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Citation – Fourth Quarter 2021



Chief Economist
Estimated reading time: 17 minutes 33 seconds

This year is the Chinese Year of the Tiger. According to the Chinese Horoscope, this will be a year of positive change. Business will be stable, finances should be smooth, and it is a good year to save for the future. This horoscope is very much in line with what the economic fundamentals are telling us at the moment.

Global overview – high inflation, but no recession

On the whole, the global economy had an excellent rebound with economies and businesses doing well. However, this upward trend will not last forever, and to protect against volatility, it is prudent for investors to start positioning portfolios for a rainy day.

Global growth for 2022 is expected to be in the region of 4% – still higher than trend growth observed pre-pandemic but slower than the phenomenal growth we saw in 2021, which came off a very low base after the 2020 economic meltdown. There are numerous factors that will ensure a healthy global economy in 2022.

There is a huge focus on the green economy after the 2021 United Nations Climate Conference in Glasgow. It appears global economies are taking climate change seriously.

Global monetary policy will remain accommodative. Keep in mind that when the United States (US) Federal Reserve (Fed) and the European Central Bank (ECB) talk about tapering, they are simply stimulating the economy less. However, given increasing inflation risk central banks are likely to end stimulus this year and start hiking interest rates. The path to normalising policy will take time but will likely start acting as a headwind during the latter part of this year.

Another positive for the global economy is that we are likely to see COVID-19 risk factors moderate very quickly. With the focus moving to rolling out vaccines in emerging market economies, this is paving the way for a speedier end to the pandemic.

Around the world, healthy spending, especially on the services side, is picking up. We saw a lot of spending on goods for much of 2021, but as economies open and consumers become more confident, they are shifting their spending from goods to services.

This year will see most countries, especially developed market economies, finding themselves back at pre-COVID levels. Countries like China, the US, the European Union (EU) and the United Kingdom (UK) are already at pre-COVID levels, and the global economy is expected to be back to pre-COVID levels during the course of the year. This sort of environment will help get employment back to normal levels, something we expect to happen in the latter part of 2022.

However, it is important to be aware that when the world starts reaching full employment, we are then starting to enter the late part of the current business cycle. When this happens, we need to watch out for the potential overheating of economies. Add to that, higher inflation, which will be a reality for most of the year, and central banks’ action to address this, may be the breeding ground for a looming recession. Although we will monitor developments, we do not believe that a recession is imminent, as all indicators still suggest the risk for a recession remains low.

In fact, there are numerous indicators that the risk of recession remains very low. The first is the US yield curve. Looking at the difference between long-term and short-term rates reveals that it is currently in good territory. When this inverts, meaning it goes negative or below zero, then we can assume a recession is looming. Currently, it is quite elevated and is still increasing, suggestion a low risk for a recession in the next 12 to 18 months.

Unemployment figures are still improving which suggests a robust economic environment. When unemployment numbers start increasing, so too does the risk of recession. But we are not there yet, and we do not expect unemployment numbers to rise for at least another six to 12 months. In fact, we are not at full employment yet, which suggests that the recovery still has some way to go.

Global trade is at its highest level in history and exports are higher than pre-COVID times. This further creates a healthy economic environment globally and is not pointing to an imminent recession

The United States – inflation up, interest rates to follow

We can expect the US economy to grow at around 3% per annum over the next three years, which is a solid number in the current environment. This despite the Fed starting to tighten policy. Currently the Fed is tapering it’s quantitative easing and should complete the process soon. The first-rate hikes are expected soon after, probably already during the first quarter of this year.

Inflation will be the Fed’s priority this year as it is currently at a 40-year high of 7%, way above their target of around 2.5%. The markets are watching the US closely to see how quickly they can get inflation down and what the resulting policy action will be. However, we think this is a very different inflationary environment to what the world experienced in the 70’s. The supply shock back then (oil related), could not be quickly resolved and resulted in global high inflation for a number of years. The current inflationary environment has predominantly been caused by supply issues caused by COVID-19, the European energy crisis, a shortage of shipping containers and limited labour participation. But we expect these inflationary pressures to work themselves out over the next 12 to 18 months. During this period inflation is likely to remain sticky before it moves closer to target.

