October 2024 newsletter
This month’s newsletter provides an in-depth look at both international and South African markets, highlighting key trends and developments. It also examines the U.S. election and its potential impact on global economics. The theme of the month, "Cloud Computing & AI," explores how these technologies are transforming industries. Additionally, this issue includes a focus on Chapter 11 of The Psychology of Money, which discusses the importance of time in financial decision-making and wealth accumulation.
Categories:
Date Posted:
November 12, 2024
In this month’s newsletter
“Half of the American people have never read a newspaper. Half never voted for President. One hopes it is the same half. “
– Gore Vidal, Screening History
Summary
Source: Julius Baer, 28/10/2024
International market overview
The US presidential election is naturally dominating the minds of most investors. When faced with such uncertainty, it is tempting to position portfolios to benefit from a particular outcome. Such a strategy is grounded in the assumption that other investors have mispriced the probability or impact of that outcome. While that may be true in some circumstances, it seems unlikely this year, given how close the race is.
This means positioning a portfolio for a particular outcome is a coin flip, and one should not risk a lot of capital on it. We should instead be positioning our portfolios to withstand a range of scenarios and looking for opportunities as the market adjusts to whatever new political reality emerges after Nov. 5. The stock market goes up and down under every president, but the path of least resistance has always been higher.
Historically, US equities are volatile but generally post positive returns after elections and after the first Fed rate cut. Exceptions to this trend occurred during the 2000 dot-com bubble and the 2006–2008 credit crisis.
Figure 1: Average performance of S&P 500 Index 12 months before and after the first Fed rate cut
Source: Edmond De Rothschild
Figure 2: Average performance of S&P 500 Index 12 months before and after past US elections
Source: Edmond De Rothschild
The United States and the eurozone will release their preliminary third-quarter economic growth estimates, with expectations of markedly different outcomes. In the U.S., growth indicators suggest the economy continues to defy predictions of a post-pandemic slowdown, while the eurozone has seen limited economic expansion for over a year. Julius Baer projects U.S. GDP growth at 2%, compared to the eurozone’s near-stagnant 0.1%. Consensus forecasts diverge even further, anticipating 3% growth in the U.S. and just 0.2% in the eurozone.
This substantial growth disparity stems largely from Europe’s tepid consumer spending versus the U.S.’s robust consumption. The eurozone’s savings rate has reached nearly 16%—its highest since the pandemic—while U.S. consumers are saving just 4.8% of disposable income, below the long-term average of 8.4%. Rising U.S. household wealth and comparatively lower wealth relative to income in Europe partially explain the variation in spending, with consumer sentiment also significantly more positive in the U.S. than in Europe.
While few indications suggest this trend will shift soon. Additional interest rate cuts in the eurozone could stimulate consumption over savings, promoting wealth growth and marginally enhancing investment appeal. With lower inflationary pressures due to weak demand, the European Central Bank can maintain a more accommodative monetary policy stance than the U.S. Federal Reserve.
Figure 3: Personal savings diverge sharply in the US and the Eurozone
Source: Julius Baer
US inflation
The September Personal Consumption Expenditures Price Index increased in line with expectations, up 2.1% from year-ago levels.
When volatile food and energy costs are factored out, the Federal Reserve’s preferred measure of inflation increased 2.7% from one year ago, above expectations. Economists had forecast that the core PCE inflation index would rise 2.6%.
Summary
The U.S. economy remains robust, though economic indicators from Europe and China have shown lackluster results. India continues to display impressive growth, albeit with a slight deceleration. In the near term, we anticipate some asset price volatility driven by slowing economic growth globally, geopolitical tensions and the upcoming U.S. elections. Historically, however, the most effective strategy has been for investors to stay invested. In most cases, U.S. markets have rallied post-election, irrespective of the outcome.
The U.S. election
In a surprising political resurgence, Donald Trump has been elected the 47th President of the United States, marking one of the most polarizing elections in recent history. Against a backdrop of significant challenges—including legal controversies, attempted attacks on his life and a final campaign showdown against Vice President Kamala Harris—Trump’s victory signals potential shifts in U.S. economic policies with broad implications for global markets.
