Cyclical change ahead

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By Cees Bruggemans

The green shoots are apparently reaching higher.

A cyclical gear change is underway, in which 2Q2009 will show much less of a GDP decline than 1Q2009. Either 3Q2009 or 4Q2009 will probably show the first cyclical uptick in our output, heralding renewed expansion.

In the US, the May non-farm payrolls gave their first positive surprise, declining by ‘only’ 345 000 jobs. The market had expected a decline of 550 000, which would have been a more modest improvement from the 660 000 average declines these past six months.

The April payroll decline was simultaneously revised down by 25 000, reinforcing the perception of reducing job losses. As job losses are a lagging indicator, these changes reinforce the view of the US economy stabilizing and shortly (3Q2009) coming out of recession.

US unemployment in May still jumped to 9.4% from 8.9% in April, with 780 000 more people recorded as unemployed.

But less than half this unemployment increase was due to people actually losing their jobs in May. More than half the change was due to people previously retired from the labour force or simply not participating re-entering it out of necessity in search of work, possibly because of reduced wealth no longer underwriting their retirement plans adequately.

In South Africa, our forward-looking gauges are also increasingly picking up favourable changes in intended output even as actual data keeps reinforcing the stabilization theme.

Electricity production for April increased, lessening the year-on-year decline to -5.7% compared to -6% in March and -11% in February. Industrially, we are no longer falling off a cliff, as also reflected in actual manufacturing and mining output data.

The renamed Kasigo Purchasing Managers Index showed its first uptick since October, rising to 37.3. With the sub-index asking about business conditions six months out rising above 50, the signal is getting louder about 4Q2009 growth revival.

As is the case overseas, this is primarily at first an inventory phenomenon, as the reduction of inventories slows down and becomes less of a drag on output, allowing the latter to rise.

Simultaneously government spending globally is supporting consumer demand and substituting private fixed investment by boosting infrastructure.

Also important, but difficult to quantify, the shock reactions to global bank crisis conditions last September through December were probably overdone. With central banks and governments preventing ultimate collapse and engineering stabilization and repair, perceptions have swung around quite dramatically.

This can be observed in the greater risk appetite in equity markets as investors are gradually starting to vacate safe havens, but it is probably already going beyond this.

In the US there is speculation about consumer saving rates falling anew, never mind steadily rising further to much higher levels. Though it is early days, the composition of forces driving activity appears to be changing steadily, away from abrupt and severe decline, favouring stabilization and eventually new growth.

As to why, there are various explanations.

If one ceases to panic, defensive cutbacks to spending lose their vigour. Many such cutbacks were more in the way of postponements than actual permanent cancellations.

Cars still need to be replaced as they get older. One can temporarily delay replacement but not indefinitely, unless switching to another mode of transportation. World car demand in recent months has started rising again (even if subsidy-assisted in parts).

An important part of the industrial and export cutback in 4Q2008 was probably considerable overreaction tied to just-in-time business models. If a business is finely meshed with other suppliers and customers, any sudden change in conditions can set in motion a chain reaction.

If final customers get cold feet (many did in October), the entire global production chain experiences cardiac arrest as nobody wants to sit with unsold output (rising inventories), which is dead capital that needs servicing even as banks increased the cost of credit while reducing access thereto.

With the worst not happening, perceptions have moderated once again, stabilizing activity levels and in certain instances starting recovery. The operational cutbacks in many instances reduced reliance on bank credit.

Three important stimulants operated throughout.

Commodity prices collapsed last year (oil alone injecting the equivalent of a $350bn annualized tax cut in the US).

Government spending stabilizers and tax cuts kicked in, while the Fed engineered a 1.5% drop in mortgage rates which allowed many households to refinance mortgages more cheaply, improving their cash flow.

Technological innovation did not cease, improving productivity by 2.5% annually, as new knowledge allowed things to be done at lower cost or creating things that added to the force of creative destruction (consumers and businesses wanting or needing such items).

If one ends the panic withdrawal, stabilization comes first but ere long renewed expansion follows, given the spending and income forces aligning anew.

South Africa is closely following in the global slipstream, with the US, Japan and China in the lead.

Though we are currently still experiencing the worst of times, stabilization is already months underway and the first general uptick in GDP is very close, even if the data will take time divulging its mysterious secrets.

Source: Cees Bruggemans, FNB, June 8, 2009.

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