Inside Insights 18 Oct 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 October 2010 @ 12:49 PM

Rally continues

As the equity rally of the last five weeks continued, the JSE's All Share index broke through the psychologically important 30,000 points level last week, a feat last achieved in 2008. The rand also strengthened to a 33-month record. Again, and somewhat ironically, the catalyst is the view that the economic recovery in America is fast losing steam. This was confirmed in the minutes of the meeting of Federal Reserve's monetary committee, which were released last week. Because of the risk of a fading recovery, with unemployment still high and inflation falling, the probability has increased that the FederalReserve might engage in another round of unconventional monetary easing. At the same time, interest rates,the conventional monetary policy tool, will remain close to zero for an extended period. This has had three broad but inter-related consequences. Firstly, low interest rates in the US (and Europe and Japan) mean low-risk capital is flowing to places - like South Africa - where interest rates and yields are higher. Secondly, investors are abandoning the dollar for fear that the Fed's money creation efforts will reduce the value of the dollar. In fact many are arguing that the US authorities will attempt to deliberately weaken the dollar to support US exporters. So in what is somewhat of a self-fulfilling prophecy, the dollar has been sold-off falling to $1.41/€, while gold surged to fresh record highs. Thirdly, the liquidity created by central banks has to go somewhere, and at least some of it is ending up in riskier assets, such as equities and commodities, particularly because the alternatives are so unattractive with interest rates so low.

Other factors have also been influencing the local equity market; including the interest foreign multinationals have shown in some of our local JSE-listed companies (though HSBC has ended talks on buying Nedbank). Lower inflation and interest rates have benefited consumer and retail shares, with the JSE Industrials index at an all-time high. The resource sector has been held back by the strong rand, despite the strong performance of global commodity prices. The JSE Resources Index remains well below its all-time highs reached in mid-2008.

Momentum loss in retail and manufacturing

Manufacturing production growth disappointed in August, according to the latest data from StatsSA. After growing by a revised 7.2% year-on-year in July, output from South Africa's second largest economic sector only grew by 5.3% in August compared to the same month last year. August production levels were 3.5% lower than July's. Augusts' purchasing managers' index (PMI) increased slightly to 50 points, and most economists expected the annual growth rate to be significantly higher than the eventual reading was. The reasons for this include the strength of the rand, which is hurting exporters; softer global growth; low levels of fixed investment spending locally; and strike action in the motor industry. The strike action will also impact September's numbers. The base effect will also contribute to lower growth in the coming months: production levels recovered towards the end of last year, so year-on-year growth number should be lower.

StatsSA provided a health-check on another key economic sector. Year-on-year growth in real retail sales also slowed in August following the Word Cup-related bursts of activity in June and July. Sales were only 4.5% higher compared to August 2009, whereas July's year-on-year growth rate was 8%. Economists expected 8.5%, almost double the actual figure. The public sector strike probably played a large role in keeping consumers' wallets in their pockets, and on the whole outlook for the retail sector is better than for the manufacturing sector as lower inflation and interest rates and decent wage increases should support household spending. Nevertheless, with both these important data releases disappointing, speculation over a further interest rate cut in November or January will hot up. A new report from the Reserve Bank out last week hinted that further policy easing could be on the cards due to the deteriorating global and domestic economic conditions, benign local inflation, and rand strength.

The Week Ahead

• It will be a quiet week in terms of local data releases. StatsSA releases building statistics for August on Wednesday.

• Global events and data releases of note this week: US industrial production and housing starts for September; eurozone current account balance for August; China releases third quarter GDP and CPI, industrial production and retail sales for September; the finance ministers and central bank governors of the G20 countries will meet in Seoul where discussions will resolve around rebalancing the global economy and, indirectly, currency volatility.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights