Inside Insights 17 August 2009

Investment Intelligence|Inside Insights

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

Added on 17 August 2009 @ 3:34 PM

MPC fires surprise salvo

The Reserve Bank's Monetary Policy Committee surprised markets last week by cutting the repo rate by 50 basis points to 7%. Only 3 out of 26 economists polled by Reuters expected the move. In its statement the MPC argued that the South African economy was lagging behind the "encouraging signs that the global slowdown may have reached its lower turning point." The statement also acknowledged risks to the inflation outlook from higher oil prices, generous wage settlements and electricity tariff increases.

Perhaps we should not be so surprised by the MPC's move. A string of data released during the week - along with the previous week's poor PMI and new vehicle sales data - confirmed the weak state of the local economy. Mining production declined 7.3% year-on-year in June. Manufacturing production fell 17.1% year-on-year in June, following a similar 17.2% (revised) decline in May. The manufacturing sector, the country's second largest, remains under severe pressure as confirmed by the latest PMI numbers (discussed last week) even as global manufacturing is stabilising. All ten manufacturing subcategories measured by StatsSA declined in June.

The strong rand - still hovering slightly above R8/$ - has been hurting the competitiveness of exporting firms, while firms who rely on imported machinery have not been making use of the stronger rand to invest in production capacity. A separate StatsSA report showed that manufacturing capacity was already 22% underutilised in May, with insufficient demand the main reason. So firms have no incentive to invest in further capacity, with so much capacity laying idle, which is bad for the medium-term economic growth outlook. Real retail sales also fell, by 6.7% year-on-year in June after a 4% (revised) fall in May, showing the continued strain faced by South African households due to high levels of debt and rising unemployment, despite the fact that interest rates had been lowered significantly (now 500 basis points in total since December).

Markets hit a brick wall on Friday

Global equity markets had a slow start to the week, consolidating after a strong run over the previous four weeks. This is not necessarily a bad thing, as several commentators have become worried that the market ran too hard, too fast. Investors were cautious ahead of the conclusion of the Federal Open Market Committee (the US's interest rate decision-making body) and because of new negative economic data. The US Treasury also warned of the continued threat of toxic assets to banks' balance sheets, particularly smaller banks facing rising losses. The combination of the above dampened global risk appetite. Things improved mid-week, however, when the US Fed announced in its clearest statement to date that the recession is stabilizing and that the worst is behind us, thanks to the impact of aggressive fiscal and monetary policies. More good news came from Euro-zone second quarter GDP results, which fell a modest 0.1% quarter-on-quarter, which was much better than market expectations and far better than the Q1 record decline of 2.5%. Germany, the biggest Euro-zone economy, and France, both surprised with a quarterly GDP increase of 0.3%. Better-than-expected earnings from companies such as Macy's and Wal-Mart further fueled risk appetite.

Everything seemed to be going well on Friday too, before the release of bearish US consumer confidence numbers caused market boards to go red. The JSE immediately swung into negative territory, ending the week down -1%, after having earlier shrugged off both the interest rate cut and the onslaught of weak local economic data. The rand was also largely unaffected by the rate cut, as the interest rate gap remains high with interest rates at virtually zero in developed markets and the flood of liquidity created by central banks in these countries finding their way into riskier assets, such as emerging markets. Global risk appetite thus continues to drive the rand's fortunes.

The Week Ahead

South Africa's second quarter gross domestic product (GDP) data will be released on Tuesday. The GDP growth rate (quarter-on-quarter, seasonally adjusted and annualised rate) plunged to -6.4% in the first quarter. The second quarter's growth rate is also likely to be negative (for the third consecutive quarter), but not as bad. Following the release of mining, retail and manufacturing data for June, the consensus forecast for the quarterly GDP growth rate is -3%, although the range of forecasts polled by Inet was from -1.8% to -4%. Despite the year-on-year fall in June, mining production rose 4.5% on a quarter-on-quarter basis in 2009/Q2, suggesting a possible positive contribution to GDP. Retail sales, however, were down 6% on a quarter-on-quarter basis in the three months to June, while manufacturing will also detract from second quarter GDP growth. Most economists polled by Inet believed that South Africa would return to positive growth in the second half of this year.

Fairbairn Capital | Old Mutual

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