What GDP number means for rates | asset allocation update | US nonfarm payrolls

French government collapses

Last week French lawmakers successfully passed a motion of no confidence in Prime Minister Michel Barnier’s government, collapsing the government. This comes after a deeply divisive legislative election in July which left the nation without a single-party legislative majority (i.e. a hung parliament). 

The bond market appeared to respond positively to the news, which was surprising given the political uncertainty to come. The difference between French and German 10-year government bond yields compressed.

However, the risks to the French economy have not completely been eliminated. A comparison between French and Greek bond yields shows only a small differential. It’s clear that there are still risks to the French economy.

The CAC 40 index rallied after the vote of no confidence, which was surprising given the political instability to be expected as well as the potential expansionary fiscal policy. The rally, however, was probably driven by the dislocation between German equity market performance and French equity market performance of late.

 France’s national debt-to-GDP ratio is now at its highest level ever, at 112%. 

The South African asset allocation committee keeps its risk score at 1.5

Our South Africa asset allocation committee recently met to discuss the risk score for South African portfolios. The committee’s score remained unchanged relative to the previous meeting, and the committee remains at the highest risk score since inception, broadly representative of the better macroeconomic story due to structural reform, consumption expenditure, fiscal consolidation, etc.

The committee is increasingly convinced that South Africa is in a cyclical upturn, even if there are still questions about a structural recovery.

While the GDP data released last week was not supportive of the committee’s view, the group believes that the lagged effects of sentiment following the announcement of the Government of National Unity (GNU) towards the end of the second quarter suggest that material improvement should become more visible in the fourth quarter and the first half of next year.

The negative GDP print was mainly driven by the agricultural sector, which fell around 29% quarter-on-quarter. Agriculture makes up around 2.5% of GDP, thus the decline shed 70 basis points (0.7%) from GDP. Had the agricultural sector been flat quarter-on-quarter, then SA GDP would have come in line with consensus forecasts of 0.4%.

That said, new vehicle sales data are already starting to show a recovery on the part of the consumer. Vehicle sales growth, on a year-on-year basis, has surprised to the upside for two months in a row. And total vehicle sales are at their highest in around three years.

There was a negligible decline in consumer confidence. Our estimates for consumption expenditure for the quarter are between a 2.5% and 4% uplift in spending due to lower inflation, lower fuel prices, the interest rate cuts over the quarter and the introduction of the two-pot retirement system.

The theme for the asset allocation committee for the coming quarter is “substance over form”, which means that more concrete evidence should continue to come through to further solidify the prospects for South Africa. IMF forecasts for South Africa’s growth rate is for it to be among the bottom 15% performing economies globally. A good fourth-quarter GDP print could therefore significantly surprise the market.

Global PMIs show world economy is still fragile

Most of the countries we track have Purchasing Manager Index (PMI) readings for November that are above 50 (the neutral level) but lower than in October. Developed markets in aggregate are slightly worse off than in October. The EU in particular is showing weakness, with a reading below 50 and lower than the month before. Emerging markets are doing better than developed markets from a PMI perspective.

Europe showed weakness from both a services and manufacturing PMI perspective, with services PMIs below the neutral level.

US PMIs did show some acceleration relative to the month before, based on the S&P PMI reading. Services remained positive while manufacturing rebounded to just below the neutral level. The aggregate PMI reading was strong for the month, but ISM manufacturing data suggest some scope for weakness in earnings growth.

According to work done by research house BCA, there are some upside risks to this thesis that earnings growth is elevated. Labour productivity growth in the US can uplift earnings potential. 

Nonfarm payrolls come in at 227,000

US nonfarm payrolls for November came in above consensus forecasts, at 227,000. Despite the strong reading, it’s worth highlighting the revision from the month before. Initially nonfarm payrolls came out at 12,000 for the month of October but the upward revised number came in at 36,000, still a weak number.

Despite the strong payrolls number for November, weak PMI readings are typically also negative for nonfarm payrolls. 

Euro area retail sales continue to rebound

Euro area retail sales came in materially higher than consensus forecasts at 2.9% (est. 1.7%). This was the third month in a row where euro area retail sales surprised to the upside, indicative of the positive impact of rate cuts by the European Central Bank (ECB) and lower inflation.

The month-on-month reading was equally strong, coming in at 0.5%, which points to retail sales growing at an annualised rate of around 6%.

This is perhaps among the reasons why consensus forecasts for GDP growth in the euro area were revised upwards this week.

The picture was a bit different in Europe’s largest economy, Germany, where retail sales were weak, with a sizeable decline in the month-on-month reading for German retail sales.

However, continued producer price disinflation is broadly supportive of continued downward pressure on consumer prices in general in Europe, which is equally supportive of further rate cuts by the ECB.

Some hope for global demand

There has been a resurgence in export growth in China, Taiwan and South Korea, which should be a good indicator for global growth. However, one risk to export performance is possible stockpiling in the US due to expected tariffs on Chinese goods of 60% and tariffs of 10% globally on goods exported to the US. 

Will the US-Canada-Mexico Agreement (which replaced NAFTA) be renegotiated?

President-elect Donald Trump recently threatened to impose 25% tariffs on all goods from Mexico and Canada. Among the potential reasons could be the suspicion that Chinese goods are being rerouted through Mexico due to tariffs placed on Chinese goods. However, Trump has also highlighted the illicit flow of drugs and illegal migrants as reasons.

Has Mexico been gearing up for the opportunity? Investment spending (gross fixed capital formation) from research house CEIC Data suggests as much.

The written section was by Osagyefo Mazwai, Investment Strategist, Investec Wealth & Investment International