Volatility returns as Greece falters
The European Union (EU) is in a shambles. A group of countries known as the PIIGS (Portugal, Italy, Irelands, Greece and Spain) are teetering on the brink of bankruptcy. How could this happen? Governments in these countries have simply spent too much in reckless attempts to meet promises to their respective electorates. In Greece the wheels came off when government debt as a percentage of GDP reached 125%. What this means is the annual production of goods and services in Greece is less than its public sector debt. To place things in context, South Africa’s debt to GDP is currently in the mid-20%, and forecast to spike to 44% by 2014. Of course South Africa Inc doesn’t look as good when you add various municipal debts to the total; but that’s a subject for another newsletter.
The battle for global financial stability has moved from bailouts for banks to bailouts for entire countries. As the EU, International Monetary Fund and various central banks from around the world try to come up with a rescue package for the Euro-zone – rumoured to run to at least $1trn – world equity markets have returned to sub-prime volatility. Markets went into freefall on Friday, 7 May 2010, and investors watched as the JSE All Share index shed 998 points! A diversified equity portfolio worth R1m at Thursday’s close would have been worth R963 726 24-hours later. But on Monday the market recovered its losses – gaining 1 147 points – for an unprecedented 4.3% single-day gain!
A ‘double dip’ recession
Volatile markets might be great for day traders; but they make it difficult for long-term investors to stick to their plans. Analysts have already warned investors not to expect a stellar performance from South African equities through 2010, with the most optimistic among them pencilling in nominal returns in the region of 15%. As an aside, recent price activity includes swings of approximately a third of the total expected annual market return in a single day!
There’s bound to be more volatility in coming months as the EU crisis plays out. In the worst case scenario we could end up with a significant market correction – with shares declining from the latest close (27 662 on Monday, 10 May 2010) to around the 20 000 mark. This scenario represents the ‘double dip’ recession so many economists warned about. Instead of a ‘V’ shaped recovery we’ll end up with a ‘W’ shape – and we’ve already started on the next downward leg! A delay in economic recovery isn’t that far fetched. The statistics suggest much of the current ‘recovery’ is due to restocking or inventories rather than actual demand. Does this mean South Africa will record another period of negative GDP growth? That’s highly unlikely; but we’re certainly in for a slower economic recovery than previously expected.
Commodities hold the key
Local growth is still linked to commodity prices. The JSE All Share index is dominated by resource-rich companies like Anglo American, BHP Billiton and Sasol. The recent market hiccup is echoed in these individual shares. Anglo American (JSE: AGL) fell 3.88% on Friday, to R283.78/share before recovering 7.36% on Monday, to R304.68. We need strong commodity prices to support the economic recovery – not because of what these prices mean to the local mining sector – but rather because of the link between strong prices and recovery-linked global demand! Mining companies also need the rand to play along. Recent commodity price improvements haven’t improved the bottom line because of the fantastic performance by the rand against a basket of currencies.
On the rand and interest rates
Is the rand too strong? If you believe the Congress of South African Trade Unions (Cosatu) then the answer is a resounding “yes”. The group recently issued a joint declaration by the country’s three major trade union federations and a selection of manufacturing concerns. Cosatu secretary general, Zwelinzima Vavi notes: “The declaration calls for interventions to ensure an appropriately valued, competitive and stable currency.” And by appropriately valued they don’t mean stronger! They want government intervention similar to that applied in China. “Government from time to time speaks about the need for the rand to reach a competitive level, but we only really hear this in the budget speech or the state of the nation address,” said Vavi.
The strong rand is hampering performance in both mining and manufacturing sectors. Mines earn dollar-based revenues linked to global commodity prices and manufacturers export their goods into competitive foreign exchange markets. The strong rand is partly to blame for recent job losses. Statistics SA reveals 171 000 job losses in the latest quarter, despite government’s claim of creating around 500 000 job opportunities over the past year. Clearly something has to give!
The relief might come by way of another interest rate cut. “Domestic economic conditions and the global outlook for inflation allow the Reserve Bank to reduce interest rates further without compromising on its mandate to keep inflation within the target range of 3% to 6% per cent,” says Dr Sheshi Kaniki, senior economist Momentum. “Another rate cut could be less of a surprise than the last one.”
Editor’s thoughts: All attention is focused on Europe to see if the region can work through its debt crisis. This time around, nobody is suggesting the emerging economies will emerge from the crisis unscathed. Meanwhile local fiscal and monetary policy decisions must be made to best serve the domestic economy. Would you approve of an economic policy that resulted in a swifter devaluation of the rand? Add your comment below, or send it to [email protected]
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