It’s passing through the system… slowly but surely

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By Jeremy Gardiner

As expected, the first quarter of 2008 produced more sub-prime write-downs, more US housing market turmoil, more US dollar weakness, more recessionary fears, higher inflation and fuel prices and fortunately for the US, lower interest rates.

Back home, the picture is much the same, yet milder. SA doesn’t have sub-prime issues; our housing market is weak but not collapsing; the rand has weakened; we don’t have recessionary fears, but we do have high inflation, fuel and food prices and, unlike the Americans, we have not had the luxury of rate cuts.

The UK situation is also similar to that in the US, but milder, and their rate cuts are about to start. They will probably see a full 2% in total, which should help our ailing currency to make up some ground against sterling.

The rand has shown a bit of life recently, which was entirely predictable. The first quarter saw the rand oversold by currency investors who, having gone overweight in other emerging-market currencies, needed someone to short. Given our massive current account deficit, we were seen as vulnerable and, of course, power problems (both electronically and politically) made us an easy choice to underweight. The currency turned a week ago and people have had to unwind those positions, hence the recent strength. Long term, however, position yourself for a weaker rand; it’s more likely than not.

Unfortunately, the rampant oil price has stoked both the petrol price and hence inflation. However, embattled SA consumers can take relief from the fact that we are either at, or close to, the peak of this interest rate cycle. Unfortunately, we don’t see much relief before the second half of 2009.

There is no doubt that economically the world (and SA) remains very much in the “eye of the storm”. And it’s not over yet. The US appears already in recession and won’t lift until the second half of 2008 at the earliest. There will be more sub-prime write-downs (although probably fewer than we have seen); there will be more US housing market weakness (although less than we have seen); more US$ weakness (also less than we have seen) and more inflation, fuel price hikes and equity market weakness (although also less than we have seen).

So what are we saying? In essence, we have probably seen the worst. We are probably about 60% of the way through the sub-prime debacle. Equity markets are not expensive, the US is bottoming out and equity investors are looking six months ahead.

A lot of money has been building up on the sidelines waiting for a chance to get back into the market, and what recent market strength has shown is that there are some powerful investors who believe that the worst is over and are starting to phase money in.

A word of caution though: we are only two thirds of the way through. It will still be bumpy and at times unpleasant, but it looks as though the second half of 2008 should see the mood lift.

Source: Jeremy Gardiner, Investec Asset Management, April 8, 2008.

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