Playbook for 2018…Lessons from a game-changer year

Investment Analyst, Reza Hendrickse, unpacks the year gone by and shares his insights into significant market factors coupled with expectations into 2018

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Recapping some of the significant global events in 2017

Global stocks surged in 2017, invigorated by a pickup in global economic growth, and extending their 2016 rally.

Positive sentiment overshadowed some key risks to markets, such as US President Trump’s unorthodox approach to foreign policy, and Britain’s triggering of Article 50 of the Lisbon Treaty, a precursor to negotiating the terms of its departure from the European Union. Markets also took the threat of nuclear war between the US and North Korea in their stride, as well as escalating tensions in the Middle East.

On the African continent, one of the most significant events of 2017 was Robert Mugabe’s ouster, ending a 37 year presidency in Zimbabwe. Closer to home political news dominated, with corruption allegations and the extent of so called “state capture” by the influential Gupta family being exposed in thousands of leaked emails. In the second half of the year, noteworthy events included South Africa’s sovereign debt being further downgraded by the credit rating agencies, a devastating corporate fraud being uncovered (pending further news from Steinhoff), and the ruling ANC party ending the year with a new leader.

Global growth surprised on the upside

Global output growth accelerated in 2017, with the most recent IMF forecast suggesting 3.6% growth for the year; an improvement on the 3.2% expansion experienced in 2016. A further acceleration in growth is expected in 2018, with forecast growth of 3.7%, potentially facing upward revision for the second year in a row. Led by China, emerging market output is projected to grow 4.9%, while advanced economies are expected to grow 2.0% in 2018.

Strengthening leading economic indicators provide evidence of sustained global expansion, while broadly easy monetary and fiscal conditions in key economies remain a tailwind for the medium term.

Will SA cash in?

In contrast to steady global growth, South Africa is on a markedly lower growth trajectory and has failed to participate in the synchronised global recovery. The economy in fact experienced a brief technical recession with two successive quarters of output contraction. The International Monetary Fund (IMF) and the Treasury both expect domestic growth of 0.7% for 2017, rising to 1.1% in 2018. Some analysts however see the potential for a positive growth surprise.

The fact that South Africa hasn’t participated in the broad-based growth seen abroad speaks to the structural challenges currently faced. Notwithstanding sustained high unemployment and low productivity locally, our slow growth of late reflects depressed levels of consumer and business confidence, which are important drivers of economic growth through consumption and investment.

Ramaphosa election appeases markets, but…

The outcome of the December 2017 ANC Elective Conference where Cyril Ramaphosa has been named President of the ruling party has been considered market friendly. The renewed optimism is sparked by Ramaphosa seen as having the potential to drive growth and reverse the malaise of the prior administration. The markets’ initial response was an immediate appreciation of the rand, strengthening of our government bonds and a bounce in shares geared to the domestic economy (such as banks, retailers and listed property).

While the Conference has given the market some certainty, any hopes for imminent and drastic market friendly policy changes could be misguided. Newly elected Ramaphosa failed to secure majority control of the NEC, with the Ramaphosa and Zuma camps now equally represented in the ANC’s “Top 6” leadership positions; offering but a tenuous hold on power.

2018 what have you got in store?

The expected further acceleration in global growth is conducive for risk assets heading into 2018, but elevated valuations in key markets such as the US leave them vulnerable to any negative shocks. Complacency is also relatively high as indicated by unsustainable record low volatility, which at some point will pave the way for increased risk aversion.

The current bull market in US stocks is one of the longest in history, so it is fair to say we are at an advanced stage in the cycle. When it will end though is anyone’s guess, but what we do know is that that bear markets in equities are usually accompanied by recessions, and the odds of a recession appear low at this stage. What is interesting is that the US yield curve has been flattening for some time now. An inversion of the curve has historically been a reliable indicator of a slowdown in growth and an associated correction in stocks, so this dynamic will be worth monitoring in 2018.

Other global developments to remain cognisant of include the delicate path of developed market central bank policy normalisation as we transition from ultra-accommodative policy to a higher interest rate environment, the effect of higher rates on the flow of capital into Emerging Markets through the global search for yield, the UK’s complex engagement with the rest of Europe in negotiating a departure from the European Union; China’s growth trajectory and reforms alongside debt levels that have historically preceded financial crises in other countries in history, as well as a host of other geopolitical risks across the globe.

In South Africa, new leadership in the ruling party presents hope of an improvement in confidence and investor sentiment needed to spur economic expansion in 2018. While this could be a step in the right direction, there remains a fair amount of work to be done in order to alter the current course. In the near term, the February 2018 National Budget Speech will be watched with keen interest as well as any response from the rating agencies, for some perspective on the government’s commitment to constructive policy reform.

Whether any of these ‘known-unknown’ factors ultimately create any disruption or opportunity in 2018 remains to be seen. Experience has shown however that it is often the “unknown-unknowns” that tend to have a more significant impact on markets. 

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