Given this week’s blowout, where the S&P 500 sold off another 6% to the end of Thursday, we’re questioning whether the global markets are already pricing in a worst-case scenario. The US Fed adjusted its policy in raising interest rates by 0.75% on Wednesday, using the escape clause of data dependency. Equity markets first reacted positively, gaining 1.5% in the session, before reversing by over 3% on Thursday.
The Fed has now raised rates by 1.5% this year, with each hike more aggressive than the previous. Inflation is still stubbornly high at 8.6% year-on-year to May 2022, and fears of a recession are increasing. But markets are forward-looking and, at some point, even a recession, which could still be some months off, may already be in the price.
The US ten-year bond rate has spiked by nearly 3% since the August 2020 lows of 0.5%, well in advance of the Fed’s first rate hike in March this year. The curve is pricing in another 3% in rate hikes over the next twelve months. The dollar has also projected these moves, gaining 17% against its major peers since May last year. These assets have thus been anticipating future moves in inflation and interest rates.
With the S&P having sold off more than 23% since its January highs, placing it now in official bear market territory, the key issue is to what extent equity markets have priced in a worst case scenario. Many quality global companies are, in aggregate, now trading at their pre-Covid levels, despite the S&P 500’s forward earnings being approximately 30% higher than it was at that point. The S&P 500 is now trading at 16 times the 12-month forward earnings, below the long-term average multiple and at a level that it has consistently traded above since 2013.
We haven’t yet seen global earnings forecasts reduced, US employment decrease from full-employment levels, the end of interest rate hikes, or a peak in inflation. The question is: What will the catalyst be for a market recovery? In our view, it will either be a resolution to the war in Ukraine, which remains unlikely in the short-term; confirmation that inflation is under control as evidenced by a meaningful decrease in the US CPI number, which is only probable in the next three to four months; or a technical recovery from an oversold position, which could occur at any point, without warning, and becoming more likely the quicker and deeper markets retrace.
We’re therefore relieved the Fed raised rates more aggressively this week than previously signalled. We would prefer to get all the negative news in the price, move beyond the point of maximum pessimism, and allow the markets to be forward-looking by pricing in a future recovery.
“Identical information can lead to opposite conclusions based on relative perceptions of its receivers.”
– Naved Abdali, author
Global News
- The US Federal Reserve departed from its planned interest rate path by reacting to a higher-than-expected inflation number in raising rates by 0.75% on Wednesday, the biggest such hike since 1994. There are mixed views on whether this was the right move – even if it did meet the updated market predictions – or if it will indeed sufficiently dim price pressures.
- European Central Bank president Christine Lagarde has also turned more hawkish than previously indicated, while the Reserve Bank of Australia is among those raising interest rates faster than policymakers had signalled.
- In an effort to combat inflationary pressures and improve energy security, some countries are investing in new oil and gas fields since the war in Eastern Europe, which prompted UN secretary-general Antonio Guterres to say this will worsen pollution and climate change. New investments being made in coal, oil and gas were “delusional” given their effect on climate change, he said. For example, Germany and the Netherlands announced plans this month to develop a new North Sea gas field. Besides these greenfield initiatives, turning on the taps in existing projects is a way that energy shortages can be resolved in the short term.
- Electric vehicle maker Tesla is on a hiring spree, offering jobs to 500 people per month at its German plant and recruiting workers no longer needed at German carmakers. Altogether 4 100 to 4 500 staff have been recruited so far, of which about 10% were foreign, primarily from Poland. This after Tesla announced earlier this month it was considering reducing headcount by 10% in the US.
- Meanwhile, a report by business consultancy EY says worldwide demand for electric vehicles has reached a “tipping point”, with more than 50% of potential buyers saying their next new vehicle will be electric.
- Cryptocurrencies have been hit hard as the overall market dropped to below $1 trillion. This week, Bitcoin dropped to its lowest level since December 2020, trading at around $21 000 as a broader crypto sell-off continued. The Celsius lending platform froze withdrawals, leading to concerns of systemic risk in the crypto ecosystem, while Coinbase announced a decision to lay off 18% of its workforce in anticipation of a ‘crypto winter’. Some suggest Bitcoin could drop to as low as $14 000.
- Amazon’s property spree may backfire as recession fears rise. Starting about three years ago, the Seattle-based company started searching for property in key US markets, such as southern California, Texas, Illinois, Florida, and the Bay Area. Buying land is a major shift for Amazon as it had previously relied on a handful of developers to find property, build simple warehouses, and rent them back to the company. This has proven to be risky because of the vagaries of the industrial real estate market.
- At the time of writing, the S&P was down 5.3% for the week.
Local News
- In economic news, the South African Chamber of Commerce and Industry business confidence index plummeted in May to its lowest level in almost two years. It declined 4.4 points to 89.3 in May, down from 93.7 in April, and 95.6 in March. It is also 7.7 index points lower year-on-year. This was much lower than the 94.3 forecast due to lower merchandise import and export volumes, the waning Covid-19 pandemic, and easing of lockdown restrictions.
- South Africa’s municipal situation threatens to derail any economic gains, according to columnist Claire Bisseker who says: “Last month, outgoing National Treasury director-general Dondo Mogajane threw up his hands and admitted that with about 170 of the country’s 257 municipalities (66%) now in financial distress, the Treasury could no longer cope with the extent of the crisis. One has to wonder how the situation has been allowed to build to the point where most municipalities are no longer financially sustainable, rendering service delivery dysfunctional in large parts of the country. Potholed roads, raw sewerage spills, and extensive water and electricity cuts are becoming the norm.”
- Although vaccines are expiring and having to be disposed of, the World Bank has approved a R7.59 billion loan to South Africa to fight the Covid-19 pandemic. The money is expected to boost the local vaccination programme, improve genomic surveillance, protect the poor from the socio-economic impact, help the health system, and bankroll the purchase of 47 million additional vaccine doses.
- The ANC is being battered by the scandal involving president Cyril Ramaphosa and the stolen millions in forex. This will set back the ANC’s efforts to reclaim support lost during nine years of misrule by predecessor Jacob Zuma. The opposition continues to demand that Ramaphosa explain the theft of foreign currency from his game farm two years ago. We cannot foresee how this debacle can be resolved in a credible way and political risks may be elevated as we progress towards the December elective conference.
- South Africa’s foreign exchange regulations carry stiff financial penalties and possible jail time for transgressors. This article looks at the consequences of breaching foreign exchange laws, which includes a five-year jail term.
- Columnist Justice Mahala has asked whether the president, and indeed his cabinet, is being blackmailed. The ongoing scrutiny raises further questions about what this means for the security and stability of the South African state.
- Turkish company Karpowership – one of the winning bidders of South Africa’s emergency power procurement programme – is set to sign power purchase agreements with Eskom within weeks, despite it accusing the utility of stalling. It will supply most of the 2 000MW of power aimed at alleviating rolling blackouts. However, it is yet to secure the required environmental approvals or the necessary permissions to dock its three gas-fired ships at the country’s ports.
- This is despite South Africa’s electricity demand still being below pre-pandemic levels. The Council for Scientific and Industrial Research has said that ‘load-shedding’ in 2021 overtook 2020 as the most intensive year of rolling blackouts to date. This is contained in its annual publication of power generation statistics for South Africa published this week.
- In company news, Comair’s business rescue practitioners lodged a court application to liquidate the company which has been in business rescue since May 2020. The airline, with a proud 76-year record, has listed assets worth at least R3.5 billion. In the end, Comair fell R125 million short of being able to stay in business.
- Sources have indicated that the head of Formula One, Stefano Domenicali, is in talks with local representatives about holding a race in South Africa as soon as next year at the Kyalami circuit near Johannesburg. Hosting a local sporting event of this magnitude would be a big boost to the national psyche, while benefitting the tourism industry and providing an opportunity to showcase the country in a positive light through various global media channels.
- At the time of writing, the JSE ALSI was down 2.4% for the week, while the rand was trading 0.6% weaker against the US dollar.
Sources: Dynasty, BusinessLive, Daily Maverick, Reuters, Bloomberg, CNBC, AP, etc.