Off the edge of a cliff?

It was roughly four years ago, back in 2008, when what was to become known as the “Global Financial Crisis” first began.

Since then an enormous amount of energy and expense has been devoted to fixing the crisis. Over the past 3.5 years, the US has added another $5 trillion of debt, and yet there doesn’t seem to be much to show for their efforts. They are still spending (and therefore having to borrow) 8% more than they are bringing in in taxes, and all this to generate an anaemic 1.5% GDP growth.

The looming ‘fiscal cliff’ won’t help either. Expect to hear more of this terminology as we head towards the end of the year. Essentially what it means is that a withdrawal of tax breaks and cuts in government spending to the tune of approximately $600 billion will come into effect at the end of 2012. This will see demand sucked out of the economy, which could see as much as 2% to 4% shaved off US GDP growth next year. It is thought (and hoped), however, that record low real interest rates will ameliorate some of the ‘fiscal drag’ induced by the ‘cliff’.

On the positive side, lending by US banks to both consumers and businesses has risen significantly since 2009. Lending for autos and demand for mortgages have both improved, indicating that current low real interest rates may finally be having an effect. Even year-on-year house prices were up in July for the first time since 2007.

Fortunately, stock markets have fared reasonably well, despite the BBB (bumpy, below par and brittle) macroeconomic recovery, a phrase coined by Joachim Fels from Morgan Stanley. The reason for this is that earnings have surprised on the upside as business enjoyed a recovery, the costs of which it did not have to pay for. However, better than expected earnings have not translated into an increase in jobs.

Meanwhile, the turmoil in Europe persists. The UK economy is back in recession and even after £18 billion of tax rises and spending cuts it looks like they will have to borrow at least £10 billion more than last year [1]. Even Germany’s AAA status is under threat of being revoked. Fortunately, however, Q2 GDP growth figures show that the Germans are at least growing (albeit very slowly) while others are slowing. Concerns continue to centre on the potential European outcome. Greece apparently now needs €14 billion to pay bills, not the €11.5 billion previously reported. Will Greece exit? If so, will it be an elegant or a disorderly exit? The German Finance Minister recently likened further Greek assistance to ‘throwing money into a bottomless pit’. Fortunately, Spanish yields are back below 6.5%, but a disorderly Greek exit would have dramatic implications for Spain, Italy and possibly many more.

There is therefore currently talk of the ECB possibly setting yield targets for the bonds of Eurozone countries, i.e. the ECB would step in to buy up short-term debt once yields go above a certain level, particularly in the case of Italy and Spain. This is powerful, as given that the ECB’s ability to manufacture money is virtually unlimited, speculative attacks would be very difficult. This strategy would ensure that debt-financing costs in the troubled areas would remain at manageable levels.

Predictions as to the most likely outcome for the Eurozone are difficult, as politicians are managing the economies. Their intentions (and actions) are often expedient and irrational rather than focussed on finding a solution that is in the best interest of the countries concerned, so almost anything is possible. September 12 is a key date to watch, as both Dutch and German commitment to austerity measures will be challenged – the Dutch, through elections (which if the Left wins, would see Germany lose one of their biggest ‘pro-austerity allies), and the Germans, through a constitutional court challenge to their involvement in Europe.

The other concern that has upset markets this year has been the possibility of a slowdown in China, with some back in Q2 predicting a hard landing, whilst some were even talking of growth rates around 3%, which would be categorised as a crash landing! Fortunately, these fears seem overdone and it now appears that a more sober number of between 7% and 8% will be achieved in terms of Chinese growth this year. This is a tremendous relief, as a significant Chinese slowdown would derail global economic growth.

Back home, despite the tragic events at Marikana and the ensuing global coverage, the JSE continues breaking new highs on an almost daily basis, notwithstanding the level of pricing of a lot of heavy-weight stocks on the JSE. Why is this when 20 years ago, the events at Marikana would have led to a 20% decline in the JSE? The reasons are – as we have been saying for a long time – twofold:

· Firstly, the JSE (and the rand) is far more affected by sentiment towards emerging markets than micro issues within our country, and

· Secondly, whilst we certainly have problems in SA, many other countries are struggling with far worse economic strife.

Remember the days when we used to stress about our proximity to Zimbabwe, the economic contagion from the region and the influx of Zimbabwean refugees into SA?

Zimbabwe certainly has had an impact on SA over the years, given that it highlights every fear Afro-pessimists have and is often used by Afro-sceptics as the case for not investing in Africa. Spare a thought for Turkey though. I was in Istanbul recently, a thriving city with a population larger than London, and positioned perfectly between East and West. They are bordered by Iraq, Iran and Syria! That makes Zimbabwe look positively friendly!

So five years into the crisis and although things feel slightly better, it is difficult to tell whether that’s because an improvement is actually underway or because investors have become immune to volatility. Equally strong arguments can be made for both recovery and collapse.

Unfortunately, this uncertainty looks set to remain for some time to come. A good economic number injects some relief, and then shortly thereafter, a bad number from somewhere far away sees fear grip the world again. This week I may regret not having gone into the market three weeks ago; next week I’ll probably be thankful I didn’t. Such is the market at the moment: short or long, you’re uncomfortable.

Despite all of this however, global equity markets continue ticking up gradually. Although the mood of the market could change at any moment, sentiment feels a bit better. The reasons for this are fourfold:

· Globally interest rates are at record lows

· Trillions of dollars have been pumped into economies

· Investors are suffering ‘low yield’-fatigue

· There’s an enormous amount of money sitting on the sidelines, becoming increasingly worried that the best time to buy has been missed. Any weakness is therefore used as a buying opportunity, which limits potential downside.

In such an environment, investors will most likely continue to direct the majority of flows into multi- asset funds, or into developed market equities with strong dividend yields.

I was in Spain recently and I got asked by a Spaniard when we (SA) would go the same way as Zimbabwe, and my answer was probably a long time after Spain goes the same way as Greece!