Inside Insights 17 May 2010

Investment Intelligence|Inside Insights

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

Added on 17 May 2010 @ 11:26 AM

PIIGS might just fly

Following hours of negotiations, leaders of the European Union announced a €750bn ‘shock and awe’ package at 2 a.m. on Monday morning to protect the highly indebted members of the eurozone (the so-called PIIGS countries) from economic meltdown. The €750bn will be two-thirds funded by the eurozone countries and one-third by the IMF. The first component is a €60bn ‘rapid reaction stabilisation fund’. The remaining €440bn of the eurozone’s share will be raised through a special purpose vehicle and will be disbursed along the same lines as the package to Greece, i.e. a combination of bilateral loans and austerity measures on the part of recipients. Significantly, the European Central Bank also announced that it would start buying eurozone government bonds on the market in an attempt to stabilise yields and inject liquidity. The ECB also reopened swap lines with the US Federal Reserve to provide dollar-based funding for European banks. When markets opened later that morning, the reaction was emphatic; most major indices bounced between 3% and 5% (France’s CAC 40 jumped 10%). But much of the movement might simply have been short-covering (i.e. traders who had been betting on a falling market had to scramble to close their positions), because by Tuesday the euphoria dissipated. Sceptics started wondering once again how a problem of too much debt can be solved by creating more debt. The painful process of paying off this debt, they argue, has to happen, whether now or later.

Perhaps this realisation pushed the dollar gold price to an all-time record high of $1249/$. The euro, which bounced on the news of the package, fell back in the subsequent days and was trading at 14-month lows again at the end of the week. The rand, it should be noted, strengthened against the dollar, and significantly against the euro.

Some good news for the eurozone – finally – came by way of gross domestic product data that showed 0.2% quarter-on-quarter growth rate for the 16 countries that use the euro currency. While low, this growth rate is up from 0% the previous quarter. Only Cyprus and Greece are still mired in recession; Italy, Portugal and Spain have returned to growth (however, their modest growth rates reduce scope for debt reduction). Across the Atlantic, key US data releases also pointed to ongoing economic recovery: retail sales rose 0.4% in April, while business inventories increased in March. As we said previously, even though markets remain volatile, the fact remains that the world’s real (as opposed to financial) economy is getting healthier by the day.

Manufacturing, mining, MPC

There were no surprises from the Monetary Policy Committee meeting, with the repo rate left unchanged at 6.5%. The Reserve Bank’s inflation forecast was revised downwards slightly, with headline inflation (CPI) expected to bottom at 4.7% (from 4.9% at the previous MPC meeting in March). While the MPC views the local and global economic environment as being more favourable, it did not expect demand to lead to inflationary pressures (SA GDP growth expected at 2.7% for 2010). However, it highlighted the risks posed by administered price increases, such as electricity and water tariffs. The MPC also emphasised the risk of the eurozone debt crisis to the global environment (not least to exchange rate volatility). Against the backdrop of such uncertainty, the MPC’s decision was sensible. The repo rate is 45% lower than 18 months ago, and is likely to remain low until well into 2011, providing plenty of support to the economy.

Manufacturing production grew 6.3% year-on-year in March, up from February’s 2.7%. On a quarter-on-quarter basis, production rose 4.3% in the first quarter compared to the fourth quarter of last year. According to StatsSA, March’s number was boosted by a 24.3% year-on-year increase in the production of motor vehicles and parts, in line with the recent strong new vehicle sales data. Mining production rose even stronger. Output rose by 11% year-on-year in March, after a revised increase of 6.6% in February. Despite the record gold price, gold output declined again by -12%, but increasing global demand for industrial commodities, especially platinum, supported non-gold output growth of 15%. Over the first quarter, mining output increased 6.6%. Given that mining and manufacturing together account for about a fifth of total economic output, the first quarter GDP growth number could be quite healthy.

The Week Ahead

• StatsSA releases retail sales data for March will be released on Wednesday, which will give a very good indication of the strength of consumer demand in the economy. February retail sales contracted unexpectedly by 1.5% year-on-year in after-inflation (real) terms, due to high levels of unemployment and household debt. It is expected that retail sales will have moved into positive territory in March, but only marginally so.

• StatsSA also releases building plans passed data for March, an important leading indicator of construction activity.

• The Reserve Bank releases its bi-annual Monetary Policy Review on Thursday.

• Important global data releases this week include: US leading indicator; April US housing starts; April inflation data for the eurozone, US and UK; results of Germany’s ZEW and Ifo economic confidence surveys; and Japan’s first quarter GDP numbers.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights