2009: THIS IS NOT A BATTLE, THIS IS A WAR
Bulls versus Bears
This was the heading that the Alphen guys used on their latest market update, and is probably as close as one can get to reality (if there is such a thing presently!).
It is very difficult to be optimistic when one is privy to so many papers being written by leading academics, strategists, economists, asset managers, businessmen and government officials who occupy both camps. If these guys cannot reach consensus, how are us mere mortals supposed to?
In the one camp we have the BEARS (the doom and gloom artists who firmly believe that we will linger for many years in this mire, and see no solution), and in the other camp, we have the eternal BULLS who firmly believe that current Federal Reserve and other central bank stimulus packages, as well as government interventions such as TARP in the US, are non-negotiable imperatives to stave-off a prolonged Japanese-style depression.
But what are the basic facts?
- In the US the market harbours a significant portion of US private wealth - most of the 60's and 70's baby boomers, estimated to be about 80m people, have very low savings levels and their wealth is captured in their home.
- To understand the magnitude of the housing market, US GDP is about $14.4 trillion annually - so the housing collapse that has occurred so far has been equivalent to 42% of annual GDP vaporizing.
- Since the peak of the housing boom in mid 2006, the market has fallen over 20% and it is estimated that as many as 12 million home owners (or 13%) now have negative equity within their properties - that is, the value of their home is worth less than their mortgage.
- The inventory of unsold homes in January 2008 was almost 10 times the level of home sales in December 2007; this is the largest inventory build since 1981.
Despite both these camps swamping us with data, we at Brantam also have our internal disputes over the recovery period. As many of you (my wife included) would have gathered by now, the general feeling in our home base is one of caution. We appreciate both arguments, and have been rather bearish on markets for the past 12 months, a period that placed us under severe strain. We have always felt that no one is or was capable of fully appreciating the magnitude both in terms of depth and breadth of this economic problem or capable of predicting the time or extent of the collapse.
Has this changed much?
It is difficult to remain too bearish when markets fall 50%. This is almost unprecedented and statistically, one would be on the right side of returns by being long of equities (or in normal terms, buying equities right now). Our biggest problem is that many of our client base are retired and thus also rely on us to provide a monthly income, so “time” becomes an issue. But in a declining domestic interest rate environment, equities have always outperformed cash, and we know that Tito will probably be on a rate cut exercise during 2009. Do we thus increase our equity exposure?
Going forward in 2009, the evidence is plentiful. The US economy is officially in a recession that started in December 2007. Japan and some European countries (Iceland, Ireland, Italy and Germany) are in the same boat, and growth in most emerging economies is faltering. This all indicates that a deep and protracted global recession lies ahead and the recovery could be delayed well into 2010. The authorities’ massive infusion of capital into the global banking system in recent months, along with their fiscal stimuli and multiple rate cuts since mid-2007, has brought some relief to turbulent financial markets, but it will take a great deal more government reflationary action to arrest the global economy’s downward spiral.
But how does this impact on us back here in little South Africa?
2009 confronts South Africa with a number of major challenges and uncertainties. The domestic economy has been losing momentum since early-2008, driven by the cumulative effects of an interest rate hiking cycle that started in June 2006. Given the usual lag between rate changes and real economic activity, the full impact of rate hikes are yet to be reflected in economic numbers, given that the last hike occurred in June 2008. More recently, the slowdown in activity has also reflected the impact of record-high rand commodity prices up to the first half of 2008. While signs of the cooling impact of collapsing global activity on the local economy are tentative, 2009 could show a very different picture.
Cadiz African Harvest Asset Management
Areas to be considered:
- Economic activity slowed sharply in the third quarter of 2008, with real GDP barely positive at an annualised 0.2% in the quarter. The wholesale and retail sectors slipped into recession, registering two consecutive quarters of negative growth, and the mining and manufacturing sectors contracted in the quarter.
- Mining is being hurt by falling commodity prices (leading to marginal mines closing down), safety-related shutdowns, power rationing, and soaring costs. The consumer-driven subsectors of manufacturing are bound to slow even further as the beleaguered consumer cuts back even more. These developments, coupled with low confidence levels in this sector, would likely lead to the sector slipping into recession for a short period.
- Consumer spending contracted in the third quarter, the first decline since 1998. Durable spending has been in recession for the past year, non-durable spending also contracted in the quarter, and semi-durable spending was weaker. That consumer spending is buckling was to be expected, as households struggle to balance their budgets. Consumer spending should remain weak through most of 2009, as households use the breathing space provided by falling interest rates and inflation to consolidate their budgets, with spending showing more vigour into 2010
- Rising debt levels even as interest rates moved higher meant that debt service costs were spiralling. Rising inflation has squeezed real wages. Employment growth has lost steam and recent financial market turmoil and lacklustre housing activity has meant significant wealth destruction.
- While overall investment spending maintained its momentum over the third quarter, this was due to a pickup of investment by public corporations. Private investment was again weaker as interest rates, lacklustre global and domestic demand and high input prices eroded profitability. There are also increasing signs that the current global financial turmoil is adversely impacting the fundability of public infrastructure expansion plans. Thus, while investment is still expected to continue being the key driver of domestic demand, the risk is that it is significantly weaker than was generally expected.
- Consumer inflation has been falling after having peaked in August 2008, driven by high base effects and falling commodity prices. CPIX inflation peaked at 13.6% in August and has declined to 12.1% in November. The declining trend is likely to continue through to the third quarter of 2009 to a bottom below 4%. Thereafter, base effects from fuel prices would likely cause some pickup in inflation, although inflation looks likely to remain well within the target range.
- While the rand remains a risk, the general inflation environment has improved markedly over the last few months, with weak local and global conditions (and consequent improvements in output gaps), falling commodity prices and tight credit conditions.
- South Africa’s current account deficit widened further in the third quarter to an annualised R185.7bn from R166.4bn (in other words, we are spending more than we earn) On balance, we’d expect the current account deficit to shrink to levels closer to 6% over the course of 2009. The fundability of South Africa’s large current account deficit will remain the rand’s Achilles heel, especially in the current environment of reduced global risk appetite.
- Most currencies suffered from a flight to quality over the second half of last year, with emerging markets and commodity producers harder-hit, and South Africa suffering even more. At its worst point on the 23rd of October last year, the rand had lost more than 35% of its trade-weighted value year-to-date. By the end of the year, the local currency had made up some ground, although it was still down by 25%. Some rand strength may follow from a normalisation of market conditions, but weakness over the medium-term remains a necessary part of the adjustment towards a more sustainable current account deficit
- As you all know, the Reserve Bank cut its repo rate by 50 basis points to 11.5% in December. At the press conference announcing the decision, the governor noted that the MPC had discussed the prospect of a cut of 100 basis points, a move that was favoured by two MPC members. The MPC sees the rand as the key upside risk to inflation. However, the MPC noted a number of downside risks to inflation, including lower oil and food prices, a widening negative output gap and very weak household consumption expenditure. The December cut was the start of the rate cutting cycle and we expect the MPC to continue cutting in 50 basis points increments at subsequent meetings in 2009.
So, a lot of information, and unfortunately, much of it “bearish” (and I would hazard a guess that most of the readers, should they even have reached this paragraph, will probably have just scanned the above!??!).
This leaves us with the big question - which way forward?
The general feeling (for now, and it could change within a month) is that it is probably too early for the retired “income drawers” to get too aggressive in their risk stance, and Classic Port or Cabernet appear to be the best for now. The investors with a longer investment horizon can start to take some equity bets (but if you do, would still recommend that you consider phasing your capital in over a 6 month period to catch the volatility), but be aware that 2009 may not deliver much by way of equity returns. The market, however, appears to be offering value over the longer term. Also not a bad time to be looking at a monthly investment into a fund such as SHIRAZ or even CHAMPAGNE.
Now was this more upbeat? NO, because we have to present the facts as we see them, and the picture still does not look that pretty. Sorry, but that’s the way it is!
WELCOME TO 2009! |
