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Citation – Third Quarter 2021









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Having reached peak growth post the pandemic recession, the world is moving onto the second stage of its economic recovery. Phenomenal growth came off a very low base following the COVID lockdowns of 2020. Although not as severe, last year’s economic decline was reminiscent of the depression of the 1930s. The subsequent sharp rebound in global economic activity has seen a significant rise in commodity prices and growth assets across the globe. The second phase of the recovery, however, means global growth is starting to slow.

Moving from peak growth to slower, but still solid, economic growth, what can we expect from financial markets going forward? Although global economic growth will slow over the next two to three years, it is likely to remain well above capacity. The slowdown in economic growth does not mean we are entering another recession – far from it. Right now, given strong economic fundamentals, coupled with very accommodative monetary and fiscal stimulus, we expect global growth to average around 4% over the next few years – which is some of the best growth we have seen in decades. However, given the speed of the recovery we will soon see a rethinking of monetary and fiscal stimulus from global central banks, which will create some headwinds for the global economy and financial markets.

Current growth is being supported by four key factors. The first is that household spending is up, which is driving global consumption. As the pandemic abates, we are seeing very high savings rates, meaning there is excess cash to be spent, especially in the United States (US) where consumers are sitting with very healthy personal balance sheets. US consumers have also paid back a lot of their debt, so there is room to increase credit spending if need be. The second factor driving growth is the building of inventories from a supply point of view after many has been depleted due to last year’s lockdowns. Thirdly, there is the ongoing support from central banks. Although there is talk about the tapering of asset purchases, this is merely a slowing down of support. Currently central banks are maintaining very accommodative policies. Finally, the vaccine rollouts across the globe are continuing, and this will allow economies to open up fully, which will further support economic growth in the longer term. It was estimated that at least 25% of the world’s population would have been vaccinated by the end of September 2021. If you are one of them, consider yourself very fortunate, notwithstanding South Africa’s slow start.

Despite this healthy economic backdrop, there are a number of issues that are developing from the return to economic normalcy. Supply-chain bottlenecks have arisen, and we are starting to see inflation building in the system. Shortages of shipping containers around the world are increasing the cost of moving goods around the globe. Sending a container from Asia to Europe is currently ten times more expensive than it was at the same time last year. This is feeding through to the end price being paid by consumers. Increased consumer demand is adding pressure to the supply chain, while manufacturing woes have increased, as major economies are experiencing labour shortages which are driving up wages, further building inflationary pressure in the system. But the resolution of these issues, coupled with the higher base effect of the data over the next 12 months, should see inflation reverting back to central bank targets over the next few years. As such, we do not feel inflation is of major concern in the longer term.

The US economy surpasses pre-COVID levels

The US economy surpassed its pre-COVID economic levels in the second quarter of this year, just nine months after the bottom of the recession last year. The speed of this recovery is unprecedented, and is largely due to the fiscal support from the US government and the US Federal Reserve (the Fed). The same speed of recovery can be seen in company earnings, which have bounced back as the economy opens up.

From a labour perspective, the stimulus cheques and the unemployment benefits from the federal government came to an end at the end of September. However, despite the record-high job openings, employment is not back to pre-covid levels. Employers are battling to fill positions due to people receiving support and/or being unwilling to return to work. But we expect this will change later in the year now that the support has come to an end.

In addition to government support, US labour supply is being impacted by a number of factors. Work and lifestyle changes, brought on by the pandemic, has meant people are looking for alternative employment because in some cases “old jobs” are no longer available or in existence. However, with the economy opening up, there is a huge demand for employees in tourism and hospitality, but there are currently not enough people to fill these positions. Another factor impacting the labour market is the increase in wealth that we have seen over the last year. As asset prices have increased, many people have seen their wealth grow, meaning they have been able to take early retirement and have exited the job market. Ultimately, all of these factors point to higher labour costs, as businesses need to pay more to get people into positions.

Manufacturing has been negatively impacted by these labour shortages, as well as by increased manufacturing costs and freight costs, with the US manufacturing producer price index (PPI) jumping to its highest level since 1970. These factors have resulted in a slowdown of US manufacturing activities. Although this is adding to the US economic slowdown, we believe this is a short-term issue. In the last quarter we have also seen a surge in the US consumer price index (CPI), which is being driven by a significant increase in car prices, especially amongst second-hand cars, as demand for those has risen. The new car market has been knocked, as manufacturers cannot get cars off the production line due to the supply-chain bottlenecks.

