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Everything you need to know about the markets this week

Share portfolio monthly Market Overview

Global markets were volatile in the month as generally hawkish comments from the US Federal Reserve and panic in the banking sector following the collapse of Silicon Valley Bank (SVB) sparked a sizeable sell-off towards the middle of March. The SVB collapse was the largest bank failure since 2008 and the second largest in US history after the Washington Mutual Failure in that same year. While the Fed stepped in quickly to assure depositors that they will be made whole - and put in place a short-term liquidity facility for lenders in temporary trouble - investors began looking at other strained banks globally for signs of further cracks. Intervention from Swiss authorities saw UBS purchase the embattled Credit Suisse, resulting in some calm returning to the global banking space as the month came to an end.

The Federal Reserve's Open Market Committee increased its target rate by 25bps. Chair Jerome Powell emphasised that inflation remains policymakers' top concern, noting that further tightening may still be on the cards, despite concerns over financial stability following the collapse of SVB. Powell made it clear that officials don't expect to cut rates this year. The dot plot is signalling higher rates this year with cuts expected next year and in 2025. This is out of keeping with the futures markets - which are pointing to Fed cuts this year (maybe to counter a recession). Regulatory controls are expected to become more stringent among small to mid-sized banks, which will result in tighter lending standards and credit availability. This will be supportive of an economic cooldown, in line with the Fed's agenda. Easing fears around a broader banking crisis contributed to a steady recovery in the S&P 500 (+1.6% towards month end). This was driven by a strong performance from interest rate sensitive sectors, particularly tech companies - with the S&P 500 Info Tech Index rallying around 9%

European banking shares were not immune to banking fears with Credit Suisse coming into the spotlight as the struggling Swiss lender failed to convince the market that its collapse was not imminent. Fortunately, UBS agreed to buy Credit Suisse in an all-share deal for ~$3.25 billion, which was brokered by government as a crisis of confidence in banks threatened to upend financial markets globally. The European Central Bank (ECB) pushed through another 50bps rate hike (core inflation continues to trend upwards), despite the banking chaos, citing that the euro area banking sector remains resilient, with strong capital and liquidity positions. The ECB is, however, monitoring current market conditions closely, and is ready to take action to maintain financial stability in the region. The Euro STOXX 600 bounced off its lows but ended the month down ~1.2% (Euro STOXX 50: +0.6%).

The local bourse also saw some reprieve during month end but lagged offshore counterparts - the All Share Index gave back around 1.9% for the month in both ZAR and US dollar terms. Overall, South African markets remain slightly out of favour in the emerging market basket given the strain associated with ongoing idiosyncratic risks (dominated by political turmoil, structural issues, load-shedding, and soft growth prospects). Meanwhile, local inflation came in higher than expected at 7% in February (January: 6.9%) and prompted the South African Reserve Bank (SARB) to hike rates by a further 50bps while markets had expected a smaller 25bps increase.

Local bonds saw outflows during the month while offshore bonds, particularly US treasuries, continued to benefit from healthy demand.

Economic data overview

The US banking crisis has begun to ebb with the Federal Reserve remaining focused on taming inflation

Flash estimates showed that the S&P Global Composite PMI for the US increased to 53.3 in March 2023, from a final reading of 50.1 a month before. It was the fastest pace of expansion in private-sector activity since May 2022, as growth for the services sector offset a slower decline for manufacturers. Retail sales for February increased 5.4% y/y, better than expectations (4.3%). In January, the trade deficit widened to $68.3 billion, compared to forecasts of $68.9 billion, as exports grew more than imports. The unemployment rate in January edged to 3.6%, above market expectations of 3.4%. Annual inflation slowed to 6%, the lowest since September 2021, in line with market forecasts. The Fed raised the fed funds rate by 25bps in March 2023, matching the February increase, and pushing borrowing costs to new post-2007 highs, as inflation remained elevated. The decision was in line with expectations. The Fed noted the US banking system is sound and resilient, and recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation.

The ECB remains hawkish to tackle stubbornly high inflation levels

On a preliminary basis, the S&P Global Eurozone Composite PMI increased to 54.1 in March, compared to 52 a month before. This was above expectations of 51.9. Retail sales in January were down 2.3% y/y, compared to forecasts of a 1.8% decline. A trade deficit of €30.6 billion was recorded in January, compared to forecasts of a $28.5 billion deficit, as imports climbed 9.7% y/y, while exports rose 11% y/y. The unemployment rate stood at 6.7%, above market estimates of 6.6%. Consumer price inflation for February came in at 8.5%, slowing from 8.6% a month before. The European Central Bank (ECB) raised interest rates by 50bps in March, as expected, to help temper the region's stubbornly high inflation. Policymakers also said the euro area banking sector was resilient, with strong capital and liquidity positions, and that they were monitoring current market tensions closely, while they stood ready to respond as necessary to preserve price stability and maintain financial stability in the region.

UK inflation unexpectedly edged higher but is anticipated to trend downwards over the year

Initial reports showed that the S&P Global/CIPS UK Composite PMI fell to 48 in March, below market expectations of 49.8. Retail sales volumes decreased 3.6% y/y in February, compared to forecasts of a 4.7% drop. In December, the trade deficit narrowed to £5.86 billion as imports fell 6.3% and exports slumped 5.1%. Below market expectations, the unemployment rate was unchanged at 3.7%. Annual inflation in the UK unexpectedly edged higher to 10.4% in February. The Bank of England raised its key bank rate by 25bps during the March 2023 meeting, in line with expectations. The BoE confirmed that inflation is still likely to fall sharply this year and to a lower rate than anticipated in February, but policymakers warned that if there were to be evidence of more persistent pressures, further tightening would be required. On the recent banking crisis, the central bank noted that the UK banking system maintains robust capital and strong liquidity positions and remains resilient. Policymakers will also continue to monitor closely any effects on the credit conditions faced by households and businesses, and hence the impact on the macroeconomic and inflation outlook.

Data out of China continued to gain momentum following the reopening of the economy in January

China's composite PMI rose to 54.2 in February, from 51.1 a month before. It was the second successive period of growth in private sector activity that was the strongest since last June, buoyed by the removal of tough pandemic measures. Retail sales expanded 3.5% y/y in January-February, matching market consensus. Better than market forecasts, the country's trade surplus increased to $116.88 billion in January-February, compared to $81.8 billion over the same period a year ago, as exports and imports fell 6.8% and 10.2% respectively. The surveyed urban unemployment edged to 5.6% in February. Chinese inflation fell to 1% in February, missing market forecasts of 1.9%. This was the weakest print since February 2022, with prices of both food and non-food easing sharply, as consumers stayed cautious despite the removal of the zero-Covid policy.

Inflation in Japan dropped to its lowest level since September, however, policymakers remain vigilant

Early estimates showed that the Jibun Bank Composite PMI reading in March increased to 51.9. This was the third straight month of growth in private sector output and the steepest pace since June 2022. Retail sales for January increased 6.3% y/y, exceeding market consensus of a 4% gain. Japan's trade deficit widened to ¥897.7 billion in February, compared to ¥711.5 billion in the same month a year ago, and better than the estimated gap of ¥1.1 trillion. The unemployment rate was unexpectedly lower at 2.4%, compared to forecasts of 2.5%. Annual inflation fell to 3.3% in February, in line with consensus (3.3%). The latest figure also marked the lowest print since last September, as cost of transport rose the least in five months, while prices of fuel, light, and water charges dropped for the first time since May 2021. The Bank of Japan (BoJ) kept its key short-term interest rate unchanged, in line with market expectations. Policymakers indicated their concerns over the economy by lowering their views on exports and production while leaving the overall economic assessment unchanged. The BoJ reiterated it would take extra easing measures if needed while expecting short- and long-term policy interest rates to stay at their present or lower levels.

In South Africa, inflation surprised to the upside with ongoing load-shedding and political headwinds adding further pressure

In 1Q23, the RMB/BER business confidence index dropped to a two-year low of 36 as rampant load-shedding continued to weigh on the outlook. Composite PMI in February increased to 50.5 (January: 48.7) - signalling a marginal uptick in private sector activity. Manufacturing PMI, however, dropped to 48.8 from a seven-month high of 53 a month before. Back in January, the leading business cycle indicator edged 0.1% lower m/m.

Retail sales in January contracted 0.8% y/y, with Food & Beverages, Tobacco, Personal Goods and Pharmaceuticals the largest detractors to growth. Nevertheless, this was better than the expected 2% drop. The trade balance swung from a surplus of R5 billion in December, to a deficit of R23 billion in January (forecasts: R10 billion). This was driven by a 14% slump in exports amid reduced shipments of vehicles and transport equipment, precious metals & stones, as well as machinery & electronics. The value of recorded building plans passed in SA's larger municipalities dropped a further 40.4% y/y, following a decline of 11.5% a month before.

Mining production was down 1.9% y/y in January, following an upwardly revised drop of 3.6% in the previous month. This was, however, better than expectations (-2.7%). Manufacturing production decreased 3.7% y/y but was also better than expectations (-5.1%).

CPI data for February surprised the market when it edged higher to 7%. This remains well above the SARB's target range of between 3% and 6%. Core inflation (which excludes the price of food and energy) picked up to 5.2%. Producer price inflation (PPI) dropped for a sixth consecutive month to 12.7%, slightly below forecasts.

