Inside Insights 18 January 2010

Investment Intelligence|Inside Insights

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

Added on 18 January 2010 @ 10:14 AM

Plenty to ponder

Global equity markets have continued where 2009 left off, by adding marginal gains in the first two weeks of 2010. Just to recap, the Dow Jones gained 22.7% in 2009, the FTSE 100 43% and Frankfurt Dax 30%. Emerging markets were the best performers, with the MSCI Emerging Markets index gaining 79% against the (largely developed market) MSCI World Index's 30.8%. Brazil's Bovespa Index shot the lights out with a 144% return (in US dollars). By comparison, the JSE All Share returned 32% in 2009 (in rands). Still, not many would have predicted that the All Share would start the new year above 28000 points, only about 15% below 2008's dizzy peak of around 33000. Resources were the best performers, but industrials and financials were not too far behind.

As we know, the rally on equity markets was largely a combination of three factors: economic recovery hopes, as the world emerged from its deepest post-War recession yet; better-than-expected corporate earnings as companies had dramatically cut their cost bases; and ultra-low interest rates, which meant that once panic had subsided, investors in the developed world had to look to risky assets to find yield.

So where are we in the first few weeks of 2010? As discussed below, economic recovery is continuing, but unemployment and the fiscal debt hangover cloud the medium term outlook. As for corporate earnings, fourth quarter earnings season in the US got off to a disappointing start, with aluminium producer, Alcoa, missing its profit targets - although Intel's results were impressive. Many analysts worry that equity market valuations have run ahead of earnings. Bad earnings news could lead to a pull-back, giving earnings time to catch up with valuations. Lastly, the big question is when will authorities wind down emergency fiscal support and quantitative easing, and start normalising interest rates? Authorities have to strike a fine balance between allowing their economies to recover, and preventing asset bubbles and inflation. As things stand, they will probably err on the side of the former.

Growth momentum carrying on into 2010

The global economic recovery is continuing, although the pace varies from country to country and sector to sector. Global manufacturing and trade, which fell fastest during the crisis, is leading the way. Purchasing managers' indices from leading economies are still in expansionary territory, i.e. above 50 points. The latest US PMI stood at a healthy 55.8 points. The JP Morgan Global PMI, which covers some three-quarters of world industrial output, is also around that level. The great inventory correction has come to an end as firms are running out of stock to sell. Even with demand still sluggish, stocks have to be rebuilt which is good news for factories. Consumer spending is picking up, but at a more moderate pace, with unemployment and household debt acting as a drag. US retail sales, for instance, rose by 5.4% year-on-year in December. Unemployment in the world's largest economy has stabilised at 10%, but even this harsh number does not count the millions who have given up actively searching for work.

The picture is similar in Europe, but obviously with differences from country to country. Industrial powerhouse Germany, whose economy shrank a record 5% in 2009, is recovering, but Spain's massive burst housing bubble will drag on economic growth for years to come. Greece's public finances are in shambles. The UK has still to exit recession officially, but things are looking better.

Japan, the world's second largest economy, is still in deflationary territory, and its monetary authorities are embarking on fresh stimulus efforts. China is racing ahead, so much so that the central bank has raised banks' reserve requirements to slow lending growth. GDP growth of 10% for this year is still expected, which should be supportive of commodity prices.

The latest data from the local economy are also encouraging, but hardly worthy of too much excitement. The pace of decline in manufacturing production continued to slow in November, with output growing -4.6% year-on-year. Export-orientated sectors fared better than those sectors catering for domestic demand. This despite the strong rand and because the local consumer is still very shy to spend. The decline in mining production also moderated to -1.5% year-on-year.

The Week Ahead

The Kagiso purchasing managers' index for December will be released on Monday. The index, which is an indicator of future business activity in the local manufacturing sector, moved above the 50 points level in November for the first time in 18 months. 50 index points is the dividing line between contraction and expansion in the manufacturing sector. This supports the notion that conditions on the ground are improving, even if tentatively so. The PMI is expected to remain above 50 in the months ahead, although the December figure itself could be slightly disappointing due to the annual slowdown in business activity during the month.

StatsSA will release retail sales figures for November 2009 on Tuesday. Unlike in the manufacturing sector, there has been little sign of improvement in retail sales, with real sales growth in October slumping to -6.5% year-on-year from -4.9% the month before. With unemployment still rising and household debt levels remaining high, the 500 basis points reduction in the repo rate since December 2008 has not yet stimulated spending in any significant manner and the festive season is likely to have been disappointing for many retailers. This boost will eventually be felt, though, and analysts are expecting retail sales growth to move into positive territory towards the second quarter. Consumers will also benefit from the continued decline in inflation.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights