Inside Insights 11 May 2009

Investment Intelligence|Inside Insights

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

Added on 11 May 2009 @ 12:00 AM

Risk appetite continues to improve

Global risk appetite continues to improve, in the process driving equities and emerging market currencies (such as the rand) higher and emerging market bond spreads lower. The US government's stress tests revealed that 10 out of the 19 largest banks would have to raise additional capital to the tune of $74.6 billion between them. However, none of the banks face insolvency. Questions remain about the rigour of the tests and it is also not entirely useful having well-capitalised banks, if they aren't lending. But for the time being a major source of uncertainty has been removed. By the end of the week, the Nikkei soared to 6-month high levels while the S&P 500 traded above 900 for the first time in 2009. To further fuel the rally, the US Pending Home Sales Index, based on contracts signed in March, rose 3.2% as first-time buyers entered the market to take advantage of favourable prices and mortgage rates, suggesting that US home sales are beginning to bottom out. More good news came in the form of US construction spending edging 0.3% higher in March - the first increase in 6 months while the pace of private-sector U.S. job losses and future planned layoffs slowed dramatically last month (8.9% vs. 8.5% in March) showing signs that the worst may be over. Historically, the peak in US unemployment has coincided with the end of the recession. In another sign that the fear of Depression-style deflation is receding, US long-bond yields have increased to 5 month-highs, pointing to less safe-haven demand and perhaps worries of future inflation as the US government goes on a borrowing spree.

However, in the meantime authorities are not sitting still. The European Central Bank cut its key lending rate to 1%, a record low and also announced plans to purchase assets to push down borrowing costs ( i.e. quantitative easing). The Bank of England also announced an unexpected expanded asset purchase program, but kept its policy interest rate steady at 0.5%.

Local economy continues to splutter

As far as the local economy is concerned, the news out this week was fairly bleak. Vehicle sales have gone from bad to worse. Weak demand and a lack of available credit resulted in April new vehicle sales falling 43% year-on-year, although it needs to be borne in mind that due to public holidays April 2009 had fewer work-days. The Investec Purchasing Managers' Index (PMI) fell to record low levels for the third month in row. Optimists will compare April's 35.6 to March's 36 and point out that the pace of decline is slowing (interpretation of a lot of the global economic data coming out now depends on whether one is a glass-half-empty or glass-half-full kind of person). The PMI points to future activity in the manufacturing sector, and a level below 50 implies the sector is contracting. The ongoing weakness in the manufacturing sector is one reason why one would expect the Reserve Bank to cut interest rates at its next few MPC meetings though not necessarily 100 basis points at a time. It also poses questions around the Reserve Bank's foreign currency purchase strategy. As we pointed out last week, a stronger currency hurts export competitiveness, so one might've expected the Bank to intervene in forex markets to weaken the rand a bit, though it must be said they have historically not been keen on the idea. The Bank purchased $106m during April, not enough to weaken the rand. Overall the Bank's net foreign reserves (including gold reserves) are only enough to cover five months of imports. Combined with the high current account deficit, the low levels of reserves increases the perception of the rand as a risky currency. Another way to help the rand gradually weaken is to cut interest rates so that the interest differential between SA and its trading partners narrows to a point where it forces foreign investors to look elsewhere.

Fairbairn Capital | Old Mutual

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