The SARB unexpectedly hiked rates by 50bps at its March meeting (consensus: 25bps) amid higher inflation expectations, raising the benchmark interest rate to 7.75%. This was the ninth consecutive rate hike since policy normalisation began in November 2021. Continued efforts are being made to anchor inflation more firmly around the mid-point of the target band (~4.5%). The SARB expects to achieve this target by 2024.

Market Outlook in a nutshell

Local

• Weaker global activity, and its impact on SA's export commodity prices, as well as local energy and logistical constraints continue to cloud the growth outlook for 2023. The IMF recently downgraded its 2023 growth projections for SA to 0.1%, from 1.2% in the January World Economic Outlook update. SA growth rises to only 1.5% in the medium term, below the 1.7% growth recorded in the decade to 2019 and 3.6% in the decade to 2009. The IMF predicts that medium-term growth will be constrained by labour market rigidities that mitigate the incremental benefit of investment into energy and a more supportive global environment.
• This update by the IMF brings their expectations closer to ours, we see growth of 0.4% this year and 1.5% over the period to 2025. We also anticipate that the investment into energy supply will assist in petering out load-shedding from 2H24, which should average stage 4 until then, resulting in at least negligible intensities by end 2026.
• This illustrates the importance of sustained traction in implementing structural reforms, to support a lift in business confidence, private sector investment, achieve more robust growth over the longer term, and alleviate unemployment.
• The near-term drag on economic activity and lift in the cost of doing business in SA should constrain employment and income growth. In 1Q23, consumer confidence fell to the third-lowest reading since 1994 and foreshadows a fall in real consumer spending growth. Nevertheless, supportive credit conditions and residual lockdown-era savings should support real household spending growth of 1.5% this year, down from 2.6% in 2022.
• While global inflation is easing, it is expected to remain above targets over the longer term. This is as geopolitical tensions, the cleaner energy drive, and adverse weather patterns keep inflation elevated. Furthermore, a higher cost of doing business in SA and a weaker rand-dollar exchange rate should keep local inflation stubborn. We predict headline inflation of 5.9% this year, 5.4% next year and 5.1% in 2025 - remaining above the SARB's preferred anchor of 4.5%.
• Short-term interest rates increased to 7.75% in 1Q23. A rise in real interest rates in advanced economies, as rates continue to rise and inflation eases, should apply upward pressure to SA's neutral interest rate. This, along with sticky inflation, should result in the repo rate remaining higher for longer with potential cuts only coming through towards the end of 2024. Upward risks to interest rates will stem from a higher peak in advanced economy rates, more adverse risk sentiment, a weaker rand, looser fiscal policy, and stickier inflation.
• Our view is that while the rapid rise in interest rates has revealed balance sheet weaknesses in some banks, which has resulted in a sentiment fallout, the global banking system is sufficiently capitalised and can avoid a financial crisis. Therefore, the Fed should be able to continue hiking rates to bring down inflation, while also continuing to provide the liquidity required to limit systemic risk.
• Treasury appears committed to fiscal consolidation, but the risk around wage bill growth has recently been highlighted by a higher public sector union wage agreement in the region of 7.5%. While government may be able to cater for some fiscal slippage, further exposures to poor SOE performance and social spending pressures remain. These risks continue to cast doubt on how quickly and at what level government debt will stabilise.

Global

• Our primary concern going forward is whether the resilience of company earnings can be extrapolated into the future. We believe that this may prove difficult as fiscal and monetary policy, particularly in the US, will likely be on a restrictive path. In particular, the lagged effect of tightening monetary policy actions will likely begin to filter through to changes in both corporate and consumer spending patterns.
• Higher borrowing costs for both businesses and consumers will likely suppress economic activity, particularly in discretionary related areas, as economic agents look to rein in expenditure to tighten their balance sheets and income statements. This, combined with lower savings rates, subsiding government transfer payments, and depressed real disposable income will likely erode demand.
• At the moment, households will likely continue utilising various credit instruments, particularly credit card debt, which is currently at all-time highs, to prop up short-term expenditure prospects.
• While the Fed intends to tighten financial conditions heading into 2023, nearly two thirds of their balance sheet reduction has been reversed since the beginning of quantitative tightening in order to stabilise the banking sector. This took place in just two weeks.
• However, the loosening of financial conditions in recent months will likely embolden the Fed to be on a restrictive path as we progress into the year as tightening financial conditions will be needed to bring inflation down to more sustainable levels. Similar sentiments will likely be shared by the Bank of England and almost certainly the eurozone central cank, which is currently grappling with all time high core inflation.
• Chinese economic and mobility data continues to improve, and monetary policy remains on an accommodative path. It is encouraging to see China gradually re-open and Covid-19 cases well off their peak. While we remain cautious of further haphazard policy pronouncements, we are constructive on the outlook for China.
• Once peak hawkishness of the Fed has been sufficiently priced in by market participants, and inflation is firmly on a downward trajectory, we will be looking to take a more explicit position on the long end of the bond curve. This will be to reflect a deterioration in growth dynamics that will begin to overshadow inflation fears. At this stage, we believe that the rate cutting cycle priced in by the futures curve is premature.

