Inside Insights 8 February 2010

Investment Intelligence|Inside Insights

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

Added on 08 February 2010 @ 10:01 AM

The good, the bad and the PIGS

The week started well on markets, following positive global manufacturing news (see below) but the cheer did not last. The fears that Greece will soon not be able to continue making payments on its government (sovereign) debts - it has a 12% budget deficit and debt-to-GDP ratio of around 121% - are not new. But the market angst over a potential default came to a head last week as the rising yields on Greek bonds will make it very difficult for these debts to be rolled over. Moreover, attention also shifted to the other members of the Eurozone's ‘PIGS' - Ireland and especially Portugal and Spain. Spanish shares slumped 6% on Thursday after Nobel economist Paul Krugman wrote that "the biggest trouble spot isn't Greece, it's Spain". Portugal is also struggling with a 9.3% budget deficit and the political difficulties of cutting government spending at a time of fragile economic recovery - and a €500m bond auction failed on Wednesday. The PIGS countries used low euro interest rates to live beyond their means during the boom years, but now euro membership seems more like a striaght-jacket to them: they cannot offset the impact of the required austerity measures (spending cuts and tax hikes) on their population by cutting interest rates or weakening the currency to boosts exports. For the EU, the PIGS also pose a problem: it cannot bail them all out, but can probably not afford to let any one of them fail.

From the other side of the Atlantic, nervous markets also had to contend with weak US jobs numbers. Jobless benefit claims rose unexpectedly by 8,000 to 480,000 last week. Fortunately, the latest US unemployment rate decreased to 9.7% from 10% in December. Non-farms payrolls, another widely followed indicator of the US job market, improved in January (only 20,000 jobs cut), but was worse than analysts' expectations. In the process, the safe-haven US dollar rose to an 8-month high against the euro, while risky assets and commodities fell. As The Economist's Buttonwood column pointed out last week, the 2009 market rally was based on a combination of extraordinary government stimulus, and on a strong economic recovery. But both these conditions cannot persist indefinitely: either the economic recovery will fade or, if it doesn't, stimulus will be taken away. And clearly, the market is now very worried about the long-term cost of deficit-funded stimulus. Expect the ride to be bumpy for the next while.

PMI news still good

While markets shuddered last week, there was nonetheless good news on the economic front in the form of monthly manufacturing purchasing managers' indices (PMIs). These indices measure the strength of manufacturing activity with 50 index points dividing expansion from contraction. The local Kagiso PMI rose to 53.6 index points in January from 52.5 in December. This was the third consecutive month above 50 points, supporting recovery expectations in the hard-hit manufacturing sector. Most of the local PMI's sub-components continued to rise in January. Business activity rose to the highest level since mid-2007, with new sales orders (55.4 from 54.7 in December) expanding for the third consecutive month. Expected business conditions surged to 73.3. Perhaps most encouragingly, employment rose above 50 (to 51.9) for the first time since April 2007, suggesting firms are starting to hire again.

The improvement in the local PMI continues to track the global manufacturing recovery. The January JPMorgan Global PMI rose to the highest level in 5½ years: 56.1 from 55 in December. The US equivalent, the ISM index, rose above expectations to 58.4 in January from December's revised 54.9. This is the highest level since August 2004. The US PMI is now above that of China (although the latter remains in expansionary territory). Interestingly, China's PMI fell back slightly to 56.6 in December to 55.8 in January as new orders, output and employment eased. It is too soon to say whether monetary tightening in China has succeeding in cooling the economy down as desired. The Eurozone's PMI also climbed to 52.4 in January from 51.6 the previous month, but this masks a divergence between countries as manufacturing activity in France, Germany and Italy continued to expand, while it declined further in Ireland, Greece and Spain.

The Week Ahead

The focus will continue to be on the Eurozone this week, where Greek public sector workers are expected to go on strike this week due to proposed cut backs. As discussed above, the Greek government (and those of Spain and Portugal) desperately need to get their finances under control. However, doing so will be extremely difficult politically. Lacklustre fourth quarter growth data from Germany and Italy will further sour sentiment towards the 25-member economic bloc.

StatsSA releases manufacturing production data for December on Thursday. Though still negative on a year-on-year basis, manufacturing production has improved every month since August 2009, consistent with the improving local PMI (see above) The November number came in at -4.7% year-on-year; November was also the first month that the PMI came in above 50 points, after being in contraction territory for a year and a half. Given the strong December PMI result one would expect manufacturing output data to reflect a similar picture. Medium-term worries remain though. Much of the recovery in manufacturing has been driven by restocking (just as much of the slump was due to de-stocking). Once this global inventory rebound has run its course, local factory owners will be wondering where the orders will come from. Hopefully domestic demand, which is expected to recover by mid-2010, will fill the gap.

StatsSA also releases December mining production data on Thursday. Mining production growth improved substantially in November to -1.6% year-on-year from -10.3% in October. However, this was largely due to the fact that production collapsed in November 2008. A year later, output had normalized somewhat, so that the year-on-year growth rate seemed very healthy, but output levels remain below peak. This low statistical base is also likely to boost the December 2009 growth numbers.

Fairbairn Capital | Old Mutual

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