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ECONOMIC OUTLOOK

Maarten Ackerman
Chief Economist and Advisory Partner

 
2020: DIARY OF A LOST YEAR

A major portion of this year has been lost to lockdowns, so it seems almost surreal to be preparing to close off the year and planning for the festive season. Many of us will be glad to see the back of 2020 and will be looking forward to starting 2021 with a clean slate. Of course, the markets never sleep, so as we approach the finishing line, it is worth taking stock of where we are economically given the tumultuous year to date.

In terms of the novel Coronavirus, the global pandemic is still with us, but countries are largely learning to live with it. We are seeing a second wave in parts of the world, although this uptick in cases seems far milder and appears to be causing fewer fatalities with a younger median age among the infected. More hard lockdowns appear unlikely, but life will only return to a pre-COVID normal if we develop a vaccine – which may take up to another two years.

Ultimately, this year has reminded us just how hair-raisingly quickly the global environment can shift and change – a point that is particularly notable as we count down to the November presidential elections in the United States (US). These elections are crucial and will set the course for the final months of 2020, as well as the decade ahead. Democratic nominee and former Vice-President Joe Biden is currently being touted as the favourite to win, but given that the 2016 result came as almost a complete surprise to everyone – including Donald Trump – the outcome remains up in the air until the votes are tallied and the election has been called.

Whatever your opinion of him, it is indisputable that President Trump has certainly stirred up the global political and economic scene, introducing many new changes and challenges. The more inward-facing policies introduced by his administration have seen the US shifting away from global co-operation and leadership. Additionally, the trade tensions between the US and China have sent shockwaves and continuous volatility through markets, and many other countries have now joined Trump in reprimanding China following the COVID-19 outbreak, including Japan, Australia and Germany.

The upcoming election will, therefore, present two key outcomes for the years to come. Firstly, Americans will be electing a man tasked with governing the world’s biggest economy. Secondly, this vote will determine whether the US will revert towards the path of engagement or continue to retreat from its long-held position as a global leader.

US ELECTION IMPLICATIONS FOR THE GLOBAL ECONOMY

If Trump wins we can expect that his policies may prove more harmful to the US in the longer-term, but in the short-term they would likely see a positive market reaction as he is seen to be more business friendly and inclined to introduce further tax cuts. Additionally, Trump would continue with his protectionist policies, including hiking trade tariffs against China and the rest of the world. This wouldpose a significant headwind to globalisation as many other countries could likely follow in the US’s footsteps. However, China may actually prefer a Trump win since the damage this would wreak to the US’s position as a global leader would leave a power vacuum for China to step in and fill.

Biden would be likely to introduce more populist policies, such as addressing issues around better healthcare and social support, which would necessitate raising corporate taxes again. It is for this reason that Biden is seen as being less business friendly. As a result, a Biden win could see markets reacting negatively over the short term. Over the longer term, however, his influence would likely see the US play a greater global leadership role again.

Another factor to consider is that if Trump wins and Republicans keep the Senate but the Democrats take the House, then we are likely to continue seeing government gridlocks and paralysis. The biggest needle mover would be if the Democrats took both the Senate and the House – which seems likely if we consider election polls to date. But, as history teaches us, never discount the unexpected.

Given the above implications, it is crucial to keep an eye on the November result, as this will impact how global companies interact and do business, and how economies work together and develop over the next decade. You only need to consider the effect that US sanctions placed on specific Chinese companies over the protection of intellectual property rights to highlight the possible ramifications.

October clearly illustrated that while markets may be driven by economic fundamentals and company earnings in the long term, over the short term they can be quite sensitive to political developments, a misplaced Tweet or, as happened recently, the ill health of a world leader. The market immediately reacted to the news that Trump had contracted the coronavirus, pulling back quite a bit out of concern that Biden would potentially stand a greater chance of a presidential win.

In spite of the noise and the headlines, it is important not to invest or look for opportunities based simply on who holds the presidency of any given country. Certainly, policies may influence economic fundamentals over the longer term, impacting companies for better or for worse, so it is vital to understand how policies could impact the playing field in the future. However, it is more important to pick investment winners that will comfortably see investors through changing landscapes.

Sentiment shifts and market reactions will inevitably create volatility, and we are likely to see this for the rest of the year and going into 2021. What is more important to note is that this volatility will offer investors the opportunity to rebalance portfolios by taking profits or using the chance to gain a better entry point on preferred asset classes. Ultimately, economic fundamentals drive long-term returns. So, as we prepare for the festive season, it is far better to focus on the latest data and trends, and how these could influence markets in the coming months and years.

MIXED RESULTS FOR THE GLOBAL ECONOMY IN 2020

We saw a synchronised global downturn following the outbreak of the pandemic, with economies worldwide nosediving in tandem. In contrast, recoveries have been quite diverse, dependent on the amount of stimulus or the structural issues at play in each country.

In some good news, the global purchasing manager’s index (PMI) is now higher than it was pre-pandemic at 52.3 points, demonstrating that the global economy is back in expansion mode (even if it is rebounding from a low base). Additionally, the Citigroup Global Economic Surprise Index, which measures a basket of economic indicators relative to expectations, is now at its highest level since 2007. This demonstrates that data has surprised to the upside as economies around the world reopen and data releases are generally better than expected a few months ago.

Overall it seems that the global economic recovery has started, although various headwinds will keep this recovery fairly muted over the next few years. Corporates, in particular, are likely to come under pressure as consumer behaviour and demand shifts in the wake of the pandemic. This will likely lead to a rising number of job losses and increased pressure on consumer income which, in turn, will impact demand, prevent corporates from achieving capacity growth and lead to further job losses.

In addition to this negative feedback loop, it is also important to keep in mind that many of the positives we are seeing in terms of economic data are coming off a very low base. Most economies are still way below pre-pandemic levels, although there is more stimulus in the pipeline and we are likely to continue to see more stimulus being added until economic recoveries are well underway.

SIGNS OF TROUBLE FOR THE US

US Federal Reserve (Fed) Chair Jerome Powell has commented that the US is facing one of the most severe economic downturns we have seen in our lifetime. As a result, the Fed is doing whatever it can to support households and businesses and get the economy back on track. The Fed’s balance sheet will, therefore, likely reach 30% of GDP within the next year, with a budget deficit of close to 25% of GDP – higher than the deficit recorded during the Second World War. Moreover, there is talk of more fiscal stimulus by the US government, although negotiations for a package seem to have stalled recently.

It is positive to note that retail sales and consumer confidence figures seem to be bottoming out and are slowly rebounding following the impact of lockdowns. But one of the biggest headwinds now facing the US is the fact that many temporary job losses are likely to turn into permanent losses as companies struggle to return to pre-pandemic levels.

Mortgage delinquencies have also increased to levels last seen in 2008 – a flashing light of troubling times to come if unemployment continues to rise. And finally, Trump’s vocal stance on China – in particular blaming China for the pandemic - demonstrates the continued deterioration of the US-China relationship, which will further impact trade relations.

The US is likely to see economic growth decline between 5% and 6% in 2020, before slowly recovering and getting back to capacity over the next three years.

EUROPEAN RECOVERY ALSO INCOMPLETE

Like the US, Europe has also seen a great deal of fiscal and monetary support in the wake of the pandemic, and additionally has approved the European Recovery Fund which will also bolster the region’s economy. European Central Bank (ECB) President Christine Lagarde has said that the ECB is willing to deploy more stimulus to aid Europe’s recovery as needed. She has also noted that although there are some signs that the economy is rebounding, its recovery is uncertain and incomplete, as consumer spending remains cautious. This is having a ripple effect on companies.

On a positive note, consumer and business confidence does appear to be ticking up slightly: the Future Business Expectations measure was up quite strongly and retail sales also seem to be bottoming out and rebounding off a low base. However, unemployment across Europe has already risen between 2% and 4% and is expected to increase further, which will prevent the region’s recovery from gaining momentum.

Europe is likely to see between a 7% and 8% decline in economic growth for 2020, but with stimulus will slowly return to capacity growth over the next few years.

CHINA LEADS GLOBAL RECOVERY

China is a couple of months ahead of the rest of the world in terms of its recovery, as manufacturing, infrastructure projects and consumer consumption seem to be slowly returning to normality. China is also enjoying a far more broad-based recovery than the rest of the world, as industries such as consumer entertainment and tourism have been picking up, although they remain depressed in other countries. Local air travel numbers during the Golden Week holidays at the beginning of October were even higher than last year, while cinema box office and subway numbers are also normalising.

One interesting development to note is that car sales are also higher than they were before the pandemic, marking a change in consumer behaviour as individuals avoid public transport amidst fears of infection. Overall, China’s economic recovery seems to be under control. GDP rebounded more than 12% in the second quarter of the year, following a 10.5% decline in the first quarter.

But, in a significant challenge for the country, trade tensions are back on the table – and not just with the US. Notably, other countries have also signalled their discontent with China’s trade practices and its role in the pandemic. Consequently, the Chinese government may need to rethink some of its previous growth models, which were infrastructure and export led, and rather focus on internal productivity and the services economy as drivers for future growth.

It is also worth pointing out that the country is behind on its commitments in terms of the phase one trade deal with the US, notably to increase its purchases of agricultural goods, energy and manufacturing goods from the US. While the Chinese economy is not yet back to December 2019 levels when the deal was struck, the country will need to make progress on its commitments if it is to improve its reputational standing.

Unlike the US and Europe, China is likely to see positive economic growth of between 1.5% and 2% this year. While one could argue that this is recessionary, given that the country is used to growth of 6% or more, it could reach that number again within the next two to three years.

SOUTH AFRICA HAS A NEW ECONOMIC RECOVERY PLAN - BUT CAN IT DELIVER?

GDP figures for the second quarter of 2020 revealed an unprecedented 51% quarter-on-quarter economic decline in South Africa. Given that this figure is an annualised rate (which assumes that there will be four similar quarters), the year-on-year figure revealing a 17.1% decline in GDP over the 12 months to end-June 2020 is perhaps more telling than the quarterly figure.

