The financial markets concluded the month of November on a positive note, driven by emerging indications of economic moderation in the United States and a decrease in inflation across developed markets. The released data broadly reinforced the notion that central banks have reached the peak of their tightening cycles, providing support to both equity and fixed income sectors.
The market responded positively to the October US Consumer Price Index (CPI) reading, which was milder than anticipated. Headline and core inflation dropped to 3.2% and 4.0% year-on-year, respectively. The main contributors to the decline were reduced energy and gasoline prices, followed by lower travel costs and hotel rates. The decrease in inflation raised optimism that inflation could reach 2% by the end of 2024, reducing investors’ expectations of a final interest rate hike by the Federal Reserve at its December meeting. While both the market and we are convinced that peak policy rates have been reached, the November Federal Open Market Committee minutes emphasized the Fed’s determination to maintain policy rates at elevated levels for an extended period.
Despite resilient economic data, there were indications of a cooling US economy. Initial and continuing jobless claims increased modestly, credit card delinquencies continued to rise and retail spending modestly declined in October. This suggests that consumers are moderating their spending patterns after a robust performance earlier in the year.
This culminated in major stock indices experiencing gains throughout the month, with the S&P 500 in the United States exhibiting the most significant increase (9.1%). Notably, growth stocks, particularly in the technology sector, outperformed their value counterparts on a global scale. Government bond yields exhibited a decline, with the US 10-year Treasury yield dropping below 4.4% by the end of November, down from its mid-October peak of 5%. Commodity prices retreated from their October highs. Despite ongoing Middle East conflicts, the price of a barrel of Brent crude oil decreased to $80, attributed in part to increased US supply and OPEC+ members’ failure to adhere to production quotas.
The United Kingdom experienced a larger-than-expected decline in headline and core inflation to 4.6% and 5.7% year-on-year, respectively. Despite elevated wage growth, a drop in services inflation could make the Monetary Policy Committee more comfortable with holding rates. Signs of economic activity bottoming out in the UK were observed, with the flash November services Purchasing Managers’ Index surpassing the critical 50-mark that distinguishes expansion from contraction. Chinese macroeconomic data exceeded expectations, with retail sales up 7.6% year-on-year in October. However, the housing market continued to act as a significant drag on growth, with new home sales decreasing on a year-over-year basis. The People’s Bank of China injected liquidity into the Chinese banking system once again, and a new required reserve ratio cut could be implemented before the year-end. Additional fiscal stimulus may be necessary to support consumer sentiment and mitigate deflationary headwinds.
The meeting between the Chinese and US presidents resulted in various agreements on energy transition and climate change. This development could suggest lower tensions between the two superpowers, potentially benefiting global markets.
The risk-on environment continued within the South African market as well, with the JSE All share Index ending November up 8.55%. This was after data confirmed that October’s headline inflation surged to 5.9%, nearing the upper limit of the 3% to 6% target range and moving away from the preferred 4.5% midpoint where it prefers to anchor inflation expectations. Despite this, the inflation forecast was revised slightly down to 5.8% for this year (vs 5.9% in September) and 5% for 2024 (vs 5.1%).
The South African Reserve Bank decided unanimously to leave its key repo rate steady at 8.25% on November 23rd, 2023, in line with expectations. This decision aimed to firmly anchor inflation expectations around the target midpoint and enhance confidence in achieving the inflation goal. The bank mentioned that inflation risks remain elevated, while the risks for medium-term domestic growth appear balanced.
These factors also saw the ZAR gaining some momentum in mid-November, although losing some ground towards the end of the month ending 1.08% weaker to the USD. Unfortunately, the good news in markets was hampered by loadshedding schedules worsening and the idea of rolling blackouts throughout the festive season. Politics also played its role (as always), and with next year’s election firmly in sight, we expect every politician to be vying hard for the voter’s approval.
Overall, it was a good month for our funds and portfolios as we saw opportunities to increase risk asset exposure where possible and get back to our neutral allocations. Speaking of which, we also concluded our second strategic asset allocation meeting this month, focusing on both local and global asset classes, and formulating our bull, bear, and base case scenarios for 2024.
From a global perspective, the current landscape is characterized by power play dynamics, Central Banks addressing inflation concerns, geopolitical tensions in Europe, technological advancements such as AI and the spotlight on energy transition and oil. This complex economic scenario is further shaped by five key areas:
1. The rise of labor (Capital vs Labor markets)
2. The end of monetary leniency
3. Trade tensions between the US and China
4. The impact of climate change and energy transition
5. The fate of electric vehicles.
In the South African context, the upcoming year is expected to be crucial, marked by structural challenges, issues like loadshedding and uncertainties around infrastructure development. Factors such as the outcome of the elections, the role of the private sector in infrastructure maintenance, and the potential for foreign investment are critical considerations. While our research points to a base case scenario with a 70% probability of fiscal dominance in 2024, we acknowledge the inherent uncertainties in predicting the future with certainty.
Our base case scenario envisions no hard landing in the US economy, mild CPI inflation, rate cuts and a transition to trend growth in developed economies. While we anticipate ongoing turbulence in financial conditions, the tug of war between fiscal and monetary authorities and potential positive surprises in US productivity, our outlook is cautiously optimistic. We also outline alternative scenarios with lower probabilities, including a 20% chance of a de-risking environment and a 10% probability each for adverse and bullish scenarios. These scenarios hinge on factors like geopolitical tensions, monetary policy choices and technological advancements. Transitioning to a more specific focus on South Africa, our base case assumes an ANC-led coalition government with limited improvement in structural headwinds but lower interest rates and a weaker US dollar. We acknowledge the uncertainties surrounding political developments, infrastructure challenges and the potential for foreign investment.
Taking all these factors into account, we emphasize the importance of diversification in portfolios. Our return forecasts and expected asset class performances indicate potential opportunities in the US and emerging market assets. Despite ongoing volatility, our asset allocation adjustments aim to capitalize on the expected positive market conditions. In conclusion, we advise staying invested and diversifying across alternative asset classes. Our track record during challenging periods, such as the onset of the COVID-19 pandemic, demonstrates the resilience of our portfolios.
Jacques de Kock
Quantitative Analyst & Portfolio Manager
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