Inside Insights 14 June 2010

Investment Intelligence|Inside Insights

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

Added on 14 June 2010 @ 10:13 AM

Are deficit hawks threatening world recovery?

For the second week in a row, things seemed to be going well on markets until disappointing US economic data on Friday dented sentiment. This time it was retail sales, which fell 1.2% month-on-month in May. Still, most markets ended the week in the green. Earlier in the week, in testimony before Congress, Fed Chairman Bernanke said the US economy was recovering, but was vulnerable to a setback. Therefore interest rates would be kept low, and it would be too early to rein in government spending (fiscal stimulus). However, calls to cut government spending to reduce debt are growing around the world. The leaders of the G20 nations meeting in South Korea last week agreed that “countries with serious fiscal challenges need to accelerate the pace of consolidation.” Germany’s government announced it would cut €80bn in spending by 2014, while ratings agency Fitch warned that the UK faced a “formidable” fiscal challenge, implying that the country could lose its AAA sovereign rating.

While the fears over the long-term sustainability of public debt in the developed world are justified, cutting government spending and raising taxes while these countries’ economies are still fragile is risky. Of course in the case of Greece there was little other option, since Greece had completely lost the confidence of the bond market from which it still had to source a great deal of funding. But for other countries prematurely cutting fiscal stimulus would amount to taking the medicine away before the patient has recovered. This is especially true since interest rates cannot be cut any further – they are already effectively zero.

At least developing countries are doing better. Brazil’s gross domestic product (GDP) grew by 9% in the first quarter (year-on-year). Chinese exports jumped by 48.5% year-on-year in May, well above the expected 32%, despite the turmoil on financial markets. Imports increased 48.3%, confirming that domestic demand remained strong, despite measures to rein in bank lending and property speculation. Equity markets worldwide responded positively to the news, as it eased fears that the eurozone’s debt crisis will impact emerging economies, which had been outpacing the recovery of developed economies. Interestingly, China’s own equity markets responded hesitantly to the news, which suggested that higher interest rates would be inevitable. Shanghai’s Composite Index is now at August 2009 levels.

Business confidence dips

The RMB/BER business confidence index (BCI) fell from 43 to 36 index points in the second quarter of 2010 (with 50 points being the cut-off between net positive and negative responses). However, considering the record 15-point surge in the first quarter, sentiment appears to have consolidated at a more realistic level, in line with the gradual economic recovery and the fact that unemployment remains high in South Africa and abroad. The BCI bottomed out at 23 points in the third quarter of 2009, the lowest point in 12 years, and remains well below the 30-year average of 47. All of the five sub-components of the BCI (new vehicle dealers, wholesalers, retailers, building contractors and manufacturers) declined in the second quarter, but vehicle dealers’ and retailers’ confidence fell fastest, with consumer spending remaining weak due to high unemployment and household debt levels. It also suggests that surging vehicle sales growth seen over the past few months won’t be sustained. Of the five sub-components, confidence among building contractors was the lowest. The sector has been hard hit by the slowdown in the residential property market and the end of World Cup-related construction work.

While the dip in business confidence is not entirely unexpected, production levels are still expanding in the manufacturing and mining sectors, according to new data from StatsSA. Mining output rose modestly by 2.7% year-on-year in April, with higher diamond production was the main contributor. Miing output rose 11% in March. Manufacturing output surprised by rising 8.7% year-on-year in April, after a revised 6.6% rise in March. The market expected 6.9%, in line with the softer PMI readings. While a very encouraging growth number, it should be remembered that April 2009 had more public holidays, making the year-on-year calculation slightly misleading.

The Week Ahead

• Local markets will be closed on Wednesday for the Youth Day public holiday.

• The Bureau for Economic Research releases the second quarter consumer confidence index, sponsored by FNB, on Monday.

• StatsSA releases local retail sales numbers for April on Thursday. Real retail sales showed positive, albeit modest, year-on-year growth in March for the first time in 14 months and this improving trend is expected to continue as household balance sheets recover and inflation falls. High unemployment will continue to be a drag on the consumer recovery, however.

• Global data releases of interest: May inflation numbers from the US and UK; German ZEW investor sentiment index; US May industrial production; US current account data.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights