Global markets staged a recovery in May (MSCI World Index: +3.8%, MSCI Emerging Markets Index: +1.4%) amid an improvement in the risk environment with developed markets outperforming once again. While interest rate expectations (particularly in the US) caused angst among investors in the April, recent commentary from the US Federal Reserve in conjunction with slowing economic growth and a softer jobs market, quelled fears for an unlikely situation that will require a rate hike while reinvigorating expectations for a "soft landing". Robust earnings out of the US also provided some uplift, however, ongoing geopolitical tensions throughout several regions continued to weigh on sentiment. The European Central Bank (ECB) is widely expected to begin lowering interest rates in June.
The US market locked in solid gains for the month, with the S&P 500 Index adding 4.1% amid a solid earnings season. On an aggregate basis, revenue growth was slightly better than what was expected at the start of the reporting period, while earnings growth also pipped expectations. Major technology counters and leisure stocks were the star performers. In terms of Fed commentary, Chairperson Jerome Powell stated that he does not foresee a hike as likely and that the current policy is sufficiently restrictive to achieve the Fed's 2% inflation target, sparking a solid rally in the market. The Fed also declared its intention to reduce the speed of quantitative tightening starting from 1 June, which should support financial conditions somewhat. Still, it is possible that interest rates could remain at current levels for some time, with Powell also noting that he does not "know how long it will take" for cuts to be on the table and that the Federal Open Market Committee (FOMC) will need to be confident when that decision is made. Powell also removed reference to the timing of rate cuts as being "at some point this year" from his formal address.
The Eurozone also saw meaningful upward momentum during May with the Euro Stoxx 600 Index logging a gain of 3.2%. In terms of interest rate expectations, ECB President Christine Lagarde indicated that an interest-rate cut is highly probable in the upcoming month as Eurozone inflation appears to be under control given that the impact of an earlier energy crisis and supply-chain bottlenecks have been largely abated. Given that rate cuts in the US are expected to be delayed, the market is now also focused on the likely rate differential between the US and Europe, which could potentially cause funds to flow to the US and weaken the euro.
Chinese equities gained solid traction as well with the MSCI China Index increasing by 3.8% as investors continued to cheer generally positive economic data, with additional support measures from government providing further confidence in the market. The property market, which has been a huge detractor for the region, continued to garner attention with Chinese officials announcing a rescue package which aims to reduce unsold home inventory and support market demand. Bloomberg GDP forecasts have also been upwardly revised to 4.9% for 2024, primarily driven by stronger-than-expected first-quarter numbers and a recovery in exports.
Locally (JSE All Share: +1.6%; USD: +2.4%), all eyes were on the 2024 general election, with heightened levels of volatility continuing to filter through the market as election results are tallied. As always, there has been much speculation over the outcome of this election, but for the first time in our democracy's history, the ANC looks set to not receive the majority of the country's votes. Historically, local asset prices have performed better post-elections than before elections - but of course the main outcome had always been easier to predict. Meanwhile, the South African Reserve Bank (SARB) kept interest rates on hold at 8.25% in its third meeting of the year - a widely anticipated outcome. The decision was unanimous and comes after the annual consumer price index (CPI) cooled for a second consecutive month to 5.2% in April from 5.3% in March. Forecasts now indicate that inflation is expected to reach the midpoint of SARB's target range in the second quarter of 2025, sooner than previously predicted. Initially this was only expected to occur by the end of next year.
Economic data overview
Timing of Fed rate cuts remains uncertain
Flash estimates showed that the S&P Global Composite PMI for the US surged to 54.4 in May, up from April's 51.3, marking the highest level since April 2022 and beating market expectations of 51.1 The service sector drove the upturn, showcasing the biggest output growth in a year, while manufacturing also saw strong growth. Retail sales increased 3% in April, following a downwardly revised 3.8% gain in March - this was below expectations. The trade deficit remained almost unchanged at ten-month highs of $69.4 billion in March, compared to an upwardly revised $69.5 billion in February and forecasts of a $69.1 billion deficit. The unemployment rate edged up to 3.9% in April from 3.8% in March - better than expectations of an unchanged reading. The annual inflation rate eased to 3.4% in April from 3.5% in March, which was the highest reading since September, in line with market forecasts. The Federal Reserve kept the fed funds rate steady for the sixth consecutive time, as expected, during its May meeting, as ongoing inflationary pressures and a tight labour market indicated a stall in progress toward bringing inflation back down to its 2% target this year. Officials suggested that the disinflation process would likely take longer than previously thought.
ECB on track to cut rates before the Fed
On a preliminary basis, HCOB Eurozone Composite PMI rose to 52.3 in May, the highest in a year, compared to 51.7 in April and beating forecasts of 52. The reading showed the economic recovery in the Eurozone gained momentum, amid faster increases in business activity, new orders, and employment, while business confidence hit a 27-month high. Retail sales rose by 0.7% y/y in March, rebounding from the revised 0.5% decline in the previous month, to mark the first growth in retail sales since September 2022 - this was better than expectations. The Eurozone posted a trade surplus of €24.1 billion in March, wider than €19.1 billion in the same month of the previous year and better than market forecasts of €19.9 billion. The unemployment rate hit a fresh record low of 6.4% in April, down from 6.5% in each of the prior five months and slightly below market forecasts of 6.5%. The annual inflation rate in the Euro Area was confirmed at 2.4% last month, the same as in March, and holding at levels not seen in nearly three years. The ECB maintained interest rates at record-high levels for a fifth consecutive time during its April meeting (as expected), but it does seem as if a cut could be on the cards in June.
