Inside Insights 19 July 2010

Investment Intelligence|Inside Insights

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

Added on 19 July 2010 @ 1:19 PM

Markets still not convinced

The US corporate results reporting season has had a positive start, with JPMorgan, for instance, reporting an 80% jump in second quarter earnings. However, it seems investors are switching focus to the macroeconomic outlook again, after disappointing economic releases. The minutes of last month’s Federal Open Markets Committee released this week showed that the Fed had cut its forecast for US economic growth in 2010. US reports also indicated that there was a steep decline in manufacturing activity both in New York and mid-Atlantic regions; as well as a significant drop in wholesale prices and soft industrial production in June. US Consumer inflation in June was is at the lowest level since 1966. Many investors fear that the disappointing data releases could possibly suggest that the industrial recovery is rapidly losing momentum, which could add to the deflation threat in the US. The rising risk aversion led to the dollar falling sharply, to two-month lows against a trade-weighted basket of its competitors, and equity also lost ground (interestingly, the JSE did not follow US markets lower). Short-dated US Treasury yields (2-year notes) reached a record low of 0.58%.

However, concerns over the slowing demand in China for metals and other resources, stopped the US dollar from falling further, pushing down the price of copper in London as well as the price of oil to below $75/barrel. Gold advanced on the weaker dollar, though keeping within the narrow range of $1100 - $1250. New data showed that China’s economy grew by 10.3% year-on-year in the second quarter. While still an enviously high rate of growth, it fell below analysts’ expectations of 10.5%, following the first quarter’s 11.9%. This confirms that the Chinese government is successfully cooling the economy. However, the latest inflation numbers show that they might not need to slow economic growth too much; Chinese inflation in June was below expectations of 3.3% year-on-year and only came in at 2.9%.

At least there was some good news out of Europe, easing concerns over the sovereign debt crisis. Last week saw successful bond auctions in Greece, Portugal and Spain, encouraging fresh demand for the euro, which advanced the single currency to a two-month high against the dollar. European banks appear to be looking to tap into the bond markets in the coming weeks in an attempt to secure financing ahead of the all-important release of the stress tests results this week.

Retail recovering

The latest local retail sales numbers show that consumer spending has turned the corner. StatsSA data show that real retail sales grew 4.6% year-on-year in May from a revised 2.6% in April. This was well above the most economists’ expectation of around 3.5%. The build-up to the World Cup would’ve contributed significantly to this number (StatsSA unfortunately does not report separately on vuvuzelas, flags and Bafana T-Shirts!) but the underlying fundamentals of the economy have also improved gradually: the cost of servicing debt has fallen significantly, even though household debt levels remain high, and despite widespread job losses, income growth (for those still in employment) has been generous.

Real retail sales were 0.8% higher in the three months ending May 2010, compared with the three months ending February 2010, and 3.4% higher compared with the three months ending May 2009. The main contributors to the May 2010 figures were household furniture, appliances and equipment which grew by 17.7% over the year, followed by retailers in pharmaceutical and medical goods, cosmetics and toiletries (11.3%) and textiles, clothing, footwear and leather goods (7.5%). Sales of building supply materials were still sluggish, reflecting conditions in the construction sector. Nonetheless, all categories of retailers showed positive year-on-year sales growth, which is certainly encouraging.

The obvious question is what does this mean for interest rates? The Monetary Policy Committee (MPC) meets this week and speculation has risen that another cut in the repo rate might be in the offing. These retail numbers suggest more monetary stimulation of the demand side is probably not necessary, but the Reserve Bank has indicated its concern over the slowdown in the manufacturing sector. It has noted its concern over the situation in Europe, but has similarly warned over the impact of double-digit wage increases, and administered price inflation. It will be a close call.

The Week Ahead

• The Reserve Bank’s MPC meets on Wednesday and Thursday to decide on interest rates. A Bloomberg poll of 18 economists showed that 12 expected no cut, while 6 expect a 50 basis points cut, which would take the repo rate to 6%. The money market is pricing in a 50% chance of a cut.

• Global data releases and events of note this week: Eurozone current account data for May, German inflation data; US construction and existing home sales numbers; the announcement of the results of the European bank stress tests.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights