Our Market’s Macro-Paradox

What happens when the market is right about an event?

Simple: nothing.

If the consensus that we call ‘the market’ is correct in forecasting an event, then that event is already priced in. Hence, only if the market is wrong will there be any dramatic move.

For example, the downgrade this Friday. The ZAR movement from there and the ALSI move this morning have shrugged this event off because it was expected. Unlike what global markets did with Brexit and Trump occurred and prices went wild adjusting to an unexpected reality.

So what else is currently expected by our local market? Hence, where is there an opportunity to profit from the consensus being wrong?

Well, here is the short macro-list and my justification, but both these facts and my conclusions are all up for debate:

Event: ANC NEC in December 2017

I think the market has priced in the likelihood of a Dlamini-Zuma (i.e. Zuma, i.e. Zupta!) win in the ANC NEC in December this year. This is will stretch out the corruption and fiscal cancer further across two more years till the 2019 General Election is the next ray of sunshine to sort South Africa’s government out.

Why do I say this?

Well, you can’t look at the Rand or bond yields for this, as they are equally sensitive to global effects, carry trades and Trump’s Twitter account.

Rather, have a look at what has happened in the domestic small cap equity market space this year: it’s valuations have fallen dramatically, because investors are deeply negative on South Africa right now and desperate to find liquidity and get out.

In my mind, it is simple: If Cyril Ramaphosa wins the ANC NEC, expect a large rally in these low liquidity, domestically-sensitive stocks.

JSE’s Small Cap Index’s Price-to-Book versus the Top 40’s (YTD)

Event: Rating Decision in Early 2018

There are arguments both ways here, but my belief is that this event risk is a derivative of the above ANC NEC event risk.

If ANC NEC keeps the current regime in place, we will be downgraded. Hence, expect this reaction to price accordingly post-ANC NEC in December. Many, though, believe that we are already priced for full and deep junk status by comparing our CDS against other countries in worse positions (see here).

If the bonds and credit market is pricing South Africa at junk, the ZAR is likely to be pricing that in too.

Event: SARB Rates Cycle

After the SARB cut rates in July this year, the market has started pricing in a rate cutting cycle. Despite wobbles along the way, many of these expectations have not seen their prices adjusted.

General Retailer’s Index

Therefore, this implies that the market still expects rates to slowly fall. It may be further enhanced by the strong ZAR and the soft commodity deflation post-drought dragging inflation within the SARB’s target band.

Conclusion: The Market Is Half-Wrong

And here is the kicker: the above consensus list is a paradox.

If the market is expecting the ANC NEC to be a negative outcome and to lead to a downgrade, then the SARB cannot cut interest rates (as the ZAR will weaken, downgrade will spike bond yields etc).

But, if the market is expecting the rates cutting cycle to continue, then they obviously think that there will be a positive outcome for the ANC NEC and no downgrade early next year.

Hence, someone is very wrong here?

Sure, that someone here may be me and my interpretation of the macro. I may be missing some key macro-insight. Sure, I can accept that.

I do not have the answer for you, but I put this out there for you to decide. One thing if for certain, the domestic financial market is in for a volatile couple of months.

 

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