Other sectors of the economy are looking much more promising. Transport, hotels, and restaurants have all rebounded to pre-COVID levels, as the economy opens up and spending shifts back to services rather than goods, as has been seen over the past few months. However, US consumer confidence has been dampened by the spread of the Delta variant, and confidence figures have been pulled back from an all-time high a few prints back. Despite the softness in consumer sentiment, high rates of savings have seen retail sales and consumer spending remaining fairly solid – comparable to some of the best levels we have seen in the last 25 years. Consumer spending has also been further enhanced by low interest rates, meaning the cost of servicing debt is currently very low. As such, many consumers have paid off a lot of their debt, creating a very safe buffer for future spend, as consumers can start spending on credit again, if need be.

From a policy perspective, Fed chair, Jerome Powell, confirmed in his Jackson Hole speech that the US economy is doing well, despite a slowdown in manufacturing. Service industries are picking up, the consumer is in a good space, and unemployment is being addressed. Given these factors, we expect to see an easing of monetary stimulus in the US, and a reduction in the value of bonds the Fed is buying – currently the US Fed is buying $120 billion in bonds each month in order to stimulate the economy. Although there is a lot of contradictory information coming out from Fed policy makers, it is expected that tapering should start by the end of the year. But this does not mean the end to stimulus, rather just a reduction in the amount of stimulus. Given the strength of the US economy, we believe that the country will achieve an average growth rate of around 4% per annum over the next three years.

EU next to approach peak growth

The European Union (EU) is set to reach its peak growth around the end of the year, achieving pre-COVID economic levels by the last quarter of 2021. The region’s rebound has been fuelled by their vaccine rollout and economies opening up. EU employment levels are improving and are currently at a five-year low. As in the US, there are issues with labour supply in the United Kingdom (UK) and EU. EU citizens have been getting financial support from governments, which has exacerbated labour shortages as people are not being incentivised to return to work. Also, as an example, the UK is experiencing a shortage of truck drivers after Brexit saw the EU truckdrivers return to the continent. This is now spilling over to other industries and resulting in knock-on effects across the economy – fast food outlets are unable to obtain key ingredients with many outlets forced to close temporarily.

More evidence of an improving economy is the purchasing manager’s index (PMI) which has reached a 20-year high, the services industry – a key driver of the economic recovery – reaching a 15-year high, as well as consumer confidence which is also up across the region. But like the US, the EU is dealing with supply constraints, which is keeping a lid on EU manufacturing growth, especially in Germany, which is a big manufacturer and exporter. Another headwind for the region’s economic recovery is the spread of the Delta variant. Despite this, confidence levels are still up and are currently at 20-year highs. This is supporting strong household spending and should keep doing so into the near future.

From a policy point of view, the European Central Bank (ECB) has made it clear that it will only increase interest rates if the region’s inflation stabilises at 2%. As the ECB is not expecting inflation to rise over the medium to long term, they may allow inflation to run a little bit higher than 2% for a while longer, before looking to increase interest rates. But we do not believe interest rate hikes are imminent for Europe. However, the ECB is looking to cut back on its stimulus and has indicated that it will taper its bond purchasing for the remainder of the year. Yet, the ECB has reiterated that if the economic situation deteriorates, it will continue its support of the economy.

Indicators suggest that EU growth will slow down in 2022, but we expect growth in the EU, over the next few years to be strong, although not quite at US levels. It should average around 3.6% over the next few years. This is the best growth we have seen for the eurozone in a number of decades.

China – changing gears for common prosperity

China has been in the spotlight recently as a number of their policies have been causing volatility and concern in global markets. China’s current developmental model moved away from their previous single-high-growth (at high cost) approach, towards multiple policy perspectives which include growth, productivity, de-carbonisation, financial stability, and importantly, common prosperity, which is aimed at more inclusive growth for all of its citizens. As part of China’s structural transformation, government has started implementing various important regulatory changes, which have hit the Chinese property sector, in particular, in recent months. China’s largest property developer, Evergrande, has been a significant casualty of this approach, and the move has had a negative impact on markets and sentiment in recent months.

China’s long-term policy, which forms part of President Xi Jinping’s social objectives for the country, is to achieve greater inclusive growth, encourage competition within the Chinese economy and to get consumption – rather than fixed asset investment and exports – to be one of the main drivers of growth. The government is no longer looking for growth for the sake of growth. So, although the country will continue to be a major global manufacturing hub, they want to support development and technology that is there to benefit its population of 1.4 billion. Industries –  like the manufacture semiconductors – which create more jobs, are getting government support, but social media giants and private educational companies, for example, that only make a handful of people wealthy or benefit only the wealthy, are feeling the wrath of Chinese regulators. Going forward, we can expect to see more government control and regulatory crackdowns as government follows its longer term ambitions. This, however, will not be market friendly and will continue to add volatility to the global financial system.

China was the first major global economy to reach peak growth, back in 2020. Since then, the Chinese economy has lost notable growth momentum with policy, including (over)tightening in the first half of this year, the impact of the Delta variant, and various production challenges, all pulling growth lower.  The current slowdown is broad based, covering both the demand and supply sides of the economy. The outbreak of the Delta variant is adding to China’s woes. We have seen a drop in Chinese retail sales, industrial cement sales and car sales, which are all printing softer. In addition, the country is also dealing with labour shortages, but for slightly different reasons to the US and the EU. In China, young people are trying to get out of factory jobs and are moving to the service sector, migrant workers are staying at home for fear of contracting new strains of COVID-19, and the country’s aging population is starting to retire, creating a shrinking workforce.

From a policy perspective, in July the Chinese central bank has cut the reserve requirement for banks by half a percent, for the first time since April 2020. They are also providing ample liquidity into the banking sector to ensure smooth functioning. But beyond this, they are being less supportive than other major economies in terms of fiscal stimulus. This is likely to change as China has already started issuing more local government bonds, which should support economic activity going forward. We are expecting the Chinese economy to grow at around 5% per annum for the next three years, which is still solid for an economy of that size.

South Africa – Policy implementation will be country’s only saving grace

South Africa’s Gross Domestic Product has been revised and the base year changed to 2015 – which is done by SA Stats every 5 years. As a result of the revision, the economy is, in fact, 11% bigger than was being reported. This is important because it implies that most of the metrics, that we measure against GDP, like debt-to-GDP and per-capita income, are in fact better than originally reported.

It must be remembered, however, that these metrics look at historical data. As we go forward, we must not be fooled. These figures make no difference to the economic reality of most of the population on a daily basis. In truth, growth has remained mostly unchanged over the last decade, and the decline we saw last year with COVID, was in line with the decline we saw in the 1930s. The good news, however, is that coming off a very low base, the latest GDP numbers show that we have increased the economy by about 19% compared to this time last year. That is a huge rebound and marking peak growth for SA. But going forward, we can expect slower annual growth, especially if we do not see the implementation of President Cyril Ramaphosa’s economic policies. If things do not improve quickly, we will be back to simply matching population growth, which will average GDP growth of around 1.5% per annum over the next three years.

Despite a phenomenal rebound, South African has only reached the GDP level it was at in 2017, meaning we are still behind our pre-COVID levels. The expectation is that South Africa will only reach pre-COVID levels around the end of 2022 or the beginning of 2023. At this rate, South Africa is not growing at a rate sufficient to address the country’s serious unemployment problem. Currently, South Africa’s official unemployment figure is 35%, the highest on record, and also the highest official unemployment figure in the world. In addition, important job creating sectors, like construction and manufacturing, are currently not contributing to economic growth and employment. Fortunately mining and agriculture are the stars and have performed well since the rebound started.

Good exports of mining and agricultural products, and a drop in imports, due to the current state of the economy and soft local demand, has seen South Africa print its biggest trade surplus on record. The country’s strong trade surplus, and very buoyant commodity prices, have all been tailwinds for the rand, which has remained relatively strong for most of this year. We expect this to change as the global economy starts to slow after peak growth has been achieved. The rand will be further impacted by US monetary policy, including the increase in interest rates and the tapering of asset purchases, which will boost the strength of the US dollar, causing the rand to lose value against the greenback. This, together with the move past peak growth and softer commodity prices, means we expect the rand to stabilise at levels over R15.50/$ over the course of the next year.

When it comes to policy, South Africa needs to balance its need to restore the economy with the social needs of the country’s most vulnerable. Business-friendly policies including the revamping of the port authorities and the 100 megawatts lift on private energy production, will need to be implemented alongside more populist social policies, like a universal income grant and health insurance, to avoid a replay of the July civil unrest that negatively impact the economy and sentiment. However, to afford this, the country needs to borrow less and improve tax collection. Currently, the biggest challenge facing the fiscus is avoiding the fiscal cliff that economists are talking about. South Africa’s debt service cost is already 30% higher than before 2021, and the country is already paying 20% of government revenues on interest. In its present state, this is unsustainable going forward.

At the heart of South Africa’s economic inaction is the lack of industrialisation, which is the most sure-fire way to kickstart the economy and create much-needed employment. Yet, business confidence is at an all-time low. Although South Africa’s savings rate is at an 11-year high, the bulk of this figure is made up of corporate savings, highlighting business’s unwillingness to reinvest into the economy. Corporate South Africa is currently sitting on one trillion rand in cash and local fixed investments are at a historical low. Improving business confidence, however, will require the implementation of Ramaphosa’s policies. Treasury has noted this with South African Reserve Bank Governor, Lesetja Kganyago, saying South Africa is facing an execution deficit. While new Finance Minister, Enoch Godongwana, notes that we have no absence of policy, but rather of policy implementation, that is the problem.

With the fine balancing act taking place in the economy, the South African Reserve Bank (SARB) is between a rock and a hard place. As other global economies are talking about raising rates, the SARB has no reason to. Inflation is not a problem, despite the economic rebound many consumers remain under pressure, and the rand is still strong, so ideally the SARB will want to keep rates down. But, as the US rethinks its fiscal policy, driving the strength of the dollar, it may be necessary for the SARB to look at raising local interest rates down the line.

Investments – economic growth remains healthy

In the current investment landscape, global economic prospects remain healthy with above capacity growth expected. This is positively impacting company earnings and the fundamentals of equity markets. Company valuations seem reasonable at these levels and are not overstretched.

As global economies emerge from the fallout of the pandemic with huge amounts of government debt, it is likely that interest rates will be kept lower for longer. Governments are currently looking for negative real interest rates or what they call financial repression – where governments keep rates low so that they can afford their debt. They will also hope to see increased inflation which will deflate away the value of the debt, over the next couple of years.

Over the next three to five years, Citadel will remain focused on quality assets. We will remain significantly underweight in fixed income assets like cash and government bonds that have negative real yields. We will manage volatility in the portfolio by investing in alternatives, including hedge funds or protected equity strategies that protect against downside risks.

We believe the current strength of the rand is a good opportunity to buy US dollar investments offshore. While we will remain overweight in global assets, the local market is offering some good opportunities. The Johannesburg Stock Exchange, from a valuation point of view, is looking very attractive, and is currently offering some of the best value opportunities that we have seen in the past decade – there are pockets of value that present opportunities that can be very rewarding going forward. The local bond market is offering yields north of 9% and these are some of the highest yields available anywhere in the world. If you think that inflation is sitting at around 4.9%, it is very attractive.

Although the outlook remain promising over the long-term, there are some short term risk building that could create an environment where markets could blow off some steam. Some of these are geopolitical risk and include the US withdrawal from Afghanistan, and China’s tension with Taiwan. Also, China and Russia are playing bigger roles in redrawing the map of Asia, so there is a powershift happening in the region. This, together with the US potential tapering of assets, peak growth and the possibility of commodity prices retracting, we could see a further reduction of liquidity in the system. These headwinds, however, are expected to be temporary and won’t derail the current recovery, cause an imminent recession or impact the long-term economic fundamentals of large global economies.

As we head towards the end of this year, with these potential short-term dark clouds building, clients can rest assured that the same philosophy and processes that protected their wealth through various cycles over the past three decades, will again give them the optimal outcome as we move towards and into 2022.