Are we in for a repeat of the 1930s style recession?
When sub-prime was first diagnosed the economic experts were at pains to quantify the problem. One after the other they offered estimates of the losses that banks might incur. And one after the other they were forced to raise these estimates. Even Federal
The focus has now moved from quantifying the disaster to determining for how long it will afflict the global economy. And the prognosis is not good. While investment gurus like Warren Buffett suggest you should buy equities while others are fearful, there are those who warn that today’s purchases might languish for the next six to eight years. One such commentator is local entrepreneur Johan Rupert. He recently told a gathering of VenFin shareholders that he wouldn’t be buying equities unless prepared to hold them for the long-term.
Are we in for a decade-long recession like that witnessed in the US in the 1930s? And if we are – what case can be made for investment in locally listed shares. Metropolitan Asset Managers head of equity research, Johan de Kock explored this question in a recent presentation titled, “Credit crisis: long term investment implications.”
Putting the ‘decoupling’ and other theories to bed
At the outset De Kock made it clear that the decoupling theory espoused by numerous market commentators in recent years is now a moot point. We have absolute proof that the so-called BRICs (Brazil, Russia, India and China) are just as susceptible to hiccups in the US economy as ever before. South Africa, with all its emerging market promise, will also be affected. We’ve already seen the impact of a strong sell-off in precious metals, with gold and platinum prices fractions of their March and April 2008 highs. The gold mining sector will undoubtedly bleed jobs in the next 24 months as large mines scale back production and shelve capital projects. Smaller exploratory outfits might disappear completely.
Another scenario that can be ruled out is the ‘soft landing’ that many predicted for the US. They suggested that growth would slow; but not reverse. This might have been the case while financial markets remained robust. But with banks and financial companies closing their doors at an unprecedented rate the reality is much uglier. The US economy has crashed – and it’s crashed hard!
That leaves us with the rather unenviable possibility of a long recession similar to that experienced in the US in the 1930s. De Kock notes that the US Dow Jones Industrial average often stagnates for extended periods of time. It was flat for 26 years beginning around 1917 – and was in a rut for 18 years from 1966. So we shouldn’t expect the unimpressive returns that started in 2000 to be over any time soon. The difference between now and the 1930s is that the world is more organised. Governments have acted swiftly to restore confidence in financial markets. And for the most part, companies are in relatively strong financial positions. This is particularly true for South Africa where corporate balance sheets are extremely solid right now.
On de-leveraging, risk expectations and monumental blunders
Gearing is the process of maximising the return on available capital. It didn’t take banks long to realise that they could make more money by using their assets aggressively. By the time the US realised that their banks were in trouble, the average gearing on bank balance sheets had reached 19 times. The now defunct Lehman Brothers was reportedly geared no less than 57 times... The US was simply snowed in under piles of debt.
South Africa presents a totally different picture. Our consumers ran into trouble recently due to servicing costs rather than levels of debt. In other words, the costs of paying back our cars, mortgages and other debts has become inhibitive as interest rates creep ever higher. And we still have a lifeline in the form of future interest rate cuts. The US doesn’t have this advantage because their prime lending rate is a low 1.5%. Besides, low interest rates in the US were part of what caused the problem in the first place.
Everything points to a severe global slowdown; but nobody is taking notice. Under the current circumstances the International Monetary Fund October 2008 estimates for world growth are hopelessly overstated. To suggest the world will experience two years of moderately slower growth makes little sense – and this estimate will eventually emerge as another monumental IMF blunder.
What to expect from South African equities
De Kock identified a number of trends that should guide investors in the next year. The shortage of capital will result in relatively less share buy-backs. Companies that have to a degree underpinned their share prices by purchasing their own shares on the open market will thus suffer; these include the likes of BHP Billiton and Anglo American. Capital shortages will impact on the countries infrastructure expenditures, particularly private sector spend, which could put a cap on prospects for PPC and related construction sector shares. Although balance sheets remain strong he expects companies in capital intensive industries to suffer. This means avoiding counters like Sappi, Mondi and the steel giants, Arcelor Mittal and Hiveld Steel. Commodities don’t make compelling investment cases in the short-term either.
On the positive side, investors should focus on companies with strong cash flows. The usual defensive shares get the nod. Newly listed British America Tobacco (BAT), SA Breweries and Tiger Brands look promising. And retailers like Spare and Shoprite Checkers are in the right segment of the market. He suggests you cannot go much wrong with a cash cow like MTN either. And remember, most of the bad news is already discounted!
Editor’s thoughts:
Global stock markets have been see-sawing of late. One day up 5%, the next down by the same amount. These unprecedented levels of volatility make it very difficult for asset managers, particularly when they have to advise clients to stay the course. Have you found that client interactions are more difficult in tougher economic conditions? Add your comments below, or send them to [email protected]
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