Implications of Trump’s trade policy
A cornerstone of Trump’s economic strategy has constantly been recalibrating U.S. trade relationships. He is now considering a sweeping tariff of 10-20% on all imports, compared to the current 2% average. In targeting China specifically, Trump may elevate tariffs to as high as 60% on certain imports, a sharp increase from the current 10-25%, aimed at reducing the U.S.-China trade deficit, which stood at $260 billion.
Potential Treasury Secretary Robert Lighthizer advocates for a trade policy that aggressively tackles the monthly $78.8 billion U.S. trade deficit, even suggesting tariffs up to 200% should China move against Taiwan. Trump has also called for a “reciprocal” tariff policy, which could particularly impact European exports to the U.S., such as automobiles, which face higher tariffs when entering Europe than U.S. exports face in the reverse direction.
Figure 4: Sensitivity in % of EPS to import duties of 10% and 60% between the US and China for several US sectors
Source: Edmond de Rothschild
Supply-side tax policy considerations
Trump’s tax agenda could re-energize specific sectors. The existing Tax Cuts and Jobs Act (TCJA) is set to expire in 2025, but a Trump administration would likely extend these cuts, potentially boosting S&P 500 earnings by an estimated 11%, similar to the impact seen after the TCJA’s introduction in 2018. Sectors like utilities, consumer discretionary, industrials, and financials could benefit even more significantly. While new corporate tax cuts aren’t ruled out, they may be smaller in scope. One proposal suggests reducing the corporate tax rate for U.S.-based production from 21% to 15%, which could increase S&P 500 EPS by 5%.
However, enacting these tax policies depends on congressional support. Although Republicans lead in the House, a decisive majority is uncertain, and high federal deficits complicate the likelihood of extensive tax cuts. Extending the TCJA alone could add $5.5 trillion to the deficit by 2033, according to the Committee for a Responsible Federal Budget, making fiscal restraint a critical factor for some Republican lawmakers.
Figure 5: Impact on EPS in % by sector of Trump’s TCJA tax law in 2017
Source: Edmond de Rothschild
Historical market reactions to Trump’s elections
Looking back to 2016, Trump’s election led to a positive trend for the S&P 500. Financials experienced a sharp boost, with solid gains in industrials, materials and tech. Energy stocks lagged, though they did show gains. Market expectations of pro-business policies largely drove the broad positive response.
Figure 6: Absolute sector performance after Trump’s election in 2016, in %
Source: Edmond de Rothschild
Conclusion
Markets are likely to respond optimistically to Trump’s return, especially in sectors like financials, consumer discretionary, oil, and tech. However, Trump’s stringent trade stance, particularly on China, introduces volatility risk for industries with significant international exposure. Sectors such as industrials, materials, tech, and renewable energy could be vulnerable in the face of escalating trade tensions. Meanwhile, domestically focused businesses, like real estate, hospitality, and travel, may benefit.
International equities, especially Chinese stocks, could see pressure from renewed U.S.-China frictions. European auto and green energy sectors with U.S. dependencies also face challenges. However, luxury goods, commodities and healthcare may remain relatively stable due to diversified demand drivers.
South African market overview
Source: Moneyweb
Medium-Term Budget Policy Statement (MTBPS)
Finance Minister Enoch Godongwana has projected economic growth of less than 2% over the medium term, which will result in reduced tax revenues. In his recent Medium-Term Budget Policy Statement (MTBPS), he revised the tax revenue forecast for the current fiscal year down by R22.3 billion to a total of R1.8 trillion. The shortfall in tax collections is primarily due to weaker fuel levy and value-added tax (VAT) revenue.
According to the National Treasury, import VAT collections dropped by 4.5% compared to last year’s period. This decline stems from lower imports of energy-related goods, as Eskom’s ability to stabilize power supplies has reduced load shedding, consequently reducing demand for imported energy components.
