. ChatGPT’s plugins now allows businesses to plug the tool into their own systems, allowing for proprietary database searches or to even carry out tasks like making a restaurant booking, or reading and executing code. Although there are potential risks from this, the ChatGPT platform has created a technological lead for OpenAI against its competitors.
Twitter has ceased to exist as a standalone company after merging with a newly formed shell company called X, driving speculation about what Elon Musk intends for the social media platform. It’s not clear what the change means for Twitter, which has seen a sweeping overhaul since Musk bought the company for $44 billion last year. He has previously suggested that buying Twitter would be an “accelerant” for creating X — which he dubbed an “everything app”. Musk tweeted about the move on Tuesday with the single character “X”.
The world’s richest person, Bernard Arnault, is solidifying his lead over second-ranked Elon Musk. The luxury brands tycoon is selling more expensive goods, while the Tesla founder cuts prices on electric vehicles. The Frenchman behind LVMH saw his wealth gain $12 billion on Thursday to almost $210 billion, a record high and his second-biggest single-day rise ever, according to the Bloomberg Billionaires Index. Musk is worth $180 billion after gaining $3.8 billion. (LVMH is a top-ten holding within the Fundsmith Equity Fund, one of Dynasty’s preferred offshore solutions).
Apple’s PC shipments plummeted 40.5% in the first quarter of this year, marking a tough start to the year for PC makers still grappling with a glut of unsold inventory. Combined PC shipments slumped 29% to 56.9 million units – and fell below the levels of early 2019 – as the demand surge driven by the pandemic-era remote work evaporated, according to the latest report from the International Data Corporation. In the top five, Lenovo Group and Dell Technologies saw drops of more than 30%, while HP was down 24.2%. Asustek Computer rounded off the top five with a 30.3% fall.
Chinese company Tencent saw its shares decline by the most in more than two months on indications that its largest shareholder Prosus may extend the selling of the Chinese tech firm’s stock. Tencent shares dropped 5.2% to HK$357.2 in Hong Kong on Wednesday. while Prosus shares fell as much as 5.5% in Amsterdam.
As at Thursday’s close the S&P was 1.02% up for the week.

Local News

According to the BankservAfrica Economic Transactions Index, which tracks interbank payments, South Africa’s economy has likely entered a technical recession with a second straight quarterly contraction. The Index dropped 1.7% in the first quarter of 2023 compared with the previous quarter’s contraction of 1.3%.
While saying that lowering the inflation target to 3% would benefit the economy, South Africa’s central bank Governor Lesetja Kganyago has called for sweeping reforms to macroeconomic policies to boost economic growth and lessen exchange rate volatility and sovereign risk. Proposed changes include structural reforms, deregulation of the nation’s transport and electricity sectors, and a shift back to predictable, transparent fiscal policy rules. Lowering the inflation target will also reduce the potential for an upward drift in the real exchange rate and cut loan-service costs for the country’s over-indebted public sector.
The South African Post Office is in provisional liquidation as it owes R4.4 billion to creditors, despite a R2.4 billion bailout from the National Treasury in the budget announced in February. The technically insolvent Post Office has lost money every year since 2013 and has been forced to close branches all over the country. Creditors have been knocking at its door and in February it announced a plan to cut 6,000 jobs, which it later reduced to 3,000.
South Africa’s manufacturing production fell to its lowest level in nearly a year in February on an annual basis, reflecting the cost of power cuts on food manufacturers and allied sectors. This key indicator of future economic growth fell 5.2% year-on-year in February, worse than a 2% drop forecast by economists in a Reuters survey. On a month-on-month basis, seasonally adjusted manufacturing production contracted 1.3% in February 2023 compared with January, once again worse than market forecasts. This followed month-on-month growth of 0.5% in January and 0.2% in December.
Mining output contracted by a bigger-than-expected 5% year-on-year in February, offering another indication that the country’s manufacturing sectors are reeling from persistent power cuts. Coal and diamonds were hit hardest, falling 12.6% and 45%, respectively. However, iron ore output rose 30.6% compared with the same period a year ago.
Seven power pylons collapsed along the N4 in Pretoria over the past weekend, causing a blow to Ford’s plant in the Tshwane Automotive Special Economic Zone. The outage shut down the plant, which recently rolled the first next-generation Ranger off its lines. This has caused an output loss of 720 vehicles a day. Other businesses and manufacturers, as well as residents in large parts of northern and eastern Pretoria, were left without power days after the collapse. The plant is one of only three around the world to produce the next-generation Ford Ranger, and it also manufactures the Amarok model under contract for Volkswagen. The city has claimed vandalism and criminality for part of the pylon collapse.
Eskom, which is a burden on the economy with routine power station failures and a general lack of maintenance, incredibly won the Power Company of the Year Award in December 2001 at the Global Energy Awards ceremony held in New York. At the time, it was providing more energy per capita than any other utility in the world at one of the lowest rates.
Political party, ActionSA, will file a motion of no confidence in controversial Johannesburg Mayor Thapelo Amad. He caused controversy when he spoke about a R9.5 billion loan to the City from a private company, without being able to give reasons. He later argued that the money was actually an example of proposals the City had received for growth and development. The Patriotic Alliance has backed calls for Amad’s removal with the party’s leader, Gayton McKenzie, apologising “for backing the wrong horse”. The Al Jama-ah councillor has caused much controversy since his election in January in a vote sponsored by the ANC, EFF, and a group of smaller parties, including the Patriotic Alliance.
Public enterprises minister Pravin Gordhan and electricity minister Kgosientsho Ramokgopa seemingly have different views on the solution to Eskom’s ageing coal-fired power plants. A robust debate is pending between the two ministers when Ramokgopa presents cabinet with the findings of his visit to Eskom’s 15 power stations and with options on how to deal with their problems this month. Ramokgopa believes that the ageing power stations need investments to refurbish them to improve their performance and prolong their lifespans. Daily Maverick anticipates that extending the life of ageing coal-fired stations and anti-renewables policy incoherence could cost trillions as Eskom’s loss is expected to widen by 113% this year. Gordhan, conversely, wants money to rather go into renewables.
SBG Securities analyst Charles Russell has determined that South Africa’s big five banks could benefit by R1 trillion in new loans over the next four years as South Africans move to solar to mitigate rolling blackouts. This would be a 6% boost each year in renewable energy finance. SBG Securities says the banks with the largest portfolios of home loans, commercial property finance and corporate investment loans — Standard Bank, Absa, and Nedbank — would benefit the most, with FirstRand and Capitec bringing up the rear. At the same time, cumulative rate hikes of 425bps by the South African Reserve Bank will place pressure on banks to increase impairment provisions as default risks by customers rise.
The listed property sector, (which is already battling a low economic growth environment, rising inflation and interest rates as well as increasing municipal rates and taxes), is facing a bigger risk with load-shedding. At the end of the first three months of 2023, the South African Listed Property index was 5.3% lower compared to the end of 2022 due to expectations of weaker global and local economic growth. (Dynasty’s domestic portfolios are extremely underweight in this sector).
Those who lost money when Transaction Capital collapsed, were not watching what management was doing, writes Piet Viljoen, portfolio manager at Merchant West Investments. He makes the point that signs of issues within companies are generally not included in results publications but, rather, are indicated by management selling shares. Viljoen points to the fact that there is a growing chorus of analysts suggesting that management owning shares allows them to pretty much act as inside traders – moving to sell down before information is made public.
Amazon’s cloud service unit, AWS, is set to invest R30.4 billion in its cloud infrastructure in South Africa by 2029. Overall, AWS estimates it would have invested R6 billion between 2018-2029. A recent report by the company shows that the cloud provider’s investment during this period will contribute an estimated R80 billion to South Africa’s GDP and support an estimated average of more than 5,700 full-time equivalent jobs at local South African businesses yearly.
PSG Konsult will use its about R2 billion war chest to buy back more shares and maintain its attractive dividend distribution as it seeks organic growth over deal making. Presenting its full-year results on Thursday, the investment and insurance holding company’s cash and cash equivalents, including money market investments, jumped 18% in the year to end-February. The group’s board has raised its dividend ratio to 60% from 46% previously.
Impala Platinum (Implats) has acquired another 8.5 million shares in takeover target Royal Bafokeng Platinum (RBPlat), making its intention clear to take control of the group. Its holding in RBPlat is now just under 45%. Northam Platinum announced a fortnight ago it had immediately withdrawn its takeover bid for RBPlat, opening the door for Implats to lay its hands on the mid-tier platinum miner envied for its large, shallow, and high-quality platinum group metals.
As at the time of writing, the rand was 0,99 % stronger for the week while the ALSI was up 2.62%.