Business and Investment cycles: Where are we now?
Understanding where we are in the business and investment cycles can help investors make better investment decisions.
The business cycle is under a huge amount of pressure. The recently released PMI figure at a level of 33.2 firmly confirmed that the South African economy is in a recession. Another indicator which reinforces the absolute negative position of the economy is consumer spending, with inter alia vehicle sales falling of the proverbial cliff.
Interest rate dilemma
To counter this negativity the SA Reserve Bank is cutting interest rates at a rapid pace. However, the Bank started a bit late and is now playing catch up with other central banks. Our central bank faces a dilemma in that our inflation rate is not coming down as fast as was hoped for. If the Reserve Bank cuts too much it runs the risk of reigniting inflation and by not cutting enough it may reinforce the recession.
The South African rand has strengthened quite significantly (by 28%), but it must be remembered that the rand is still 9% weaker than a year ago. A strong rand will help in the fight against inflation, but it will also place our already precarious Balance of Payments under more pressure.
The investment cycle
From an investment cycle perspective things look completely different. A number of US indicators are improving. As the largest economy in the world and the driver of sentiment on markets, the US market provides guidance regarding the investment cycle.
Positives include a rapid recovery in the copper price as well as a more realistic level for sea freight prices. The Baltic dry index fell by as much as 95% last year, but since December 2008 has recovered by 160%. Together with an oil price that is slowly rising back to a correct level of $60 per barrel, these are indications that there is life after all in the real economy.
Fear factor
The fear factor in the US is also subsiding. It can be seen in rising government bond yields as well as a narrowing in the so called Ted spread, which is an indication of credit risk. The Volatility index, the so-called Vix, is also declining and indicates that investors are much more relaxed about the immediate future.
Negatives are deflationary pressures possibly taking hold in the US and still very low levels of consumer confidence.
Equity markets
Interestingly, equity markets don't react negatively to bad news any more. Equity markets throughout the world has risen significantly since middle March, reacting positively to lower interest rates and a determination by policy makers to prevent major economies sliding into deflation and depression.
The programme of quantitative easing by the Fed and the Bank of England shows that policy makers will overcome the problem with liquidity. Investors and speculators who fight the Fed will do so at their own peril.
Looking at various measures, most equity markets are cheap. Since 1982 and 2003, when the SA equity market relative to bonds was as cheap as it is today, our equity market rose by more than 300% in the subsequent five years. Can it happen again? Undoubtedly yes, unless you believe that it is different this time round.
It is a well known fact that the time to buy the market is when news flow is extremely negative, which is certainly the case now. It is always difficult to invest with confidence when you are faced with these issues, but the time to buy is when "blood flows in the streets".