UK inflation eased once again, still higher than expected
Initial reports showed that the S&P Global UK Composite PMI dropped to 52.8 in May, below the expected 54, indicating a slight decline from April's 54.1. Despite the fall, this data points to a solid expansion in the private sector, as a resurgence in manufacturing production supplemented a further, albeit slower, upturn in services output. Retail sales decreased 2.7% y/y in April, compared to a 0.4% gain in March and much worse than forecasts of a 0.2% decline. The UK's trade deficit narrowed to £1.098 billion in March, the smallest in three months, from a revised £1.478 billion in February - this was better than expectations of a deficit of £2.1 billion. The unemployment rate rose to 4.3% from January to March, slightly up from 4.2% in the three months to December 2023, aligning with market expectations. The Bank of England (BoE) maintained the key bank rate at 5.25% on 9 May, the highest level since 2008, and in line with expectations. However, two committee members preferred to reduce the rate by 0.25ppts, compared to only one member in the previous meeting and officials revised down inflation forecasts while boosting its growth outlook. CPI inflation is expected to return close to the 2% target in the near term, with potential risks from geopolitical factors. The MPC emphasised the need for restrictive monetary policy to return inflation sustainably to the 2% target, with a commitment to adjusting policy as warranted by economic data. A few days later, annual inflation data was released and showed that CPI eased to 2.3% in April 2024, the lowest since July 2021, compared to 3.2% in March and market forecasts of 2.1%.
Chinese state promised more stimulus to assist lagging housing market
The Caixin China General Composite PMI was confirmed at 52.8 in April, up slightly from 52.7 in the March. It was the highest reading since May 2023, pointing to the sixth straight month of growth in private sector activity, as the manufacturing sector grew the most in 14 months and the services economy expanded for 16th month. Retail sales rose by 2.3% in April, missing market forecasts of 3.8% and moderating from 3.1% in March. China's trade decreased to US$72.35 billion in April from $86.46 billion in the same month last year, below market forecasts of $76.7 billion, as exports grew much less than imports. The surveyed urban unemployment rate dropped to 5% in April, the lowest reading since November 2023, and compared to the previous month's reading and market estimates of 5.2%. China's annual inflation rate rose to 0.3% in April, compared with market estimates and March's figure of a 0.1%. It was the third straight month of consumer inflation, amid ongoing recovery in domestic demand despite a fragile economic revival. The People's Bank of China (PBC) kept key lending rates unchanged at the May fixing, matching market expectations. Rates remain at record lows, amid Beijing's attempts to spur an economic recovery. Last week, the PBC held its medium-term lending rate, continuing its efforts to stabilise the yuan. It also moved to lower down payments for first- and second-time home buyers and scrap a floor on mortgage rates. Separately, Beijing pledged fresh stimulus for the property sector by easing purchase rules and urging local governments to buy unsold houses from builders for conversion into affordable housing.
Bank of Japan (BoJ) to proceed cautiously with inflation-targeting frameworks
The Jibun Bank Composite PMI ticked up to 52.4 in May 2024 from 52.3 in the prior month, pointing to the highest reading since last August, a flash figure showed. The reading indicated that private sector expansion continued to accelerate for the third successive month, with strong activity in the service economy prevailing. Retail sales rose 1.2% in March, slowing significantly from an upwardly revised 4.7% gain in February and coming in way below market expectations for 2.5% growth. Japan's trade deficit increased to ¥462.50 billion in April from ¥429.79 billion in the same month of the prior year, more than market estimates of a ¥339.5 billion shortfall. The unemployment rate was at 2.6% in March, the same pace as in the prior month but above market forecasts of 2.5%. The annual inflation rate fell to 2.5% in April from 2.7%, moderating for the second straight month. The BoJ flagged upside risks to inflation and indicated that it stands ready to adjust monetary policy but expects accommodative financial conditions to remain for the time being.
Local interest rates remain on hold, CPI expected to reach SARB's target ahead of initial forecasts
In March, the leading business cycle indicator declined 1.9% m/m (following an increase of 1.3% in February), marking the largest contraction since August 2022. The SACCI Business Confidence Index was unchanged at a reading of 114.7 during March, as positive economic and business relations as well as increased inward tourism continued to play a key role in maintaining business sentiment. Retail sales increased 2.3% y/y, following a decline of 0.7% in February, but was slightly below expectations of 2.5% growth. The trade balance in March amounted to a surplus of ~R7.3 billion (below expectations of ~R10 billion) as exports advanced at a slower 1.8%, while imports rose 6.1%.
