Market Wrap April 2010

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Added on 05 May 2010 @ 12:40 PM

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Two themes dominated global markets during the month of April: US corporate earnings and the Greece debt crisis. On the former, major US-listed corporates released earnings results for the first quarter, during the so-called ‘earnings season.’ For the most part, the results have been encouraging with companies reporting not only forecast-beating profits (which can be achieved with drastic cost cuts) but also top-line growth in sales and revenues, pointing to a healthier economy. Indeed, US gross domestic product (GDP) grew 3.2% in the first quarter (while the headline number was slightly below expectations, the data also showed an improved showing from consumers). The Federal Reserve’s Open Markets Committee also noted the improving economic situation, even as it voted to keep interest rates low ‘for an extended period’. The Dow Jones Industrial Index ended the month up 1.5%, breaking through the psychologically important 11,000 points level, with the broader S&P 500 index improving 1.6%.

The other theme was the Greece debt drama, which really came to a head in April when the eurozone’s official statistical authority announced that Greece’s budget deficit position was worse than thought due to accounting irregularities, and was actually 13.6% of GDP. The debt to GDP ratio was also worse than previously thought. A week later, ratings agency Standard & Poor’s cut Greece’s sovereign rating by three notches to what is known as ‘junk status.’ In other words, Greece’s government is now viewed as a more risky debtor than most companies (even though governments can raise taxes to pay creditors) and several emerging markets (including SA). Portugal’s rating was also cut by two levels, as was Spain’s by one, leading investors to worry whether these countries would be able to service bonds or roll over their debts. Greece alone has a €300bn debt pile. The bond market punished Greece, temporarily pushing 2-year yields above 20%, and 10-year yields above 10%, worried that it would not be able to meet its repayment obligations. Such a default would have serious consequences for those banks across Europe (particularly in Germany) that hold Greek debt. Little wonder then that the euro remained under severe pressure against the US dollar during the month.

The market’s nerves were soothed when Greece, the International Monetary Fund and the eurozone countries signed the dotted line on an assistance package that will see the beleaguered Mediterranean nation access €110bn in loans, while making a further €30bn in spending cuts. Questions remain, though, and the debt saga is by no means behind us. For one thing, the Greek economy continues to shrink and the austerity measures will only increase the deflationary pressure, meaning lower tax revenues and worsening debt ratios. For another, even if Greece can be successfully bailed out, what about Portugal? Spain is the eurozone’s third largest economy and is almost certainly too big to bail out if its fiscal situation ever worsened to the extent that it could not meet its debt obligations. While this could contribute to considerable market uncertainty over the coming months, long-term South Africa should benefit if capital flows away from highly indebted, slow-growing developed economies to more dynamic emerging markets with healthier public balance sheets.

The global market jitters spilled over to the JSE, particularly the (non-gold) resource sector. Bonds outperformed cash in April for the third consecutive month supported by foreign inflows, an ongoing strong rand, lower trending inflation and the (apparently) more accommodating monetary policy stance of the Reserve Bank. On the graph below, a lower value indicates a stronger rand. The graph also shows how the JSE followed its New York-based counterpart in lock step over the last year. The question on everyone’s lips remains: Have equity markets run ahead of fundamentals? Those who answer ‘yes’ will not mind a period of sideways movement, giving earnings a chance to catch up and PE ratios to normalise.

In terms of the South African economy, high-frequency data released during the month was mixed. The local Kagiso purchasing managers’ index (PMI) fell to 55.6 in March from February’s strong showing of 60.4 (a level above 50 points to expansion). But, as the BER, the compilers of the survey, points out, the PMI averaged 56.5 during the first quarter of 2010, the best quarterly showing since early 2007. February retail sales numbers disappointed with a -1.5% year-on-year reading, unchanged from January’s revised -1.5%. The market expected a modest positive year-on-year number of 0.6% following many months of contracting. The weak retail numbers reflect ongoing high unemployment (with close to 900,000 jobs lost last year) and high levels of household indebtedness (the household debt-to-disposable income was 79.8% in Q42009). Credit extension, which continued to contract in March for the sixth month in a row, was also a factor. There were no inflation surprises, with consumer inflation (CPI) in March slowing to 5.1% year-on-year from 5.7% in February, driven by slowing food inflation and the stronger rand, and moving squarely within the Reserve Bank’s 3% - 6% inflation target. However, comments from Reserve Bank Governor Gil Marcus that “the scope for further easing is limited” dampened hopes for a further cut.

Fairbairn Capital | Old Mutual

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Market Wrap April 2010

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