ESG Investing

The incorporation of environmental, social and governance (ESG) factors in investment decision-making has grown in importance among institutional investors over the last decade but retail investors have also started to take note. What exactly does ESG investing involve? And where do you start?

ESG investing is a form of socially responsible investing. Sustainable investing means looking beyond "just profits" and into how future-proof a company is. As in will it be around in 30 years' time? ESG investing is means of investing sustainably by considering the impact that companies have on the world around them (the environment and social impact) and how it is being managed (governance).

For example, for a South African mining company to be considered an ESG investment it should practise good corporate governance and protect its shareholders, it must be known that it is not polluting water resources close to its operations, has a rehabilitation programme in mind for when operations reach end of life, and employs and empowers women and historically disadvantaged individuals. Will the mine make the lives of people living in surrounding communities better by bringing employment, infrastructure and sustainable growth to the area ... or will it bring migrant labour, a ruined environment, and long-term community health issues?

Am I giving up on performance?

It has been shown that companies considering the E, the S, and the G tend to do better than companies that do not. In South Africa, ESG strategies have outperformed the JSE over the past decade.

Let's look at the mine example again. If the company is focussed on ESG issues, odds are it will avoid major industry pitfalls.

• On the "E" - self-generation of electricity will result in less electricity (and probably safety disruptions) thereby improving production, sales, and profitability.
• On the "S" - a good relationship with labour communities surrounding the mine will mean that the probability of wage strikes and communities targeting the mine during times of unrest declines. Again, resulting in less production delays.
• On the "G" - a well balanced board ascribing to best governance practice will ensure proper oversight and ensure shareholders are protected. This will result in strategy being well considered which may see the mining company avoid bad investments or miss improprieties that could lead to financial loss.

The mine will also be more likely to maintain its mining licence or be granted exploration permits and new mining rights if it takes these issues into account - ensuring that it is around for many more years into the future.

At worst, taking these factors seriously may not see your investors perform better than the market but could help you avoid "bad" investments. Here, major public lapses on the ESG front could have offered some red flags to investors in the past. Take Steinhoff as an example - a very low tax rate is a major warning sign that something is a cookin', but because this meant that the company was showing higher profits, even professional investors largely glanced over it.

Where to start?

It is a difficult and onerous process to self-identify companies that have a strong ESG focus and, equally important, a track record of implementation. Investing in exchange-traded funds (ETFs) provides a simple solution.

Internationally, there are many listed ETFs and exchange-traded notes (ETNs) that focus collectively or individually on the E, S or G. On the JSE the options are still limited but thankfully growing. These ETFs and ETNs will provide exposure to companies that have been carefully selected based on how well they are executing on the E, the S and the G.

• Satrix's Inclusion & Diversity ETF tracks JSE-listed companies that meet a specific set of ESG criteria including diversity, inclusion, people development, and news and controversies.
• The Sygnia Itrix S&P Global 1200 ESG ETF invests in global securities meeting S&P sustainability criteria. Satrix also has ETFs listed on the JSE that track global and/or emerging market companies with good ESG scores.
• The FNB Social Responsibility ETN provides exposure to the MSCI World SRI Low Carbon Select 5% Issuer Capped Index. The index invests in global companies that have low carbon exposure and high ESG performance.

Another more direct route to incorporating the E, S and G into your portfolio is to look at companies, ETNs or ETFs that are actively investing in industries of the future. This includes companies engaging in environmentally conscious industries such as water and renewable energy, and in areas such as infrastructure, which is a social good.

• The Satrix Infrastructure ETF tracks the FTSE Global Core Infrastructure Index, offering investors exposure to worldwide listed companies involved in "core" infrastructure activities.
• Sygnia's Itrix 4th Industrial Revolution Global Equity ETF tracks the performance of companies set to become the behemoths of the future.
• The FNB Global Water ETN (WWETNC/WWETNQ) tracks the iShares Global Water UCITS ETF.
• The FNB Clean Energy ETN (EGETNC/EGETNQ) tracks the iShares Global Clean Energy UCITS ETF.