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A long term view

20 January 2005 Angelo Coppola

One of the most talked about issues in South Africa over the last few years has certainly been the booming consumption side of the economy and the impact this has had on general economic prosperity.

Neels van Schaik of Alphen Asset Management says the one thing that is quite clear is the effectiveness of the monetary policy transmission mechanism in stimulating economic growth through lower interest rates.

In 2003 we made a lot of effort to provide our readers with an idea of the impact that declining interest rates would have on the wellbeing of SA Inc. and its consumers. Needless to say, history has once again repeated itself and this time not even in a different form.

Since interest rates reached their cyclical peak in 2003 at 17%, the general retail sector has returned 200% to the advocates who invested in April 2003.

Interest rates remain one of the most effective monetary tools to manage the business cycle, assuming of course that central banks can effectively implement the monetary decisions.

It is evident that interest rates have played an important/vital role in bringing South Africa's economic growth closer to its full potential.

By the way, the debt servicing cost as a percentage of disposable income over the last few years has fallen to 10 year lows. This is a function of investors forcing down their overall debt levels after the interest rate shock of 1998, as well as falling interest rates.

South Africans with a similar capitalistic mentality as our developed peers, of course, can't wait to get to the malls when they have excess cash.

This desire to spend cash explains the close relationship between growth in disposable income and growth in consumption. Personal consumption expenditure is being used in this case, but the currently surging retail sales would have given the same picture.

All this information is of course history and the more important question is: how to effectively use this for future decision making?

Many a word has been spoken about the emerging black middle class and the effect that it will have on consumption going forward.

I am indeed one of the first who will acknowledge this, but the important point is that this sector remains susceptible to interest rate movements and a turning point in the interest rate cycle will cause a slow down in disposable income growth as well as consumption growth.

This is when the demand for credit should be closely watched, which is of course a separate topic.

What seems to be clear is the fact that the widening of the consumption base in the financial system will go a long way in ridding the economy of the boom-bust cycles we were used to in the 1980's. This still does not eliminate the cyclicality of the sector though.

In a period where the currency and deflation played havoc with merchandisers, the retail sector still managed to deliver record profits and volume growth.

Although this growth is likely to continue in the next few years, it will be at more subdued levels. The sector looks overdone in the short term from a technical perspective, but is likely to squeeze out profit-growth-correlated returns in the next 12 months.

Interest rates will remain on hold in the next quarter and will be supportive of South Africa's economic fundamentals. For these reasons, there remains a place in a portfolio for retail stocks over the longer-term.

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