Local mining production was down 5.8% y/y in March (compared to forecasts of a 3% decline) due to lower output of iron ore (-6.8%) and coal (-9.1%). Manufacturing production contracted 6.4% y/y (vs. forecasts of 0.4% growth) marking the first decline in industrial activity for over five months. Composite PMI improved to a reading of 50.3 in April (March: 48.4), suggesting a stabilisation in private sector activity. Manufacturing PMI climbed to a reading of 54 (March: 49.2), pointing toward a renewed uptick in factory activity, with better domestic demand filtering through to higher new sales orders.
Annual consumer price inflation (CPI) moderated to 5.2% in April (slightly below expectations of 5.3%) amid softer price hikes across food & non-alcoholic beverages, alcoholic beverages & tobacco, miscellaneous goods & services, as well as housing & utilities. This, however, is still above the midpoint of the SARB's targeted inflation range of 3% to 6%. Core inflation, which excludes the price of food, non-alcoholic beverages, fuel and energy, cooled to 4.6%, below forecasts of 4.9%.
As anticipated, the SARB left its benchmark interest rate unchanged at 8.25% during its meeting in May, with policymakers emphasising the need to bring inflation firmly within the targeted range. CPI is now expected to reach the targeted level of ~4.5% by 2Q25, much sooner than initial forecasts that stated 4Q25. The inflation projection for this year was left unchanged at 5.1%.
Market Outlook in a nutshell
Local
Global
As South Africa, and many economies globally, navigate through the aftermath of peak interest rates, investors find themselves at a crucial juncture, contemplating the next strategic move for their portfolios. The recent halt in the rate-hiking cycle signals an opportune moment to reassess investment strategies, with the likelihood of interest rate cuts looming on the horizon over the next six months.
Behavioural finance principles shed light on the psychology driving investor decisions during such pivotal times. It's natural for investors to gravitate towards safe havens like cash assets during periods of uncertainty, and indeed with rates rising, holding cash becomes more attractive as it offers a higher "risk-free" return. However, it's essential to also recognise the potential drawbacks of this approach. Firstly, history has shown that remaining overly cautious in times of shifting monetary policy can lead to missed opportunities for portfolio growth. Secondly, as rates fall, that "risk-free" return becomes increasingly "risky" - with a diminishing likelihood of an investor maintaining their purchasing power and achieving a real return over time.
In anticipation of interest rate cuts, it's prudent for South African investors to consider reallocating their assets towards riskier investments. This shift is not merely a leap into the unknown but rather a calculated move backed by historical performance data.
During previous rate-cutting cycles, risky assets such as equities have demonstrated resilience and delivered favourable returns. The influx of liquidity into the market, coupled with improved economic prospects brought on by lower rates, often fuels a rally in stock prices. Additionally, sectors sensitive to interest rate changes, such as real estate and consumer discretionary, tend to flourish in a declining rate environment. As illustrated below, over the two years following rate cuts, equity markets have performed somewhat better than typical - although the response has varied widely. Importantly, the reason why rates are being cut matters - and equity market performance will correspond with the broader economic reality and forward-looking views on this. The performance prior to rate cuts is also telling; as investors grapple with a weakening economy, the equity barometer has historically fallen over the previous year.
For those anxious about the prospects of equities, fixed income may also be an appealing way to allocate away from short duration cash-like investments, and the conclusions drawn here from the last four rate cutting cycles are more convincing, with performance strongly positive over the following two years in each of the cases in Figure 3, and the bond market rallying even before rates are cut.
While the allure of higher returns from riskier assets may seem enticing, it's crucial for investors to approach this transition with a well-thought-out strategy. Diversification remains key to mitigating risks associated with market volatility. Allocating a portion of the portfolio to defensive assets can provide stability during periods of turbulence while still allowing investors to capitalise on the growth potential of riskier investments.
Moreover, staying informed and adaptable is paramount in navigating the evolving market landscape. Keeping abreast of economic indicators, central bank policies, and geopolitical developments can provide valuable insights for making informed investment decisions.
One other area that has received much attention over the past two years is allocating offshore. Interestingly, over the past four rate cutting cycles, offshore equity markets have underwhelmed relative to local assets, with a median performance roughly flat over the two years following the South African Reserve Bank's (SARB) first rate cut, and underperforming the typical performance expected. One direct cause of this is due to the performance of the rand relative to the US dollar. In the cases of 2001 and the Covid-19 pandemic, we saw initial strength of the dollar, as investors flocked to it as a safe haven, but over each of the last four SARB rate-cutting cycles, holding dollars has resulted in a median negative return for South African investors over the 12 to 24 months following the SARB cutting the repo rate.
As we look beyond the pause in the rates cycle, South African investors are urged to embrace a proactive mindset. By strategically reallocating assets towards riskier investments, investors can position themselves to capitalise on the anticipated rate cuts and potentially unlock greater returns for their portfolios. We view well-diversified multi-asset investment solutions as attractive investment options in the current landscape, particularly as our investment approach aligns target investment horizons with appropriate return objectives and risk constraints.
In conclusion, the journey beyond peak rates presents a prime opportunity for investors to reevaluate their asset allocation strategies and embrace the potential of riskier investments. By understanding behavioural finance principles and historical performance trends, investors can navigate this transition with confidence and seize the opportunities that lie ahead.
