Inside Insights 1 February 2010

Investment Intelligence|Inside Insights

A weekly, in-depth yet concise report on the most important recent market movements and economic developments.

Added on 01 February 2010 @ 9:30 AM

Plagued with doubt

It seems as if the nagging doubts over the astonishing post-crisis recovery on global equity markets have finally caught up with us. Risk aversion was stoked by the same set of issues as in preceding weeks. Leaders at the World Economic Forum (WEF) slammed China's monetary polices, warning that the Chinese economy is overheating due to high levels of liquidity, while the fixing of the renminbi against a weak US dollar is giving China an unfair trade advantage. This added to uncertainty as investors are already concerned that China would tighten its easy monetary polices too soon and too aggressively. Furthermore, leaders at the WEF predictably attacked banks on their excessive bonus payouts and threatened stricter regulations. This weighed on bank shares, as several banks are still battling to return to normality. Several large companies also reported earnings below expectations. Finally, fears that the government of Greece could default on its debt payments haven't gone away. In the process, global share prices fell back to November 2009 levels, while the US dollar rose to a 5-month high against a basket of major currencies, depressing commodity prices.

On the plus side, investors took some comfort from the lack of emphasis on banking and healthcare reforms in President Barack Obama's first State of the Union address. Instead, his speech focused on job creation and economic growth, which was well-received. Furthermore, the US Federal Reserve kept its expansionary monetary policy in place to aid economic recovery - these policies are supportive of equity prices. New data also showed that US GDP rebounded strongly by 5.7% during the fourth quarter of 2009 (the consensus expectation was 4.6%). At the end of another volatile week on world markets, the rand traded at R7.54/$, while the FTSE/JSE All Share index was 1.6% down at 26618. The S&P 500 lost 1.1% during the week, while the MSCI Emerging markets index was down 3.1% in dollar terms.

MPC leaves door open

As expected, SARB's Monetary Policy Committee left the repo rate unchanged at 7% (with prime at 10.5%), although the outcome was apparently hotly debated in the Committee. The inflation outlook did not change since the previous meeting, and the MPC expects CPI to return to the 3% - 6% target range in March 2010. The key issue, though, is that the MPC's forecast is based on electricity tariff increases of 25% per year for the next three years. Eskom has applied for 35% per year. Governor Marcus noted her concern that increases larger than 25% would have a large direct impact and also result in second round effects, pushing inflation above the Reserve Bank's forecast with potentially negative consequences for interest rates. Conversely, increases lower than 25% would open the door for a further cut, given that the MPC is otherwise comfortable with the inflation outlook: the rand is still strong, credit growth is negative and consumer demand remains very weak. Put differently, if we are to see accelerating inflation, it will not be demand-pull but cost-push inflation. The Bank expects the South African economy to grow by 2% in 2010 and 3% in 2011, meaning that it would take some time before pre-recession levels of economic output are reached.

StatsSA released December inflation numbers after the MPC meeting, but the numbers were in line with expectations. In fact, year-on-year growth in CPI was marginally below the 6.4% expected, coming in at 6.3%. CPI inflation was 5.9% in October and 5.8% in November. The increase was largely due to the low statistical base created by the substantial petrol price cut in December 2008. Producer inflation, as measured by year-on-year changes in the producer price index (PPI) also picked up to 0.7% in December, after seven months of declines. This was also largely due to the base effect created by very low commodity prices in December 2008, as well as higher electricity prices.

Finally, according to data released by the Reserve Bank on Friday, annual credit growth contracted for the third consecutive month in December, due to the ongoing weakness in domestic demand. Coming in at -0.76%, however, it was better than November's -1.59%, suggesting the contraction might have bottomed out.

The Week Ahead

The Kagiso purchasing managers' index (PMI) for January will be released on Monday. The index, which is an indicator of future business activity in the local manufacturing sector, moved above the 50 points level in November for the first time in 18 months. 50 index points is the dividing line between contraction and expansion in the manufacturing sector. The index then improved to 52.5 points in December, supporting the notion that conditions on the ground are improving.

Industry body NAAMSA will release new vehicle sales data for January on Tuesday. New vehicle sales growth fell back in December, to -13.1% year-on-year from -12.2% in November. This was largely due to a decline in the growth of passenger vehicles; although still negative on a year-on-year basis, commercial vehicle sales showed a significant improvement from November to December. This is confirms the notion that the supply side of the economy is recovering, while the demand side continues to falter.

Fuel prices will increase at midnight on Wednesday, so remember to fill up before then. Due to higher international petroleum prices between 31 December and 28 January, the retail price of petrol will rise by 18c/l while diesel will be 10c/l more expensive. Fortunately, the rand strengthened during the measurement period, taking some of the pain away for local motorists. The rand dollar exchange rate averaged 7.47 compared to 7.52 in the previous period.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights