Inside Insights 25 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 25 January 2010 @ 9:56 AM

Markets nervous as banks come under scrutiny

There were two interesting developments that had big impacts on global markets last week. The first was the latest Chinese GDP growth data. China's economy expanded by an incredible 10.7% in the fourth quarter from the fourth quarter of 2008. For the whole of 2009, its economy grew by 8.7%, this in a year when Germany, for instance, contracted by 5%, and South Africa contracted by an estimated 1.7%. Rather than finding comfort from these figures, the market is worried that the Chinese economy is overheating, especially given that inflation has surged. Consumer inflation in China grew 1.9% year-on-year in December. This does not sound like much compared to our own inflation rate, but until recently consumer prices were falling in China. Prices only rose by 0.9% year-on-year in November. Producer prices have also stopped falling and are beginning to increase. The big unknown investors are faced with is how the authorities will respond. The central bank, the People's Bank of China, has already increase reserve ratios to slow bank lending, which is growing around 30% a year (again, compared to South Africa's -1.59%). Has the time come for them to start hiking interest rates?

Still on government action, but from the other side of the world, President Obama announced his intention to "propose new limits on the size and risk taken by the country's biggest banks." Following shortly after America's big banks reported mixed fourth quarter results, financial shares slumped as Obama's proposals would curb profitability. Certain activities, such as proprietary trading - when banks trade using their own capital, rather than on behalf of clients - would be banned. Banks would also be prevented from owning hedge funds. These measures are further aimed at preventing ‘too big to fail' scenarios in the future.

Equity markets had their worst week in three months, with the Nikkei 225 losing 3.6%, the S&P 500 2.8% while the JSE All Share index lost 3.1%. The VIX experienced its biggest weekly jump in a year. Commodity prices dropped and the dollar surged against the euro (and also the rand).

Local growth momentum carrying on into 2010

Economic data out last week confirmed what we said the week before: when it comes to economic recovery, manufacturing is leading the way while consumer demand is acting as a drag. The December Kagiso purchasing managers' index (PMI) came in at 52.5, up from 50.3 in November. The local PMI seems to be finally catching up with global PMIs, indicating an upturn in the manufacturing sector.

On the other hand, real retail sales contracted by 6.6% year-on-year in November, following October's (revised) 6.1% contraction, according to StatsSA. It was worse than market expectations of -5.5%, and suggests that the run-up to Christmas was far less festive for retailers last year. Sales of durable goods were particularly hard hit, as expected, but sales of clothing and footwear - which normally rises ahead of Christmas - fell 4.4% . With around 1 million jobs lost during 2009, and debt burdens still high, it might take well into 2010 for consumer confidence to recover. That households are struggling with debt was emphasised by new data from StatsSA showing that civil judgements issued for debt increased by 18.8% year-on-year in November.

The bleak retail sales numbers might give the Monetary Policy Committee (MPC) food for thought, but by the same token they might infer decent economic recovery from the PMI numbers. The MPC knows that interest rates work with a lag, and that the 500 basis points in interest rate relief they've granted over the past 13 months will impact the economy fully this year only. The MPC is also likely to wait on the outcome of energy regulator Nersa's deliberations on Eskom's electricity tariff application. Eskom wants 35% per annum for the next three years, and this is widely considered to be the main threat to the inflation outlook (which, otherwise, is quite benign, especially with the strong rand). If Nersa puts its foot down and grants a lower increase, the inflation outlook will improve (but not necessarily the electricity security outlook) and the MPC might be tempted to fire a final salvo. Either way, we'll probably have to wait until the next MPC meeting in March for any interesting developments in monetary policy.

The Week Ahead

The big event of the week is the meeting of the Reserve Bank's Monetary Policy Committee, although, as discussed above, the outcome is likely to be boring. No change in the repo rate is expected when the decision is announced on Tuseday afternoon.

StatsSA releases December liquidations and insolvencies data on Monday.

This week also sees the release of local inflation data for December by StatsSA, which interestingly will occur only after the MPC meeting. Consumer price index (CPI) data will be released on Wednesday. Year-on-year growth in CPI slowed to 5.8% in November from 5.9% in October. This was largely due to a decline in food inflation, imported inflation due to rand strength, and statistical base effects. These base effects (comparing price levels in one month to the same month the previous year) will accelerate inflation over the coming months, before it is expected to settle within the Reserve Bank's 3% - 6% target range again for much of the remainder of the year.

Producer price index (PPI) data will be released on Thursday. Year-on-year growth in PPI was still negative in October, although the pace of producer inflation had slowed as the statistical base effect of falling commodity prices in mid-2008 wanes. Indeed, the prices of oil, metals and other commodities have risen sharply in recent months, though the strong rand would've ameliorated some of this impact.

Another data release this week which would have bearing on interest rate decisions, but which happens after the MPC meeting is December money supply (M3) and private sector credit extension (PSCE) growth. PSCE contracted by 1.59% year-on-year in November, the lowest growth rate since 1966, and an indication of how little demand for credit there is in the economy.

SARS will release December trade balance data on Friday. This figure is typically quite volatile from month to month. November's data showed that imports exceeded exports by R2.5bn.

Fairbairn Capital | Old Mutual

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