As we head into the second half of 2024, we are eventually starting to see some green shoots. Economies are winning their fight against inflation, and a number of central banks are starting to offer some relief by easing monetary policies and cutting interest rates. Most developed markets, except the United States (US), are also slowly emerging from their economic growth slump. Furthermore, a number of high-profile elections are behind us, with the outstanding few still potentially likely to have a significant impact on markets during the latter part of this year.
A convergence following desynchronised growth
The Bank of Canada was the first to cut rates in June and was closely followed by the European Central Bank (ECB). The Bank of England (BoE) is preparing to cut rates imminently. While these central banks usually move in line with the US Federal Reserve (Fed), their cutting rates first, indicates how out of sync the US economic cycle is with its global peers.
Following its unprecedented growth over the last two years, we are now starting to see the world’s largest economy showing signs of cooling, and we believe it is set to experience some headwinds going forward. With the US economy coming off a fairly high base in 2023 of around 4% growth, we expect it will revert to capacity growth of around 2% over the next three years.
In comparison, its peers are coming off a very low base – the European Union (EU), for example, saw an average of 0.5% growth – following significant slowdowns in their economies. By the end of 2023, countries like Japan, Germany and the United Kingdom (UK) found themselves flirting with negative growth and recessionary environments on the back of economic headwinds. However, they are seeing an uptick, and we expect the EU to return to capacity growth of around 1.8%, which is a convergence of the unsynchronised market cycles between the US and its peers.
Central banks’ cautious war on inflation
Despite the economic winter of 2023, a global recession was prevented. We attribute this to the way in which central banks have proactively managed their monetary policies to target soaring inflation. It has taken 18 months, but we are seeing inflation being brought under control and interest rates being cut without any real damage being done to their economies. In addition, the desynchronised growth, where the US is slowing as the rest of the world is starting to pick up speed, can be seen as a positive. This is because as the US slows down, there are other cylinders coming online, which will help maintain global capacity growth over the next two to three years.
The risk for economies, however, lies in how central banks continue to manage their monetary policy. While it appears that most of the major central banks have avoided any damage by keeping rates high for an extended period, any policy mistakes at this point could inadvertently cause unintended harm. For example, keeping policy tight for too long could result in an economic slowdown. Cutting rates too soon, however, could open them up to the risk that they do so before inflation is under control, which could prolong the need to keep rates higher for longer – putting businesses and consumers under ongoing pressure.
An example of this is the ECB. Although it has started to cut rates, it has increased its inflation expectation. This means that over the next two or three quarters, if EU inflation has not been adequately controlled, it will rear its head again, meaning that the ECB will have to pause its rate cuts, or even hike rates again, which could trigger another slowdown or, worse, a recession.
Elections – coalitions and populism
Another key theme that is set to continue to the end of the year is that of elections, with the buzzwords being “coalitions” and “populism”.
If we look back at the second quarter of 2024, the world saw a number of elections take place, including the Indian, Mexican and South African elections, all of which provided surprising results. In South Africa, the African National Congress (ANC) saw its support fall to just over 40%, and Jacob Zuma’s uMkhonto weSizwe (MK), which was only launched in December 2023, garnered over 15% of the votes. This result forced the ANC to form a coalition government in the form of a Government of National Unity (GNU).
In India, Prime Minister Narendra Modi, although elected president for his third term, failed to win a majority. As such, his Bharatiya Janata Party (BJP) party has also had to form a coalition government called the National Democratic Alliance for his next term. The Mexican elections saw a woman, Claudia Sheinbaum, being elected as president for the first time in that country’s history. Despite critics hailing it as a win for women, her election was closely tied to outgoing-President Andrés Manuel López Obrador, and some of his more controversial policies.
Moving to Europe, at the end of June and beginning of July, the French far-right made massive gains in the first stage of the French election, with the left coming out stronger in the second ballot. The lack of an outright win has left Macron’s government also having to form coalitions for the next term. This situation not only presents massive political risk for France, but also for the stability of the EU. In the UK, Labour was elected to power after 14 years of Conservative rule. Unlike the French election, this is a positive for UK-EU relations.
The wave of populism is set to continue, with the election of Donald Trump as US president for a second term becoming an increasing possibility. If Trump gets in, we will see increased political risk to global relations and trade.