Adding to the US inflation problem is labour participation. The number of job openings in the US stands at a record high, with almost 11 million positions needing to be filled. Many of the open posts are lower-paying jobs, especially in the service, hospitality and tourism sectors. This is fuelling inflationary pressure as employers are having to pay people more to fill these positions, which will keep inflation higher for longer.

The US consumer is doing well. US retail sales are good, beating expectations, and headline retail sales are currently 18% above pre-COVID levels. This is a function of pent-up demand and people having more savings, having not spent as much during months of lockdown and working from home. But this increase in consumer demand is also driving inflation as it is putting pressure on supply. Following the slump due to the Delta variant, US consumer confidence is once again on the up, and we are seeing a strong increase in consumers looking to buy big ticket items like new homes, automobiles and appliances – likely a sign that consumer spending will continue to be strong in early 2022. Consumer health is also good. We are seeing a fall in the number of financial delinquencies, like mortgage defaults, which spiked at the beginning of the pandemic as people lost their jobs. Consumer health is back to pre-COVID levels, and financial delinquencies are the lowest they have been in three decades.

Europe – Manufacturing booming despite COVID-related challenges

Across the Atlantic, in Europe, we are expecting similar growth figures to the US, around 3% per annum over the next three years. The region’s fourth COVID wave has, however, impacted consumer confidence and economic activity, but with this wave, the eurozone has made the decision to keep manufacturing open. As such, the industrial side of the economy continues to do well, and the services are now also recovering, both of which are paving the way for strong numbers in 2022. The region’s Purchasing Managers Index (PMI) stands at 60, pointing to a healthy expansion (anything above 50 means the economy is expanding).

Unemployment is lower than pre-pandemic levels, so it has been a very sharp recovery on the job market. As is the case in the US, wages are going up, which will underpin increased consumer demand, ultimately impacting the service industry positively too. Many businesses are saying that they are battling with staff shortages, despite employment levels being at all-time highs. Consumer confidence is also picking up but currently remains slightly below pre-pandemic levels with the Business Climate Index at an all-time high. While consumers are still mindful of COVID, we believe a positive for 2022 will be that as soon as consumers see this pandemic is under control, they will fully join the economy again, which will increase service spend in Europe.

Europe’s most important economy, Germany, has new leadership. Olaf Scholz has taken over from Angela Merkel as the Federal Chancellor. We will see how this change plays out in the German coalition government in 2022. This change in leadership should pave the way for a fairer, more liberal Germany, with a focus on green energy and a green economy, as the agenda is heavily focused on climate issues.

Given the pandemic and consumer concerns, the ECB has been a bit slower than the US in terms of tightening monetary policy. Unless things change dramatically in early 2022, they are likely to delay tapering but that will depend on what COVID, growth and inflation numbers dictate over the next couple of months. ECB President, Christine Lagarde, announced after last month’s meeting that the governing council had agreed on a “step-by-step reduction in the pace of asset purchases” in 2022 while judging that “monetary accommodation is still needed” for inflation to hit its medium-term target.

China – Uncertainty hampers growth

In the Chinese economy, there have been a lot of moving parts. The Winter Olympics are taking place in China for the first time this year. Although athletes will be allowed to participate, numerous countries are boycotting by not sending their diplomats to the Games, posing an interesting geopolitical challenge for the Chinese.

In addition, the Presidency has passed its historical resolution. The document is a summary of the past 100 years and looks at the party’s key achievements and its future direction. There have only been three of these issued since the party was founded, the first passed in 1945 and the second in 1981. The document serves to give President Xi Jinping the same standing as Chairman Mao Zedong, father of the People’s Republic of China. This document has brought quite a few radical regulations into play. The major one is Common Prosperity – aimed at making Chinese society more equitable. While there is nothing wrong with the sentiment, the document has also introduced many disruptive regulations on the country’s industries.

Although the Chinese recovery has been strong and they are back to pre-COVID levels, this recovery has been very unbalanced. There has been a lack of policy support and also a huge lag in consumption. The government is looking to move its economy away from exports and infrastructure development towards consumption. As such, they are loathe to provide stimulus to the economy, and while it is still growing, growth is slower than the country experienced pre-pandemic.

A contributing factor to China’s slower growth is that consumer confidence remains low. COVID lockdowns have prevented consumers spending. Confidence has also been hampered by the power outages over the last year. Chinese retail sales are not that strong going into 2022 – in fact, they are the lowest they have been in two decades. This shows that Chinese consumers are not spending as much as they can to keep the country’s growth rate up.

The strong slowdown in the real estate market is also negatively impacting economic growth. But China’s lack of stimulus to infrastructure and property development has now resulted in corporate giants like property group, Evergrande, finding themselves on the brink of default.

The government has also tightened regulation across numerous sectors, including technology, education and property, further increasing policy uncertainty. This uncertainty is expected to continue, which will make it more difficult for businesses to operate in the Chinese economy as if it is a free market. China needs a much more balanced and inclusive macroeconomic policy.

Macroeconomic policy was addressed during December’s Central Economic Work Conference which had a very pro-growth agenda, with a targeted growth of around 5% in 2022. To achieve this, there has been a commitment by the Central Bank to commence with fiscal easing, commenced with pro-consumption measures to get the economy going and give green infrastructure a boost. They have also cut corporate tax rates and lowered the repo-rate by 0.5%. We do not believe this is enough to address the uncertainty currently surrounding the Chinese economy. We may even see more pro-consumption measures being announced. The green agenda is very much an issue China is grappling with. They have set targets to phase out coal by 2030, with 80% of their energy coming from renewable energy sources and 15 million electric vehicles being produced by the same deadline. This new focus may provide China with a green-infrastructure boost.

The Chinese have been very slow in their support for the economy, and we expect that they will battle to maintain 5% growth in 2022. But the measures they have implemented pale in comparison to what they have done historically. This may address sentiment, but it will not address other uncertainty within the economy.

South Africa – Tailwinds turning into headwinds

South Africa had a tough 2021. Yet, despite loadshedding, the July civil unrest and the late December travel bans we are still looking at good growth for 2021 of around 5%. This stronger growth can be attributed to two factors: the low base effect due to very poor economic performance in 2020 and the country benefitting from the export and commodity rebound around the world.

Third quarter growth was hard-hit, declining 1.5%, due to the impact July’s unrest had on the economy. Adding to this were the third wave COVID-19 lockdowns implemented a week later and another alcohol ban – all of which negatively impacted the quarter’s growth. Agriculture also took a knock due to the unrest along with factors impacting harvest and exports.

However, growth in the fourth quarter should come in at around 5.8%, and we expect the overall annual GDP growth for 2021 to be in the region of 5%. Solid growth has benefitted the country through increased tax revenues, especially from the mining sector, which is helping the fiscus to do slightly better.

Unfortunately, the commodity and export boom cannot continue indefinitely, and we expect the local economy’s growth to return to pre-COVID levels of around 1.7%. This talks to the country’s slow structural reforms and when you factor in South Africa’s population growth, it is not enough to counter the country’s dire unemployment figures which currently stand at the highest in recorded history and the highest in the world.

Although the travel ban came at an unfortunate time, tourism, which used to contribute upwards of 10% to the local gross domestic product (GDP) now contributes around 4.5%. So, the impact of the travel ban should be fairly limited as tourism is already contributing significantly less to the economy, and the ban proved not to be long-term. Tourism is a low hanging fruit and government needs to address this – it is easy to double the returns from tourism with little input again and it is labour intensive, making it a good industry to boost employment.

More damaging to the economy is loadshedding, which reached the highest levels ever in 2021. Loadshedding is disastrous for the country’s productivity and competitiveness. It is also devastating for foreign direct investment (FDI) coming into the country. There has been a slow improvement in business confidence after the unrest in July, but we have a long way to go before we can attract FDI back to the country and loadshedding is not helping.

South Africa’s issue with productivity has been documented in the latest World Economic Forum Global Competitiveness Index, where South Africa is ranked 62 out of 64 countries. Part of the problem is that there are too many government policies that are preventing productivity, rather than encouraging it. When we talk about capacity growth in a country, it is a function of productivity and population growth. We therefore need productivity growth to offset the rate of population growth by a healthy margin. That is why the country desperately needs President Cyril Ramaphosa’s touted reforms to achieve sustainable growth.

Reforms are happening, but far too slowly. In the Medium-Term Budget, we were updated on what reforms are in the pipeline, including electricity, transport, water, telecommunication, infrastructure and tourism, but there were no specific dates given as to when things will start to happen. It may therefore almost be too late before we see sustainable growth emanating from these reforms. But at least we are on the right track. The upcoming ANC elective conference later this year will play a determining role regarding future policy reform.

We expect that in the short to medium-term, the tailwinds of 2021 will quickly turn into headwinds. Exports are already falling, and our trade-surplus will soon be a deficit which will put pressure on the rand. And as the global economy slows, there will be a slowdown in demand for commodities, so tax collection from the mining industry will fade.

Government, however, has a delicate balancing act between avoiding further discontent amongst the poor of the country, through embracing populous policies like national health insurance, social grants and the general income grant, with more business-friendly policies that encourage investment and address unemployment.

On a more encouraging note, the South African Reserve Bank (SARB) Financial Stability Report says that the country’s financial situation and markets are stable, given that the financial cycle has turned up for the first time in five years. Part of this comes from cutting back on dividend payments due to the pandemic, leaving companies in a healthy financial position. The financial sector is one of the biggest industries in the South African economy, and if it is doing well, this creates a stable market environment which can assist in getting the economy going.

Although local consumer confidence is at decade level lows and South African inflation is under control, the SARB has raised interest rates by 25 basis points in line with global trends. These rate hikes are set to continue as the SARB reportedly would like to be proactive and gradual. This is a precautionary measure as the local economy does not currently need tight monetary policy. Treasury is joining the SARB in this phase of counter-cyclical monetary and fiscal policy tightening, with a view to building a buffer for more difficult times ahead. Fortunately, they already have a little buffer with 2021’s good growth to do this.

Citadel Approach

Since the lows of 2020, last year saw the markets more than double. The S&P 500 had its longest run with an all-time high since 1997 and it closed at record highs 65 times during 2021. So, the question has to be, where to from here? Due to substantial financial and policy support, economies are recovering, and companies are generating good profits. As such, both local and international growth assets have done extremely well.

We believe that the risk of a recessionary environment is at least 18 to 24 months away, which paves the way for companies to do well over the next two years. If you look at current expectations for earnings growth in 2022, we still have double digit growth, around 20%, meaning we are in an environment where growth assets should still be good. This year, returns may be slightly lower than 2021, but they will definitely beat inflation which is currently a high hurdle around the world.

In the current, high-inflation environment we need to look at alternative asset classes. In this inflationary environment, cash and bond yields are deeply negative, so holding onto those assets is dead capital. For this reason, Citadel is using alternative strategies, including managed volatility strategies and hedge funds.

In South Africa, the Johannesburg Stock Exchange did well in 2021. With the rebound in mining company earnings, they are offering good value, but we need to be selective around which sectors we invest in. So, while we will cherry pick good value local stocks, we still prefer global equities where there is faster growth and fewer structural issues, where companies can generate greater profits, and often have similar valuations. We will remain overweight in global stocks.

In local fixed income assets, there are still good opportunities. Our bond yields have priced in most of the potential fiscal risk that may play out over the next few years. Government needs to be very prudent with fiscal spending as they don’t want to overspend and need to get their debt levels under control. So, where yields are trading at 10% plus, and our inflation is not a problem, South Africa remains one of the most attractive real yields in the world. We believe they still have a place in a well-diversified portfolio allocation.

Currently our cash allocation is at historical lows. We believe alternatives are still preferable, but we are in a cycle of rising rates, so in time, a bigger cash allocation could make it back into portfolios.