Inside Insights 23 Aug 2010

Investment Intelligence|Inside Insights

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

Added on 23 August 2010 @ 10:17 AM

Bonds or shares?

Global share prices faced more headwinds last week, while investors continued to reach for the perceived safety of bonds and gold. Fears over weak economic growth in the US persist, fuelled by new data showing a large decline in manufacturing in the mid-Atlantic region and a rise in weekly initial unemployment claims to 500,000, the highest level in 9 months. US equities fell to their lowest levels in almost a month, exacerbated by low trading volumes due to the northern hemisphere summer holidays. Gold has climbed to its highest level in seven weeks, reaching $1,237/oz., while risk aversion also pushed the yield on the 2-year US treasury down to fresh record lows (bond prices and yields move in opposite directions). German, Japanese and UK government bond yields also moved lower (as did SA yields, as the flood of yield-seeking foreign capital continues). The bond markets of developed countries seem to be betting on very low inflation or even deflation. Most bonds do well when inflation is falling, as coupon payments are fixed; when the economy is in deflation, the real return from bonds increases. Equities on the other hand will probably give a poor return in a deflationary economy. Thus global bond and equity markets seem to believe different things, to the extent that equities have not fallen quite as much as bonds have risen.

In another notable development, Japan's disappointing second quarter gross domestic product (GDP) growth number - 0.1% - means that China is now the world's second-largest economy (by most measures). China's extraordinary rise over the past two decades has changed the global economy and also global investment markets. For instance, its voracious appetite for commodities has supported growth in resource-exporting countries such as Australia, Brazil, and also SA, and has kept the currencies of these countries relatively strong. Germany's stellar second quarter growth can largely be attributed to Chinese demand for capital goods. China will continue to reshape the global economy and financial markets in the years ahead, but China-bulls would do well to remember that in the 1970's and 1980's, many predicted that Japan would overtake the US to become the world's largest economy; instead, Japan has spent the last 20 years battling deflation. The recent strength of the yen will cause further pain for the export-intensive Japanese economy. No wonder, then, that Japanese shares fell to an 8-month low last week.

Retailers score during World Cup

Domestic spending continues to recover, with real retail sales growing by 7.4% year-on-year in June after rising 4.5% in May and 2.9% in April. The consensus expectation was slightly higher, at 7.6% year-on-year. While the environment for consumers has undoubtedly improved with lower interest rates and inflation and solid income growth for those who did not lose their jobs, the question will obviously be asked: how much of June's growth was due to the World Cup? The month-long event which kicked off on the 11th of June certainly gave the economy a boost with large numbers of tourists pouring into the country, while locals either splashed out on soccer paraphernalia or travelled to quieter parts of the country. The World Cup-impact will also feature in July's retail numbers, but beyond that will probably have been a once-off shot in the arm for local retailers.

The recovery in sales continues to be fairly broad-based, with six of the seven main sub-categories of sales recording year-on-year growth in June. Sales of textiles, clothing, footwear and leather goods rose to 13.1% from 6.3% in May (no doubt including replica team shirts), while household furniture, appliances and equipment grew by 17.7%. Sales of food and beverages increased by only 3.4%; one would have expected stronger growth in this category. Sales of hardware, paint and glass declined again in June, following moderate growth in May, reflecting the ongoing weakness in the residential construction sector.

On a quarterly basis, retail sales increased 1.2% (seasonally adjusted) during the second quarter of 2010 compared with the first, and 4.9% compared to the second quarter of 2009. Sales growth will probably moderate towards the end of the year as high debt levels, a weak job market and higher administered prices will constrain consumer confidence compared to previous cycles. The public sector strike could certainly inhibit spending in the short-term. The outlook for subdued growth towards the end the year could convince the Reserve Bank to cut interest rates again. The market is certainly pricing in this possibility, but the Bank will once again face a difficult decision.

The Week Ahead

• StatsSA will release gross domestic product (GDP) growth numbers for the second quarter on Tuesday. With second quarter manufacturing, mining retail and vehicle sales data already known, GDP growth in the second quarter is likely to have moderated from the 4.6% quarter-on-quarter seasonally adjusted and annualised growth rate of the first quarter. The domestic demand-side of the economy, such as retail trade, improved over the quarter, but the external trade sector softened due to a stronger rand and weaker growth in key trading partners. The consensus forecast according to I-Net is 3.6%, but the range of forecasts is from 2.7% to a robust 5.1%.

• StatsSA will also release July inflation numbers this week. On Wednesday, consumer price index (CPI) data is expected to show that headline inflation declined to around 4% year-on-year - or even below - from June's 4.2%. Inflation has been on a declining trend for the past number of months as food prices moderate and the strong rand contains imported inflation. A petrol price cut at the beginning of July will add further momentum to disinflation.

• Producer inflation (PPI) numbers will be released on Thursday. Year-on-year growth in PPI rose to 9.4% in June due to a low measurement base and significantly higher commodity prices.

• Global events and data releases of note: US house price indices, durable goods sales and revised Q2 GDP numbers; Eurozone industrial orders and money supply numbers; and Japanese unemployment numbers.

Fairbairn Capital | Old Mutual

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