Inside Insights 15 February 2010

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

Added on 15 February 2010 @ 9:59 AM

Greece lightning

Greece's debt woes continued to dominate market news this week. Greece needs to raise about €53bn this year to finance its deficit, and much of this financing will need to be found by April. The total debt burden is expected to grow to €290bn by year end - 120% of GDP. If Greece defaults on its debt payments, Spain, Portugal, Italy and Ireland could be next; European banks would face massive losses.

The European Union (EU) held a crucial summit on Thursday to address Greece's debt situation. The leaders of the 27-nation bloc reaffirmed their commitment to safeguarding the stability of the eurozone and their willingness to assist Greece. However, the lack of a detailed immediate response to the debt crisis disappointed investors and led to a sell-off in equities and bonds. The lack of concrete plans to address the situation resulted in the euro extending its losses to a nine-month low of $1.36/€. The euro certainly was not helped by disappointing fourth quarter GDP results from the eurozone. The 16 eurozone economies' collective GDP grew by only 0.1% in the fourth quarter, compared to 0.4% in Q3 and less than the expected 0.3%; overall GDP fell by 4% in 2009. Europe's largest economy, Germany did not grow during the quarter (0.2% was expected), while France grew by only 0.6%. Greece shrank by 0.8%.

The rand typically tracks the euro against the US dollar, depreciating sharply when investors flee towards the perceived safety of the greenback (as the graph shows). What is interesting is how little the rand has moved over the past month or so even as the dollar strengthened substantially. The rand weakened somewhat, but remains below the key R7.76/$ level, suggesting there is still appetite for the local currency and that investors are still comfortable with our economic policies. The lesson from the Greece debacle for SA is clear though: government borrowing needs to be kept at sustainable levels. The bond market will hope that Minister Gordhan heeds this message when he delivers the budget on Wednesday.

Rand-dollar and dollar-euro exchange rates

Manufacturing recovery

The positive numbers from the PMI survey over the past few months has finally been reflected in output data. Manufacturing production grew by 3.2% year-on-year in December, the first positive annual growth rate in 15 months. Production rose 3.3% quarter-on-quarter in the fourth quarter of 2009, suggesting another positive contribution to Q4 2009 gross domestic product (GDP). (The manufacturing sector contributes about 14% to GDP, a percentage that has steadily declined over the past number of years). The largest positive contributor was the motor vehicles and parts category (34.6% year-on-year growth) on the back of a global recovery in the auto sector. Basic iron and steel (9.9%) also made a positive contribution. However, domestic consumer demand due to high unemployment and household indebtedness is still weak: furniture goods fell 7.8%; textiles, clothing and footwear fell 13.0%. Also worrying was that the electrical machinery category had another negative month (-4.9%), suggesting weak demand for capital equipment as firms limit expansion plans and continue to cut costs. Thus, while the economy is recovering, the medium term growth outlook is muted.

The contraction in local mining production continued in December, with output falling 2.5% year-on-year after falling by 1.5% year-on-year in November. The mining sector has been experiencing a downtrend since mid-2007, hobbled by electricity supply problems, strikes and safety issues, the move of older gold mines towards marginal status and of course the impact of a stronger rand. The biggest detractors from growth in the mining sector came from year-on-year declines in gold, coal and copper, which together make up 44% of the total mining production index. Gold output fell 8.8% despite the dollar gold price remaining above $1000/oz. Despite the negative December figures, mining production was 0.9% higher in the final quarter of 2009 compared to the third quarter (after the 5.8% quarter-on-quarter fall in Q3 2009). This suggests that the mining sector is also likely to make a positive contribution to GDP in Q4 2009. The mining sector contributes roughly 5% of total GDP, and is expected to recover off a low base in 2010, supported by firmer commodity prices and the recovery in the global economy.

The Week Ahead

All eyes locally will be on finance minister Pravin Gordhan, as he delivers the Budget Speech on Wednesday. Because of the large 2009/10 budget deficit (around 7.8% of GDP with an estimated R75bn revenue shortfall due to the weak economy), unexpectedly big tax relief on the scale we saw last year is extremely unlikely. At best lower income earners could get a moderate upward adjustment to tax brackets to compensate for inflationary "bracket creep". The bond market will want a clear commitment from Gordhan to reduce the deficit over the next few years, especially given the global nerves around sovereign debt issues. Because the economy seems to rebounding stronger than Treasury's expectations (they projected 1.5% in 2010; the market expects closer to 3%), the deficit could be smaller than the -6.4% projected for the 2010/11 fiscal year, which would be very well received.

European finance ministers will meet in Brussels on Monday and Tuesday to iron out the details of a plan to support Greece. After the vague promises made by Europe's heads of state (see above), he market will be anxious for concrete plans to emerge.

StatsSA will release real retail sales data for December on Wednesday. Year-on-year growth in real retail sales has been negative every month since February 2009, and unfortunately there has been very little by way of a discernable improving trend, although at least there isn't a worsening trend either. Sales growth was -6.6% in November and -6.1% in October, emphasizing the tremendous pressure on household finances due to high inflation, unemployment, debt and lower variable income (overtime, bonuses and commissions). However, the impact of the interest rate cutting cycle, which started in December 2008, typically works with a lag of at least 12 months. This means the benefit of lower interest rates should start appearing in the data. Also, with consumer inflation now on a much lower trajectory, real incomes can start catching up, which will boost spending.

The local earnings season is now in full swing, with Afrox, Kumba, Grindrod, Italtile, Woolworths, Truworths, Absa and Hulamin presenting annual results to shareholders this week.

The Federal Reserve and Bank of England will release the minutes from their recent respective monetary policy-setting meetings.

Fairbairn Capital | Old Mutual

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