The year of living dangerously

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By Jeremy Gardiner

Before we delve into what surprises may lurk during the “Year of the Rat” it is important to reflect on what was delivered by “the Year of the Pig”. “The Pig” proved to be a year of many surprises. As the beginning of 2007 dawned, many of the World’s leading investment bank CEOs had no idea of the subprime carnage that they were sitting on, nor that by year-end they would have suffered very public executions. Many US homeowners had not budgeted for their house prices to come down and very few believed that two US dollars would buy only one English pound. Western investors thought emerging markets may once again outperform developed markets, but not by four times!

Not a surprise, but still not pleasant, were rising inflation, interest rates, oil prices and a rapidly slowing US economy.

Back home, predictions for the year of ‘more of the same, but slower’ proved accurate. The stock market rose a satisfying 19%, house prices rose, albeit slower, and the economy grew close to 5%, a little slower than before. However, there are some fairly significant changes underway, both economically and politically, which could influence our future dramatically over the next 12-18 months.

So what then lies in store from “the Rat”?

The subprime mess will drag on throughout the year. There will be more losses and more casualties.

US homeowners will feel more pain and this should spread across the Atlantic to the UK and Europe, and possibly even further.

Home equity withdrawals, the alcohol that has fuelled the debt-driven party in the US, are over, and the hangover has finally set in. This will significantly impact consumer spending.

Growth will slow substantially and the chances of a US recession are significant.

World growth will moderate as a result.

The US dollar will remain under pressure.

Geopolitically, Iraq remains a mess, Iran defiant and Pakistan is armed, nuclear, dangerous and ungoverned and according to The Economist, is the “world’s most dangerous place”.

Oil will remain higher rather than lower.

US rates will drop in an attempt to resuscitate the economy, which will further weaken the US dollar.

And back home:

Higher interest rates, food and petrol prices coupled with the new Credit Act have effectively ended our consumer party that has significantly contributed to growth and earnings over the past 4-5 years.

House prices, in line with global trends, should slow further, and declines will be seen in certain areas, particularly some of the buy-to-let areas.

Political wrangling looks set to continue for some time. We can only hope that the ANC Government and the Party find common ground on how to work together, rather than the persistent conflict which we are seeing at the moment.

It appears, at this stage, that the post-Polokwane leadership of the ANC understands the importance of maintaining current economic policies and foreign investor confidence. It is, however, early days yet and both words and actions will have to be closely monitored.

The rand was essentially flat last year, but should continue its hopefully gradual decline going forward. The Zuma camp is likely to favour a weaker rand in order to stimulate manufacturing growth and employment. This would obviously have implications for inflation, rendering bonds unattractive and reigniting interest in offshore investments.

The good news for SA is that while we have our economic problems, Western economies look set for a worse year yet again. While our consumer party is over, corporate spend is finally starting to accelerate, and Government’s massive infrastructure programme over the next three to five years will drive growth, earnings and jobs, so we should therefore avoid the slump that the developed world is staring in the face right now.

Finally, liquidity injections in the form of rate cuts in the developed world may reenergise markets, and the weaker US dollar will further boost American exports. Asia remains strong and assuming you don’t have a complete housing/subprime meltdown, you should see a world that slows but doesn’t stumble.

Yes it will be a bumpy year, but if it’s any consolation, most of it is not news to the markets and is hopefully already in the price.

Source: Jeremy Gardiner, Investec Asset Management, January 9, 2007.

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