2009: So far not so good

We are a couple of months into 2009, and the only way to describe the year at this point  is - so far not so good.  While the stock market turmoil of September/October 2008 has subsided to some extent, what markets are telling you is that at this stage, they can’t see the end of the global credit crisis.  Markets look 12 – 18 months forward, so last year’s share price collapse was because markets could see what lay ahead on the economic front in 2009.  The crisis predictably moved from Wall Street to Main Street, i.e. newspaper headlines have become less obsessed by what happened in the stock markets the day before, and more focussed on economic deterioration.  And that deterioration is key, as the global economic downturn continues, whether it’s unemployment, growth or companies’ earnings, the numbers are worse than analysts expected.

In fact, the crisis is much worse than anyone expected.  Central banks, governments, ratings agencies, armies of risk and compliance officers have all been caught off guard by the severity of the sell-off.

We now live in a world where banks don’t want to lend to anyone.  A world where companies, almost regardless of industry, are finding their revenues are falling off the edge of a cliff, whilst their costs remain constant.  You can’t go to the banks for money anymore, so you go to government to help you keep your head above water, but government can’t bail out everybody, so you have to close your business.  Cash flow will expose those companies still in denial.

So where is this all going?

Most people have accepted that 2009 is going to be a tough year.  We all know that “this too will pass”.  The big question however is when, so let’s try and put some timing to it.

The first key point is that not all countries will recover simultaneously.  It is all about your ability to stimulate (stimulate is the new “bailout”, as it has a more positive association with the tax-paying public).  So those governments with high savings and low debt rates are sitting pretty.  If your country’s consumers have also not borrowed that much, you are in an even better position.

Of course, those countries with high government debt and highly leveraged consumers can also stimulate, but they will have to print the money, which will affect their currency later. The United States is in this position.

So expect a weaker US Dollar in the second half of 2009.  The Euro, celebrating its tenth birthday, and far away from the “toilet” currency which traders initially called it, is strong, although vulnerable.  Cracks are already starting to show.  Some, such as the hardworking Germans save, whilst others such as Portugal, Italy, Ireland, Greece and Spain spend.   Therefore, some countries have surpluses, and others have deficits.  Some governments can stimulate, others can’t.

And that’s not even mentioning the banks.  The Western European banks have lent the Eastern European banks so much money that even a 10% default rate would see several Western European countries’ financial systems under significant pressure. 

So who’s going to emerge first?

Expect emerging markets to improve before the developed world, but not all at the same time.  Asia, with high savings and low borrowings (both government and consumers) will emerge first.  Obviously, China is key here.  Next to emerge will be Latin America.  Brazil will probably grow 1.5% this year, Mexico due to its reliance on the US will probably see a recession, and Argentina may default.  Europe is in bad shape due to infighting amongst the Euro zone, banking problems and over indebtedness (80% of Turkey’s foreign reserves this year will be spent servicing their debt).

So, Asia, followed by commodity emerging markets, including SA, should bottom towards the end of 2009, with SA receiving an artificial, but perfectly timed, and very welcome boost, in the form of the Soccer World Cup.

And what happens after 2010?

There seems to be large concerns around what happens to SA after 2010.  After 2010, comes 2011, and by then the developed world should be in the throes of some form of recovery, which would be positive for emerging markets, including SA.

And what about the Rand?

The Rand was sold off heavily last year against most currencies as foreigners fled emerging markets for safety.  We are the most liquid emerging market from both a currency and a bond perspective, which means that when foreigners want out, they sell us first.  You can try and sell Icelandic or Polish bonds, but you may find there are no buyers on the other side.  In addition, we have a big current account deficit and that also makes us vulnerable.  The Rand has already recovered roughly half of last year’s fourth quarter sell-off, and going forward, certainly over the next twelve months, the environment is Rand positive.  Demand for commodities will return, 2010 will be Rand positive, gold should have a decent year and a resumption of risk appetite should also help the local currency going forward.  

So in summary - what can investors expect?

• Expect emerging markets, led by Asia to recover first, followed by commodity producing countries. 
• Expect the developed world to take longer, probably only seeing a meaningful economic recovery in 2011.
• Expect demand for commodities to return as the world uses massive infrastructure spend to resuscitate economic growth.
• Expect stock markets to recover four to eight months before the end of the recession.
• Expect volatility to remain part of investing for the next two years at least and make sure you are properly diversified.

So what should investors be doing?

If you’re conservative, you have to stick to cash/bonds, or at most low equity managed funds.

For most investors a moderate asset allocation fund, where the fund manager makes the asset allocation decisions, between equities, bonds, cash and possibly property, is optimal.

For the more aggressive investors with cash to invest, opportunities abound.  Within each sector there will be winners and losers and it’s about being able to select the winners.  Crucially important in this environment is to take at least a three year view, and probably to phase funds in, as certainly in the short term, markets will remain volatile.

And finally, a silver lining to the credit crunch?   

• How well SA has come through the financial crisis.
• The credit crunch probably helped Obama to get elected.  His message of change was particularly popular, given the dismal state of the US economy.
• Oil prices are lower and therefore the price of petrol has also declined.
• Slowing inflation and a drop in interest rates are providing relief to consumers and companies.
• Less demand for electricity will help the lights stay on.
• The crisis has diverted the world media’s attention away from our politics over the past volatile six months.
• Emigration is down – there are a lot less jobs available in Australia and the UK. 
• There are loads of South Africans coming home, which will be great for skills shortages and knowledge transfer. Bottom line - we are better off here!

By Jeremy Gardiner, director, Investec Asset Management