Inside Insights 4 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 04 October 2010 @ 10:45 AM

September surge

US stock markets experienced the best September for 71 years, gaining 8.9% (in dollar terms) during the month. Other global markets fared equally well: the FTSE 100 gained 9.1% and the JSE All Share index followed with an 8.74% gain in the month of September. The latter moved above 29,000 points, the highest level since April. September is usually a weak month for world equities; however, sentiment improved on the expectation that the US Federal Reserve may introduce further quantitative easing (QE) - bond purchases financed by money printing to drive down interest rates. Low interest rates in turn make risk assets relatively more attractive, as well as supporting economic activity. The equity rally was thus largely driven by a negative economic outlook (the Fed would not need to engage in further QE if the economy was recovering strongly). Normally, of course, equities would rally on positive news, but then we live in unusual times. There was some positive news during the week though: the US posted a surprise decline in initial jobless claims and a small upward revision in GDP (raising the second-quarter rate from 1.6% to 1.7%) while China' manufacturing sector grew strongly in September. Solid company earnings also contributed to improved investor sentiment as has an increase in mergers and acquisitions activity (with US giant Wal-Mart's bid to acquire local retailer Massmart being an example).

In terms of the third quarter's returns, global equities did very well: the FTSE All-World Index rose 13.7%, the fifth-best quarter of the past decade. The FTSE 100 climbed a staggering 19.8% and the S&P 500 rose by 11.3% (in dollar terms). The JSE All Share index returned a 13.3% gain for the quarter.

Finally, as we've pointed out over the last few weeks, the ultra-low interest rates (along with unorthodox monetary policy measures such as QE) have wreaked havoc on foreign exchange markets as investors try to eke out the extra few basis points of yield. This led to comments last week from Brazilian Finance Minister, Guido Mantego, that an ‘international currency war' has broken out, forcing governments in emerging markets to take steps to curb the unwelcome gains in their currencies. Gold's rise above the $1300/oz. level can also be linked to a lack of confidence in the word's paper currencies, especially the US dollar.

Inflation keeps falling

Once again, consumer inflation data surprised on the downside. According to StatsSA, headline consumer inflation (CPI) fell to a five-year low of 3.5% year-on-year in August from 3.7% in July. The lower rate of annual inflation was largely due to a 3.3% decline in durable goods prices, especially cars and household goods. Food inflation edged up slightly, increasing to 1.5% in August, mainly due to higher fruit and vegetable prices. Producer inflation accelerated in August to 7.8% year-on-year from 7.7% in July. While slightly higher than expected, most economists agreed that producer inflation posed little risk to consumer inflation because the impact of industrial and commodity price gains would fade in the coming months.

Data released by the Reserve Bank showed credit extension to the private sector (PSCE) grew at a rate of 2.99% year-on-year in August from a revised 1.96% in July. Mortgage advances, the largest credit sector, grew slowly by 5.54% year-on-year from July's 4.65%, in line with the sluggish property market. The other loans and advances category, which is the second largest and is dominated by company borrowing, rose marginally by 0.45% year-on-year, from July's 0.53% decline. Companies are clearly have little need for credit, as there is little need to invest in new capacity amid weak final demand for their products and services.

What does all this mean for interest rates, which are already at a 30-year low? Governor Marcus noted at the previous monetary policy committee (MPC) meeting that the "scope for further downward movement is seen to be limited, but would be assessed on an ongoing basis." The latest data is unlikely to result in a change in interest rates at the November MPC meeting. But another cut early in the new year cannot be ruled out if the rand continues to appreciate, and overall economic recovery continues to be slow and uneven. Certainly September's Kagiso purchasing managers' index (PMI) points to further pain in the manufacturing sector. The PMI fell back to 48.4 points, with any reading below 50 points indicating contraction in the sector. A strike in the motor industry is partly to blame, but overall manufacturing conditions are clearly very challenging.

The Week Ahead

• Industry body Naamsa releases new vehicle sales data for September on Monday. Vehicle sales surged in August ahead of the introduction of a carbon emissions tax in September. Total new vehicle sales increased by 36.9% year-on-year, while sales of new passenger vehicles increased by 49.1% year-on-year. However, the strike in the motor components industry will probably have had an impact in September. The low base also contributed to the strong growth numbers, which are clearly not sustainable even though growth in the passenger segment will continue to be underpinned by lower interest rates. Growth in the commercial vehicle segment will require a broader and sustained economic recovery.

• The petrol price will increase by around 5c/l on Wednesday.

• The South African Reserve Bank releases September gold and foreign exchange reserve data. Analysts will be looking for signs that the Bank used the significantly stronger rand in September to increase reserve accumulation.

• The South African Commerce of Trade and Industry releases its composite Business Confidence Index (BCI) for September.

• Other international events and data releases of note: US factory orders and pending home sales for August, and key September unemployment data; Eurozone PMIs; the IMF releases its World Economic Outlook; interest rate decisions from the Bank of England and European Central Bank.

Fairbairn Capital | Old Mutual

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