Through April, some initial data evidence started to emerge of an even weaker economic situation than the already recessionary conditions prior to Covid-19.
It is important to understand that the economy’s growth had already been broadly stagnating slowly for around seven years, starting all the way back in 2012. This means that for many industries and businesses, the financial pressures had long been building, and we thus entered the Covid-19 crisis already financially fragile.
The BUSA Business Confidence Index had been in broad decline all the way from 2011, and declined noticeably in March, from 92.7 in the prior month to 89.9.
Business confidence declines not only reflect business conditions but can also be a predictor of near-term economic performance, given that economic decision-making runs to a great degree on confidence.
Also released during April, we saw the March rate of month-on-month decline in the OECD Leading Business Cycle Indicator pick up downward speed, suggesting a weakening in the economy to come. The SARB Leading Indicator March datapoint has yet to be released.
But more startling data weakening was seen in the February and March New Sales Orders Index of the Manufacturing PMI, recording just above 30 (on a scale of 0 to 100), sharply lower than prior months, and a massive March year-on-year drop in new passenger vehicle sales (these data series both seen as leading business cycle indicators in their own right) to the tune of -26.8%.
Not only did the country go into the Covid-19 crisis in a fragile financial state, but global shutdowns and disruptions have led to expectations of a deep global recession too. And for a country as open as South Africa’s economy, this alone would usually translate into a significant recession domestically even without the help of any lockdowns locally.
Evidence is that the global economic shock has been severe to date, and this has surely been a key influence in some of SA’s most recent economic data. The United States (the world’s largest economy) has seen massive job loss that has led to more than 30 million Americans filing initial unemployment claims in the previous sic weeks. The US GDP declined by -4.8% in the first quarter at a seasonally-adjusted annualised rate.
And then the deliberate lockdowns domestically, aimed at slowing the spread of virus, a further dampener on domestic production through many sectors.
This has all led to some severe economic growth forecast revisions since the beginning of 2020. FNB’s economists forecasting a -4.5% GDP contraction (while the SARB recently projected nearer to -6%), which would be the worst in post-World War II history, and far more severe than the -1.5% contraction in 2009’s Global Financial Crisis period.
Some key markets, from a property point of view, have corrected sharply in recent months too, increasing the likelihood that significant corrections in physical property values could follow soon.
Confidence in the listed property sector on the JSE remains extremely weak, the Listed Property Index as at last week about -49% down on the end-2019 level.
In addition, government long bond yields remain sharply higher at above 11%, from below 9% as at mid-February.
The bond market correction comes as little surprise, after steadily rising government indebtedness over the past decade that looks set to be propelled even higher by Covid-19 crisis-related borrowing, as well as big increases in borrowing requirements as tax revenues are dented by a deep recession.
Short term interest don’t exert pressure on the property market just yet, however, having moved lower recently. Inflation remains subdued and the SARB has been able to lower the repo rate by a further 200 basis points in less than two months to support the crisis-alleviation measures.
These recent rate cuts, while seen as useful in alleviating some pressure, are not expected to prevent a deep recession in 2020, given the massive production disruptions that we have seen to date.
MSCI Digest data was released in April, completing the property picture for 2019.
Since 2014, the commercial property market has been gradually weakening, with broadly declining total returns that have more than halved, from 15.7% in 2013 to 7.6% by 2019.
The key contributor to these declining All Property Total Returns has been slowing capital growth, from a decade high of 6.9% in 2013 to a negative -0.2% by 2019.
The expectation of a deep recession in 2020, along with big recent corrections in both the listed property sector and the bond market, lead to the expectation of significantly greater magnitude of negative capital growth in 2020, and continuing through into 2021 given the slow nature of property value corrections.
Therefore, from the MSCI data estimate of -0.2% negative All Property Capital Growth for 2019, our 2020 projection is for a bigger -5% decline. Further decline in 2021 is possible in lagged response to the deep economic recession of this year. In addition to this year's GDP contraction, actual 2021 GDP level is forecast to remain significantly below that of pre-Covid 2019 levels, with a forecast +0.5% positive growth rate next year insufficient to yet claw back the -4.5% projected to be lost this year.
This year’s negative capital growth rate forecasts would exceed the previous multi-decade low of -3.4% recorded during the 1998 “interest rate shock year”.
Economy-wise, much depends on how the Covid-19 virus spreads both locally and domestically, and when medicines that can aid recovery from it, or vaccines, emerge. The economic environment is thus arguably in territory more uncertain than in many decades, highly-dependent on a virus.
The average All Property Vacancy Rate of MSCI has been rising since the multi-year low of 5.2% reached in 2014, to reach 6.7% by 2019. 2014 was the year where GDP growth dropped to below 2% (recording 1.8%) for the first time since the 2009 contraction, and a further slowing to 1.2% in 2015 appeared to be the catalyst for the start of a rising vacancy rate trend.
It would thus appear that GDP growth battling to reach 1% in recent years has already been insufficient to create the level of property demand required to turn the All Property Vacancy Rate downwards. A -4.5% forecast GDP contraction could thus be expected to speed up the rate of increase in the vacancy rate significantly. This would likely place downward pressure on rental growth, which we would in turn expect to slow nearer to zero than its 2019 +4.1% positive growth rate.
Cap rates in all of the major categories of property had begun to rise mildly in recent times. We would expect to see more of the rising trend, but possibly at a faster rate, given that the vacancy rate increase is likely to speed up, and given the recent sharp weakening in both the bond and listed property markets.
All Property Total Return (based on MSCI historic data including both capital growth and income return) is thus forecast to decline further, from 7.6% in 2019 to 2.6% for 2020. This would be lower than the previous two-decade low of 5.5% recorded in 1998, but we believe that such an expectation is justified given the apparent severity of the unfolding recession this year.