Inside Insights 18 April 2011

Investment Intelligence|Inside Insights

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

Added on 18 April 2011 @ 11:38 AM

INFLATION AND DEFAULT RISK STILL HIGH

If anyone thought that Portugal's recent bail-out would solve the eurozone debt crisis, they were being optimistic. For one thing, Portugal still needs to elect a new government need to negotiate the terms of the bail-out. Greek and Portuguese bond yields spiked to record levels last week, when measured against benchmark German bonds. The more the market is concerned about a country's creditworthiness, the higher the yields on their bonds rise. But highly-indebted countries also need to constantly roll over debt, and the higher the yields, the more expensive it becomes to do so. No wonder Portugal's yields are now higher than on similarly dated South African bonds, (explaining why foreign investors find our bonds so attractive: South Africa's budget deficit and debt as a percentage of GDP are more than half than that of Portugal). The good news is that there is no sign yet of Spain's borrow costs rising. Meanwhile, Irish government bonds were downgraded by ratings agency Moody's. Moody's said Ireland needed more austerity (less government spending and higher taxes) to prevent a further downgrade, but also warned that a weak economy would lead to downgrades. Talk about being stuck between a rock and a hard place: the more the government cuts back, the more the economy is likely to falter.

Fortunately, not everyone has the same problem. China's economy continues to grow at a blistering pace, expanding by 9.7% in the first quarter compared to the first quarter of 2010. However, with a fast-growing economy inflationary pressures are never far behind. Consumer inflation rose 5.4% year-on-year in March, up from 4.9%. This increases the likelihood of higher interest rates, which in turn could lead to reduced demand for commodities.

With the first batch of US corporate earnings releases rather disappointing, there was little for markets to get excited about, so profit-taking was the order of the day.

IMF: THE GOOD, THE BAD AND THE UGLY

The International Monetary Fund's (IMF) latest set of economic projections paint a picture of a world that is steadily but unevenly recovering from the recession of 2008/09, but remains beset with risks on many sides. The global economy is expected to expand in real terms by 4.4% in 2011 and 4.5% in 2012.This is slightly lower than in 2010 when the initial post-recession manufacturing-lead rebound took place, but is expected to be broader-based. Developed countries are expected to grow by only 2.4% and 2.6%, while emerging economies are expected to grow by 6.5% this year and the next.

The IMF is particularly concerned over unemployment in developed countries, as well as the recent surge in oil and food prices. However, it believes that oil prices will not have a significant effect on global growth and inflation, provided they don't rise substantially from current levels. Food prices are expected to stabilise as output is increased to benefit from the high prices. Inflation is a bigger risk to emerging countries whose economies are growing fast and where wages are rising and spare capacity is limited. Food and fuel also make out a bigger part of inflation baskets in these countries.

For South Africa, the IMF forecast growth of 3.5% in 2011 and 3.8% in 2012. This is well below the expected growth rates of neighbours Botswana (6% and 6.6%) and Namibia (4.8% and 4.5%). Sub-Saharan Africa as a region should continue to gather growth momentum, supported by high commodity prices and improved domestic economic policies. The IMF noted that, because SA's projected growth is below potential (the ‘output gap' remains wide), interest rates should be kept low. This is because consumer demand remains subdued due to high debt levels and high unemployment, while business investment is constrained by excess capacity.

THE WEEK AHEAD

• Statistics South Africa releases March consumer inflation numbers on Wednesday. CPI annual inflation was flat in February at 3.7%, but is expected to have quickened to 4% in March due partly to higher petrol prices. Food prices have also risen this year, after being a key contributor to lower inflation in 2010.

• StatsSA also releases key February retail sales on Wednesday. Retail sales are expected to have increased in real, year-on-year terms in February to 7.1%, from January's 6.4%. Consumers continue to enjoy the fruits of lower interest rates and disposable income growth (for those with jobs). However, high levels of household debt, rising fuel and electricity prices, as well as a lack of strong growth in employment will continue to keep consumer spending at lower levels than was the case at similar points in the previous cycle.

• Markets in many parts of the world, including South Africa, will be closed for Good Friday.

• Global events and data releases of note this week: US NAHB Homebuilders index for April and March housing starts and existing home sales; eurozone April consumer confidence; Japan March consumer confidence and machine tool orders; Germany's Ifo survey for April.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights