Reza Hendrickse, Portfolio Manager, PPS Investments
Key themes shaping this quarter?
The quarter began with worries about the shift in US Federal Reserve rhetoric, which implied that they no longer consider higher inflation as being transitory; the implication being that the outlook for monetary policy had become more hawkish. In a further dent to sentiment, geopolitical tension between Russia and Ukraine culminated in a full-blown invasion of Ukraine, because of Russia’s strong opposition to Ukraine’s wishes of joining NATO.
The rest of the world responded with economic sanctions on Russia, and energy prices skyrocketed, with Russia being a key oil producer, a major supplier of natural gas to Europe, and also an important supplier of agricultural commodities to developing nations. This further stoked inflation fears, while also denting the global economic outlook, which was later also threatened by renewed COVID concerns in China. Back home, the environment was more benign, with the equity market proving resilient, the economy muddling along, and the National Budget in February instilling confidence.
At the start of the year the global economy looked poised to grow comfortably at above-trend pace once again, but after the events of this quarter, there is sufficient grounds to be more cautious on the outlook. Firstly, monetary policy looks set to tighten more aggressively than initially anticipated, in response to persistently high inflation. Secondly, the war in Ukraine is having far-reaching indirect consequences, despite Russia and Ukraine together making up only 3.5% of global GDP, and only 0.2% of G7 exports. And lastly, the recent re-introduction of lockdowns in China are once again proving disruptive to global supply chains.
The key question is “how much can we expect growth to slow?”. Are we facing a stagflation scenario of slower growth, high inflation, and potentially rising unemployment, or perhaps even a recession? One of the most reliable recession indicators, being the US yield curve (specifically the difference between 10-year and 2-year bond yields) is flashing red, with the curve having inverted recently, which is adding to market worries. Fluctuations in the business cycle are normal, but what makes this time unique is that there is limited scope for policy intervention from central banks and governments, given the past decade of ultra-stimulative policy.
As a result, central banks around the world, including in SA, are hiking interest rates, and the US Federal Reserve (US Fed) is preparing to shrink its balance sheet, which has swelled through asset purchases, referred to as Quantitative Easing. This is a headwind to growth at a time when global trade disruptions, including the impact of Russian sanctions, are a risk to inflation. This is most evident in the sharp rise in energy prices, where Russia is a key player, historically providing 12% the world’s oil. It is too soon to tell how all this will play out, but what is clear is that there are more downside risks than upside at this point.
While the crosscurrents in global macro conditions are strong, the macro environment in SA is proving resilient, albeit a low growth steady state. Low single digit growth is persisting, and the SARB’s response to modestly higher inflation has been gradual rate hikes. The ABSA Purchasing Managers Index recently reached its highest level since COVID-19, confirming relatively lively economic activity. The mining sector is benefitting from high commodity prices, which has been positive for our trade balance and in turn for the rand. Strong commodity prices have also been helpful for the fiscus, through higher taxes on mining sector profits, with the National Budget in February showing an improvement in the sovereign debt outlook.
Despite all of this, SA is dependent on the global economy, and we would not be insulated from any pronounced global economic weakness.