Although this decline is shocking, South Africa is by no means the worst performer when compared with other countries over the lockdown period. Mexico, Spain, the United Kingdom, India and Peru all experienced worse economic quarters. All these countries found themselves in the same COVID-19 boat and have experienced similar economic declines; as a result, most are facing rising levels of debt-to-GDP. The real concern is that South Africa was already burdened by a number of deep-seated economic issues and a recession before the pandemic even hit. This signals that our recovery is likely to take much longer, which will see the country lagging its peers over the coming years.

That said, government and the South African Reserve Bank (SARB) both stepped up to the plate to support the economy during this difficult time. The SARB, in particular, should be applauded since its rapid 300 basis points cut in interest rates (which dropped interest rates to their lowest point in 47 years) was particularly impactful. In terms of fiscal stimulus as a percentage of GDP, South Africa’s fiscal package measured as sixth-largest compared with our peer group and, in terms of monetary policy, South Africa introduced the second-largest overall interest rate cuts. However, our growth is currently ranked as the third worst compared with our emerging market peer group. In other words, our stimulus levels relative to GDP were high, and yet the effect of this stimulus has not filtered through into growth. Ultimately, a lack of reform and structural economic issues have thrown obstacles in the path of recovery.

We have seen some positive developments on the reform front of late, with Finance Minister Tito Mboweni signing the Memorandum of Agreement on the highly anticipated Infrastructure Fund. This marks a critical step for South Africa’s economic recovery. Nonetheless, given that the budget deficit has more than doubled since the February Budget Speech, government is now facing significant fiscal challenges that it will need to address with some urgency. Additionally, foreigners have been selling our bonds, and foreign investors’ share of government debt has now fallen to its lowest level in eight years, further compounding South Africa’s fiscal conundrum and forcing government to look to other sources to finance its obligations.

In a silver lining for the country, South Africa’s economic data is beginning to demonstrate a strong rebound from a low base, which is in keeping with the rest of the world. Export numbers have risen back to January levels, and mining, manufacturing and vehicle sales are all showing an almost V-shaped recovery, although they remain below pre-pandemic numbers. The tourism industry has been one of the hardest-hit victims of the pandemic, but as lockdown has now eased to level one it is to be hoped that the sector will benefit in the months to come. Finally, our local PMI numbers recently recorded their highest reading since 2007, coming in at 58.3 points in September and demonstrating that the economy is, once again, expanding.

Growth remains under significant pressure, despite fiscal and monetary stimulus, which speaks to the structural issues at play, which is evidenced by the rising number of job losses seen during lockdown and our alarmingly high unemployment rate. Reform is ultimately the only thing that will save the country from an economic crisis.

Government is well aware of the precariousness of this situation, having introduced a new COVID-19 recovery plan. But, yet again, South Africa’s problems do not stem from a lack of plans, but rather a lack of action. On this point, it is positive to see that President Cyril Ramaphosa has introduced a government report back on the progress of implementation, which must be submitted directly to his office every six weeks. Perhaps the seriousness of the situation will finally give Ramaphosa the boost he needs to achieve some traction when it comes to implementing economic reforms. Additionally, it is worth noting that South Africa’s economic recovery plan was negotiated with government, business and labour all sitting together around the table, adding to the likelihood of the plan’s success since no parties were excluded from deliberations and decision making.

South Africa’s economy is likely to decline 8% this year. That said, depending on the speed and effectivity of reforms and implementation, we may yet achieve 2.5% growth over the next few years.

STICKING TO OUR GUNS

This year will definitely stand out in our collective memory given the unique series of events that we have seen playing out over the past months. As the world saw with previous global challenges - from the Spanish Flu to the Great Depression, the global financial crisis and now the COVID-recession - markets will revert back to underlying economic fundamentals over the longer term.

Sticking firmly to Citadel Asset Management investment process has served us and our clients well over the past 27 years, and it did so again in 2020. We construct resilient portfolios specifically designed to deliver irrespective of short-term market volatility. History demonstrates that investors who can navigate these types of difficult periods, without allowing emotion to distract them or lure them into making knee-jerk, sentimental decisions, will ultimately preserve their wealth far more effectively over the long term. In fact, they may even create wealth through the various cycles.

As a case in point, while many would never have believed it during the market plunge that took place during March, markets have since surprised to the upside as a result of synchronised central bank stimulus. Giving in to fear and emotion in the midst of the crisis would have led to disinvesting, locking in losses and losing out on the market recovery that followed. The only effective way to protect and create wealth is by having a well-diversified portfolio that dovetails with a financial plan that has been tailored to your specific needs.

While often uncomfortable, market volatility should rather be seen as an opportunity to make minor portfolio adjustments, such as increasing exposure to asset classes that may be showing better value. But, at all times, it is critical never to compromise on quality. Quality is crucial in difficult times such as these; defining moments when top-draw selections really show their mettle.

Whatever the events of November and the final months of the year may bring, our investment philosophy and commitment remains unwavering. As a valued Citadel client you can rest assured that your portfolio is in expert hands as we enter the festive season and the dawn of 2021.