The South African Revenue Service (SARS) now anticipates collecting R13 billion less in VAT than the R477 billion initially budgeted in February. Debt servicing costs are becoming increasingly burdensome, now absorbing 21.6% of government revenue. National debt as a percentage of GDP is forecast to rise from 74.7% to 75.7%.
Minister Godongwana has emphasized that sustaining debt at these levels poses significant challenges to South Africa’s capacity to service its obligations effectively.
Figure 7: Reducing debt is key to growth
Source: National Treasury
South Africa progresses toward removal from FATF grey list
South Africa is moving closer to earning its removal from the Financial Action Task Force (FATF) grey list, having received a “positive review” for strengthening its ability to counter financial crimes and terrorism financing.
In his Medium-Term Budget Policy Statement, Enoch Godongwana reported that the FATF found South Africa has now largely or entirely addressed 16 of the 22 required action items in its improvement plan”. This is a significant achievement, made possible by the unprecedented cooperation between various government departments and civil society,” said Godongwana.
“Only six action items remain, which we aim to address before the final scheduled review in February 2025.“
Boxer IPO to bolster JSE amid limited listings drought
Boxer, South Africa’s fastest-growing grocery chain, is poised to raise up to R8 billion in its upcoming Initial Public Offering (IPO) as it prepares to separate from its parent company, the struggling retail group Pick n Pay, and list on the Johannesburg Stock Exchange (JSE).
Recently opening its 500th store, Boxer has attracted investor attention, with Pick n Pay planning to retain a controlling interest of at least 51%—a strong indication of Boxer’s robust near-term growth potential. Last week, Boxer signaled that it expects the IPO proceeds to reach the upper range of the previously estimated R6 billion to R8 billion.
This IPO is projected to be the largest on the African continent this year, offering a welcome boost to the JSE, which has seen a scarcity of new listings recently.
Rising costs of essential goods deepen financial strain on South African households
The widening gap between salary growth and the inflation of essential costs, such as housing and vehicles, highlights a troubling disconnect between earnings and the actual cost of living. Although salary increases have outpaced general inflation rates, they have lagged behind the sharp rise in prices of goods vital to maintaining quality of life.
Compared to three decades ago, South African households now face significantly higher monthly expenses, intensifying financial pressure for many. Basic utilities, for example, have seen staggering price hikes: a study by PowerOptimal shows that since 1996, water tariffs have surged by 2,100% (11.5% p.a.), while electricity costs have risen by 1,710% (10.7% p.a.). This steep increase in essential expenses has made financial stability an ever-greater challenge for the average South African.
Figure 8: South African electricity & water tariffs vs. inflation (CPI)
Source: Business Tech
Theme of the month: Cloud computing & AI
There is considerable concern regarding the sustainability of the artificial intelligence (AI) investment cycle, primarily due to a significant USD 600 billion gap between spending on information technology (IT) infrastructure and the monetization of AI. This disparity raises questions about the investment cycle’s viability and the likelihood of low returns and potential capital losses.
Key factors contributing to this monetization gap include the proportion of IT infrastructure costs relative to overall data center expenses and the profitability levels of software companies. Modifications to these factors could significantly narrow the gap, making it easier for investors to manage.
The depreciation schedule for IT infrastructure plays a crucial role in addressing the monetization gap. It enables cloud service providers, often referred to as hyperscalers, to spread their investments over several years. This approach mitigates the negative impact on profits and allows more time to generate additional revenue.
The overall market size for AI adopters is approximately USD 2.7 trillion. Achieving the anticipated levels of monetization will necessitate an 11.5% compound annual growth rate (CAGR) by 2030. Although this growth rate is ambitious, it is attainable given the backend-loaded growth trajectory.
Software companies, especially those making substantial investments in AI, are well-positioned to capitalize on the expanding AI market. Firms like Adobe, Salesforce, and Microsoft represent attractive investment opportunities with the potential for robust revenue growth and increased market share.
Figure 9: Revenue trajectory of AI adopters to bridge the current level of infrastructure investments and close the monetisation gap
Source: Julius Baer
Figure 10: The leading cloud computing and AI companies in each sector
Source: Julius Baer
Hyperscalers
Morgan Stanley has updated their capital expenditure estimates for hyperscalers for 2025 and 2026, following the third-quarter earnings reports from major tech companies. Their 2025 capex estimates have increased by 9% ($26 billion) compared to previous forecasts, with the most significant adjustments seen in Amazon (AMZN) and Microsoft (MSFT).
Morgan Stanley also anticipates that Amazon, Alphabet (GOOGL), Meta (META) and Microsoft will collectively spend around $300 billion and over $335 billion in 2025 and 2026, respectively, as they continue to invest in multi-year opportunities related to generative AI and large language models (LLMs). These substantial and escalating capital expenditure figures highlight the need for ongoing disclosure regarding the new and incremental adoption rates, user engagement, and revenue opportunities that these four companies are pursuing and investing in.
Figure 11: Hyperscaler capex estimates ($bn)
Source: Morgan Stanley
Graph of the month: Data center construction is at record highs
Source: Joseph Politano using Census data
Psychology of money – Chapter 11: The importance of time
In Lesson 11, “The Importance of Time,” Morgan Housel underscores how time is one of the most powerful assets when it comes to building wealth. Unlike money or material resources, time is a non-renewable asset that, once passed, cannot be recovered. In the context of investing, the earlier you start saving and investing, the greater the opportunity for your money to grow through the power of compounding.
Compounding works as a kind of exponential growth; it’s the process by which an asset’s earnings, from interest or returns, are reinvested to generate further earnings over time. This effect is magnified the longer you invest, allowing even modest savings to grow into substantial wealth with sufficient time.
Housel emphasizes that by starting early, even small, consistent contributions can lead to impressive results over a few decades. For instance, someone who begins investing in their 20s, even at modest amounts, can potentially end up with more wealth than someone who invests larger amounts but starts later.
This is because the compounding effect accelerates as the years go on, turning time into a powerful ally. Over decades, the returns compound on themselves, creating a snowball effect that accelerates wealth-building and helps investors reach their goals without needing to contribute excessively in later years.
One of Housel’s main messages in this lesson is that the earlier you start, the less you may need to rely on extreme financial sacrifices later on.
For many people, waiting to save or invest until their 30s, 40s, or even later can mean having to save a larger percentage of their income each year to catch up, which may be challenging or unrealistic. Starting early allows individuals to invest more comfortably while still capitalizing on the same growth potential.
This lesson encourages readers not to be intimidated by the idea of “starting small”—in the context of compounding, small amounts can grow into something far more significant when given enough time. Housel also explores the idea of patience and persistence. Investing requires discipline and the understanding that meaningful returns are often built over decades, not months or years.
Short-term market fluctuations may seem dramatic, but over a long investment horizon, these ups and downs tend to smooth out, allowing long-term investors to benefit from the general upward trajectory of the markets. This patience not only prevents emotional reactions to market volatility but also reinforces the idea that wealth accumulation is a long-term commitment, strengthened by the power of time.
Ultimately, “The Importance of Time” is a reminder that time is both a gift and a tool for those who harness it wisely. Rather than waiting for the “perfect” moment to invest, Housel encourages readers to take action as early as possible, even if it means starting with small steps.
By understanding the immense value that time brings to the process, investors can create a solid foundation for future financial security and freedom. Housel’s lesson invites readers to see time not just as a passive passage but as an active, powerful ally in building the life they want.
Sources
Alpine Macro, Anchor, Bloomberg, BNY Mellon, Charlie Bilello, Credit Suisse, Compound Advisors, Edmond De Rothschild, ETFMG, FactSet, Haver Analytics, JP Morgan, Julius Baer, Morgan Stanley, Refinitive, RMB, Statista, Sygnia, Strategas, UBS
Disclaimer
VEGA Asset Management has taken care that all information provided in this document is true and correct. VEGA Asset Management does not accept responsibility for any claim, liability, loss, expense, or damage. Any information herein is not intended nor does it constitute financial, tax, legal, investment, or other advice. VEGA Asset Management is an authorised Financial Service Provider with FSP number 776. Past performance is not necessarily an indication of future performance.
