Comments on the SARB leading indicator

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By Cees Bruggemans, Chief Economist FNB.

The SARB leading indicator peaked at 127.2 in March 2007, thereafter declining for two years, initially gradually during 2007 but acquiring freefall proportions in 2008.

This indicator hit a cyclical low of 105.3 in March 2009, thereafter rising very rapidly to 112.5 by August 2009.

Given the events of 2008 and early 2009, there presumably exists no surprise regarding the indicator’s freefall in 2008. But what has made it rise so phoenix-like rapidly since March this year?

As per the June 2007 issue of the SARB Quarterly Bulletin, this leading index today is a composite of twelve individual time series which together offer superior forward-looking ability regarding the South African business cycle, leading turning points by some six to nine months.

The twelve time series can be grouped in four distinct sub-categories, each making a peculiar contribution to the behaviour of the composite indicator.

The four sub-groups are financial (3), global (2), real sector (4) and business opinion surveys (3).

Not all these time series are obvious candidates for predicting a cyclical turn in the broader economy, so sometimes counterintuitive reasoning may be required.

The financial sub-group includes three time series:

• the JSE All Share Index

• the interest rate spread between 10 year government bonds and 91 day Treasury bills

• real M1 money supply (deflated by CPI, 6 month smoothed growth).

The obvious predictor is the JSE All Share index, bottoming in March 2009 and thereafter rising by nearly 50% to date.

But possibly as powerful, and earlier into change mode, is the interest rate spread. As the market correctly anticipated the SARB’s interest rate cutting cycle from late last year, it collapsed 3-month TB yields, indeed much faster than what it lowered 10-year bond yields. This fall in interest rate spread encourages increased risk-taking, leverage and longer term commitments.

M1 money supply is roughly the cash base of the economy. When deflated by CPI inflation, it gives an indication of whether cash is accumulating or whether cash in real terms is being put to work in the economy. This one is not visible to most of us, but it yields a powerful indication of what the economy is doing and what it will be doing next.

The global sub-group contains two time series, namely:

• Dollar index of a basket of South African commodity exports

• Composite leading indicator of South Africa’s major trading partners (percentage change with year ago).

There have been very clear signals from overseas leading indicators. Nearly all have been recovering steeply this year as the world came back from the brink, indicative for an open economy like South Africa that the future demand for its exports should improve. We saw evidence of this in recent steel output trends (recovering steeply) and car exports (October being higher).

As to the commodity picture, things aren’t as clear. The Dollar gold price has risen by some 30% this year to top $1090 and the Dollar platinum price has fallen by 40% towards $1350. One still has to add coal, diamonds and iron ore prices (to get 80% of our commodity exports). On balance things have improved from their depressed lows late last year.

The real economy sub-group contains four time series:

• Job advertisement space in the Sunday Times (percentage change with year ago)

• New passenger cars sold (the percentage change with year ago)

• Number of residential building plans passed (flats, townhouses, houses >80m2)

• Gross operating surplus/GDP

Here one has to be careful. When the economy is in freefall, the change year/on/year is rapidly becoming very negative.

Then, as activity stabilises, the year/on/year change starts to become less dire with every passing month as the still falling base level plays catch-up with the stabilizing present activity levels.

This dwindling negative is interpreted as a positive development, indicative that positive growth looms ahead (once the base has reached the lowest point in the cycle while the latest data has started to advance).

Job advertisement space on this basis is apparently more believable (and so easily obtainable, weekly even) than labour statistics, household income estimates or spending estimates, and an early harbinger of more fulsome changes to come.

Follow the employers in their early exuberance and in their angst as they open and close the hiring tap, often at short notice as their future views (about the economy and their operating needs) change very, very minutely.

As to broad durable goods, all being very debt-and-interest-rate sensitive, nothing is as easily obtainable as monthly NAAMSA car sales data.

What can be said about both these time series? They fell out of bed in 2008 and early 2009, and seem to have stabilized of late?

Passenger car sales certainly have, with October’s sales volume now only 3% down on a year ago, compared to over 30% down earlier in 2009, as car sales continue to bottom out (and the year ago base keeps on playing catch-up).

Still, the motor industry expects only a very slow rise through next year (7%-8% gain from truly bombed out sales levels) as households continue to resist replacing their gradually aging cars.

As to Sunday Times job advertising space, have you been counting the number of pages advertised lately? Stabilising already for some time, yes, if at abysmal low levels? Both these indices suggest a turn in the making.

The number of residential building plans passed has fallen so low earlier this year they couldn’t possibly keep falling. That’s the turn. But you have to mine the data to pick the month and declare the turn.

As to operating profits and depreciation as a share of national income, these quarterly estimates are difficult to assess for most of us, not having access to the right information. Still, there are pointers.

Corporate tax collections are one hint (the Minister has found these plummeting so far). Company results are another important source of public information.

Companies are always eager to protect their cash flows in downturns and to start firming them ahead of everything else (mainly by cutting costs and improving labour productivity). That is also what the JSE All Share Index is sensitive about.

Both these information sources basically discount the same thing, only share prices are reported daily, and gross operating surplus quarterly (but there may be monthly estimates).

Lastly, we have the business opinion sub-group, based on BER opinion survey data, namely:

• business confidence of manufacturers, construction and the retail and wholesale trades

• net balance of manufacturers showing an increase in their average hours worked per factory worker (this data carries a half weight)

• net balance of manufacturers showing increased volume of orders received (also carries a half weight).

The RMB/BER business confidence index hasn’t turned yet. More difficult to judge is whether the net balance of manufacturers showing increased average hours worked has started to improve. But the volume of orders received has been going up for months now, according to the Kagiso/BER Purchasing Managers’ Index.

So where does that leave us?

A quick and really dirty tally suggests that at least seven of these 12 time series have been improving impressively, intuitively and otherwise year/on/year. In no particular ranking we have strong positives from:

* JSE All Share Index

* Composite leading indicators of SA trade partners

* interest spread (10-yr yield minus 91-day TB yield)

* net balance of manufacturers experiencing increased volume of orders received

* new passenger cars sold, change on a year ago

* job advertisement space, change on a year ago

* number of residential building plans passed

I feel less clear about two sub-indicators:

• Dollar index of SA export commodities (up, but how much?)

• Net balance of manufacturers increasing average hours worked per factory worker (cutting staff so fast of late, the average hours worked can only be improving?).

And then there are the imponderables:

• business confidence (yet to turn?)

• real M1 money supply smoothed 6 monthly (doing precisely what?)

• gross operating surplus/GDP (presumably stabilizing of late, but how fast, and what kind of turn?).

So is there hope? But of course. There always is. Just a matter of time. And timing. Led by the financials and overseas (each in turn led by central banks). The rest comes naturally, if slightly more sedately.

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

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