Interest rates key in a tougher environment - STANLIB

In a tougher 2008 keeping an eye on interest rates is key to a successful year ahead. High interest rates and slower economic growth globally will see consumers feeling the pinch and tightening their belts in 2008. It’s a tougher year ahead – with more difficult conditions than we have seen over the past few years. That’s the view of STANLIB’s chief economist Kevin Lings, who forecasts interest rate and inflation pressure telling on consumers and companies in 2008.

Lings sees the global and local outlook as more difficult than it has been in the past few years. Both globally and locally interest rates could dictate market moves and any interest rate movements will be key to the market’s performance.

Lings emphasizes that we cannot separate our local outlook from the global views, trends and events, “What happens in the US and other markets affects the South African market. Globally the developed world is slowing and the question for emerging markets is will they hold up? We see higher risk being attached to some emerging markets like SA and lower returns than we have seen over the last four years.”

The US remains a key factor – and concern remains that the US will slip into recession. Economic growth in the US is likely to be under 1.5% for 2008, and this is a marked slowdown from the long term average growth rate of just over 3% and the 2007 growth rate of over 2%.

“The reasons for this are the weak housing market, higher interest rates and inflation; and general lack of confidence.”

Lings believes that a recession can be avoided if the US Fed cuts interest rates sufficiently in the months ahead, but still manage to keep inflation under control. “It’s a very difficult situation to manage, and difficult economic conditions could end up being a factor in the elections.”

It’s not just the US that has economic challenges to deal with in 2008; the UK, Euro region and Japan are all struggling and Lings sees all but the Japan central bank cutting rates in coming months. “We are likely to see lower global interest rates this year.”

“China and India have spent huge amounts on infrastructure and have generated significant internal demand so to a degree they are not as impacted by global trends as other economies.”

So how will we and other emerging economies hold up? While recession is unlikely Lings sees a definite slowdown in these markets.

“Interest rates are high in South Africa and we believe they will remain high for most of the year. Consumers are starting to tighten their belts and retail sales and vehicle sales are lower. House sales are slowing and prices are under pressure.”

“Higher interest rates mean higher cash returns and portfolios may increase their cash holdings to benefit from this.

“Inflation remains problematic – well over 8% in the short term moving closer to 6% by the end of the year. But it is unlikely to be convincingly in the target range this year.”

With pressure on food prices (a global trend), wages and electricity charge increases short term inflation is mostly reflecting cost pressures. Add to the equation rising medical and education costs, and the inflation picture does not look so healthy.

“A 2008 trend could well be increasing bad debts and stress borrowing from consumers.”

“What should hold up well in 2008 is fixed investment spending and we could see more infrastructural projects being undertaken, but it won’t temper all of the downside.”

SA is still running a large trade and current account deficit. With increased global risk aversion and a higher risk assessment of SA, reflecting high inflation, interest rates and the ongoing uncertainty around the position of Jacob Zuma, SA’s balance of payments position is extremely vulnerable.

“We are forecasting local growth of around 4% - which is still reasonable but not as high as the 5% of the last three years and there is a risk that it could be revised lower.”

Are there opportunities in the less than rosy outlook?

“Yes,” says Lings. “While earnings of many companies will be under pressure with a stretched consumer, companies with quality earnings could be an opportunity in 2008.”

Investors need to look out for companies that can hold onto their prices, are offering products consumers have to buy like basic necessities and those who will benefit from the infrastructure spend.

“Infrastructure spend is a global trend and is likely to pick up over the next few years.”

“IT is also an area to look out for. In SA and globally IT spend has lagged and IT upgrades will happen.”

With the rand under pressure and global interest rate trends ahead of SA, local investors may see opportunities in offshore markets.

“The key is interest rates - it’s a cautious and defensive start to the year but if conditions start improving and rates bottoming out investors need to watch for companies that will benefit from these conditions.”

It’s been a great few years, with more to come, but tougher conditions are the order of the day as we start 2008.