World trade flatlining
World trade, another trend that we’ve been observing, is still under pressure, despite the slow pickup in economic activity in some regions. This pressure is partly caused by tariffs being imposed on Chinese goods by the US and the EU. In the US, President Joe Biden has implemented tariffs on a number of Chinese goods categories. While this may be a political move ahead of the election, these tariffs are in addition to what Trump implemented during his term. China is now also facing tariffs being applied by Europe on all Chinese electric vehicle imports. This move by the EU could cost the Chinese economy around $4 billion in trade with Europe.
Adding to these trade “wars”, economies are now actively diversifying their supply of goods and commodities away from single sources, like China, as they seek to secure essential supply chains. The new model for supply is called China +1. This follows the supply-chain crunch of the pandemic and that which occurred at the start of the Russia-Ukraine war.
UNITED STATES – slowing from a very high base
In the previous few editions of Citation, we have talked about the US economy in detail. This quarter has not seen our view change. Last year the US economy was largely unaffected by higher interest rates for a number of reasons, including fiscal spending, government support for consumers, high consumer savings, high real wages, and a robust labour market. However, we are now seeing all of these factors running out of steam, which we believe signals that the US is about to enter a slowdown phase.
This slowdown, however, as mentioned above, is from a high base in 2023 and is moving towards 2% growth annually, which is still considered to be solid growth. Nevertheless, the US economy is definitely blowing off steam at this point.
New home builds (houses that are built and have never been lived in before) are slipping and stand at their lowest level in a year. New housing starts (construction projects that are on the go) are also down by 14%. Both of these key economic indicators reflect a slowdown in the US economy. We are also seeing a gap growing between manufacturing and services. While the services side of the economy is still strong because there is pent-up demand for services, the manufacturing side is under pressure. On the back of a weaker manufacturing sector, the labour market is softening and unemployment numbers are growing. Added to this, a record number of consumers are taking on second or third jobs – there are more than eight million multiple job holders in the US currently. This indicates that the environment is not as friendly to the consumer as it was in 2023.
What is encouraging is that the US leading indicators suggest that the risk of a hard landing (long recession) for the US is fading, but that doesn’t mean that its economy won’t continue to slow. This is because of the aforementioned consumer headwinds, including a fall in savings, fewer job openings, falling wages and high interest rates. Pressure on the consumer has also resulted in the number of US credit and vehicle loan delinquencies rising.
Up until now, it has been argued that it is the lower-income consumer who is struggling and that high-income consumers are still keeping their heads above water, and as such, will keep supporting the US economy. However, if we unpack the statistics, while the poorest 10% of consumers are struggling and their credit and auto loan delinquencies over the last year have more than doubled, when we look at the wealthiest 10% of consumers, they have also seen a significant increase in delinquencies. This suggests that all US consumers are currently feeling the pressure and consumer confidence is slipping further.
These issues point to weak consumer activity in the future and are why we expect the US economy to continue slowing over the next 12 to 18 months. However, the US consumer can expect some relief in the near future, because with inflation starting to come in line with Fed targets, the Fed is talking about cutting rates as soon as September.
EUROPEAN UNION – seeing the light at the end of the tunnel
On the other side of the Atlantic, European consumers, who struggled in 2023, are now finally seeing somewhat of a reprieve.
Unlike their US counterparts, EU consumers still have excess savings, which is giving them a bit more of a buffer going forward. In addition, with inflation falling, consumer confidence is also increasing, as consumers are seeing their real wage growth exceed inflation. The fall in EU inflation numbers has also resulted in the ECB cutting rates. This has added a lot of confidence, not only to the consumer but also to the broader business community. Such overall improved sentiment will likely keep building momentum in the EU’s economies with German and European business confidence already at their highest level in over a year.
Despite high interest rates and weak economic growth, the EU has been fortunate because unemployment figures have remained low, providing an additional boost for consumers. EU retail sales, however, remain depressed, but given the improvement in sentiment on the back of rate cuts, this should start picking up. We are also starting to see industrial production pick up in Europe, specifically Germany. This is very highly correlated with the trade wars against China.
So, where the US is slowing to reach capacity growth of 2%, the EU, which is coming off a low base, is starting to move towards trend growth of around 1.8%.
CHINA – picking up
In line with the EU, China is also picking up as it moves in sync with other major economies – except the US. This pick-up is slow, however, as unique challenges remain. The Chinese property sector is still under stress, and the government does not want to stimulate this part of the economy as it wants it to mature by removing excess capacity.
This is because the Chinese government now wants the consumer to start playing a bigger role in driving economic growth. Currently, consumer spending accounts for less than 40% of the Chinese economy. Compare that to the US, where this number stands at around 70%. The Chinese government’s focus is now to increase its consumer spending to 70% as well. This will ensure greater sustainability for the world’s second-largest economy, making it less exposed to global economic cycles, infrastructure development or trade, all of which China relies on heavily.
The good news for China is that its consumers still have excess savings that they can tap into. This is because China’s interest rates are low with the country’s inflation sitting at a meagre 1.5%. Consumers therefore have the ability to pick up spending by using their savings or even by borrowing more. What we are seeing, however, is a lack of consumer confidence, which is unlikely to change until there is greater clarity on which direction the Chinese economy is moving.
Headwinds, however, remain for the country’s manufacturing sector. It has an ageing workforce that is pushing up the cost of production, and the ongoing trade wars with the US and EU, as well as the diversification away from a single source of supply, are hurting the sector. However, having said that, while Chinese trade with the US flatlined from 2010, it started to decline over the last few years as a result of the implementation of trade tariffs. Yet, if you look at Chinese trade with the rest of the world, that has picked up substantially, and now exceeds what they have lost in trade with the US. So, while US trade tariffs are an issue for China, they have not impacted the volume of China’s overall global trade. As such, manufacturing activity in China is, in fact, picking up and has grown at its fastest pace in two years, which is a significant increase in both production and new orders. New orders are forward-looking, as they are the orders that are in the pipeline.
Chinese demand indicators, however, have been mixed. So, while there has been an uptick in consumer spending and in manufacturing, we have seen weakness on the construction side of the economy. That is probably because the Chinese government is pulling support from the property and construction sectors because they do not want those sectors to overheat.
In summary, the Chinese economy is stabilising. In this environment, China will probably print growth numbers of around 4% to 4.5%, which is lower than historic numbers. However, it is an economy that is not only larger, but that is also maturing.
SOUTH AFRICA – a strong GNU could boost the outlook
May 2024 saw South Africa emerge from a historic election where the African National Congress’s (ANC’s) support fell to just over 40%, forcing it to form a Government of National Unity (GNU) with the Democratic Alliance (DA), Inkatha Freedom Party (IFP) and seven additional smaller parties. If it works, the GNU could bode well for the local economy, given its apparent focus on economic growth.
Ramaphosa’s new cabinet, while bloated to accommodate all the members of the GNU, has shuffled portfolios to ensure important sectors are diversified. Eskom has now been moved to the Minister of Energy and Electricity, Kgosientsho Ramokgopa, while the railways, PRASA and the ports now fall under Transport Minister Barbara Creecy. Enoch Godongwana continues in his role as Finance Minister, which pleased markets as it points to the government remaining on the path of fiscal discipline.
On the economic front, GDP growth in the first quarter of the year was very soft, with only the agricultural sector performing. Agriculture is gaining importance and is playing a major role in South Africa’s growth, but it is also a very volatile sector that can have a run of good quarters followed by very bad ones, dependent on weather, harvest, and the ability to export. It remains to be seen how DA leader, John Steenhuisen, will govern the sector.
Nevertheless, agriculture only makes up 4% of South Africa’s total GDP, and we cannot rely on this single sector to support the economy. Perhaps more notable is that the country’s growth engines, namely: construction, mining and manufacturing, were down significantly in the first quarter of 2024. If South Africa wishes to see meaningful growth, it needs these sectors to perform. Their poor performance speaks to the logistical issues in terms of rail infrastructure and poor-performing ports, as well as stagnation in the implementation of policy in the run-up to the elections.
Yet, at the moment, the government is focused on giving the GNU legs. This means that nobody is talking about fixing issues like Cape Town Harbour, which has been rated as the worst harbour in the world. We may also see disruptions from the Progressive Caucus, which is the opposition alliance made up of the Economic Freedom Fighters (EFF), MK, and the African Transformation Movement (ATM). So, the environment for 2024, including the next six months, is going to be driven by political agendas rather than policy implementation, which means the economy is unlikely to get any support for economic growth this year.
While South Africa’s economy is stagnating, its population continues to grow in excess of GDP growth – which has been the case over the last five years. As such, the country is experiencing a per capita recession, which could potentially create great social instability if it is not remedied.
It is also clear, not only from GDP numbers but also from high-frequency numbers, that there was a wait-and-see approach from businesses ahead of the elections, with orders and investment down in the first two quarters of the year.
In addition, over the last three quarters, South Africa has also experienced a negative turnaround in Fixed Capital Formation. After a run of eight positive quarters, we have now seen three negative quarters in a row. This talks specifically to the slowdown in the solar boom, which came off a high base in 2023. Adding to this, residential investment has started to take a knock as a result of ongoing high interest rates.
We are hoping that, in line with the US Fed and more stable local inflation numbers, the South African Reserve Bank (SARB) may also provide businesses and consumers with some relief by starting to cut rates before the end of the year.
Giving consumers financial relief is important in regard to stimulating the local economy as consumer spending contributes 68% to South Africa’s GDP. Yet, over recent quarters we have seen that South African consumer spending has slowed considerably. Household consumption, for example, last saw a positive quarter in the first quarter of 2023. Since then, it has been flat or negative. In the first quarter of 2024, for example, household consumption was down 0.3% from the previous one.
Green shoots
Despite the current stagnation in the economy, it is not all bad news. The election outcome was positive, indicating that South Africa has a robust democracy. The fact that the ANC accepted its loss without any violence is a further reflection of that, which is contrary to what may have happened in other parts of the world. The ANC’s willingness to find an amicable solution to its poor performance at the polls – and one that the markets responded well to – bodes well for the country. After 30 years, we can now say that South Africa’s democracy is maturing, and opposition parties are moving forward, irrespective of whether they are pro-business or populous. People have voted for change.
With the elections over, foreign investors are looking on from the sidelines, watching what will happen going forward. Foreigners have made it clear that if local companies are not prepared to invest, they are not going to risk putting money into South Africa. The formation of the GNU may just provide the political stability that investors are looking for, to risk investing through foreign direct investment (FDI).
While we are seeing a small uptick in FDI, South Africa’s FDI has averaged around 2% of GDP over the last decade. This number is very much in line with what we are seeing in China. Yet, if we put that in context, a country like Colombia has an FDI number of around 5.8% of GDP, and it is growing at 400% per annum. South Africa’s neighbour, Namibia, is attracting FDI of over 8% of GDP with growth of around 500% per annum due to the attractiveness of the Namibian mining resources sector. South Africa needs to ask what those countries are doing to attract that level of FDI and then put policies in action to improve foreign investment. Having said that, South Africa’s FDI of 2% of GDP equates to around R100 billion, so there is still a sizeable amount of investment flowing into the country annually.
In interrogating the country’s selling points, PwC recently conducted a survey asking foreign investors what their perceptions of South Africa are. The country ranked top in sport, followed by culture, people and history, then natural beauty. So, while that may be good for tourism, it is not attracting FDI. At the bottom of the list were safety and crime, and the economic and business environment.
However, the PwC survey also found that investors are positive with regard to South Africa’s abundant resources, especially given the green transition that is taking place. This is probably what is making Namibia so attractive, because while they are undergoing the same green transition, they have fewer logistical issues than South Africa at the moment. It is for this reason that South Africa needs to fix its structural issues, to ensure that both local and foreign investors can benefit from those resources.
Foreign investors are also really positive about South Africa’s strategic location as a gateway to Africa, especially given our transparent legal system, which is a huge positive. South Africa’s financial services sector is also considered world-class, as are our communication networks. But the country still faces upcoming structural challenges, which can only be addressed by improved policy implementation.
Looking ahead to the remainder of 2024, we believe South Africa will be lucky if it achieves 1% growth and 1.5% over the next two years. Higher sustainable growth will only be possible if we start addressing key economic challenges as soon as possible.
CAM OUTLOOK – cautiously optimistic
Harold Strydom will cover our investment outlook in more detail, but the Citadel Asset Management (CAM) team’s outlook is less cautious than it was at the start of the year. This is because we are seeing a pickup in the global economy, excluding the US, and yet the US has avoided any type of recession. While interest rates remain high, we will continue to take a cautious stance. However, when rates start to fall, we will start looking at increasing our risk exposure.
We are, however, not celebrating too early, because while there is an uptick in some regions globally, we do need to wait and see what is happening in the US. The economic reality is that if the US hits a bump in the road, its troubles ripple across the global economy very quickly.
