The anomalous business upswing

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By Cees Bruggemans, Chief Economist of FNB.

We are told things are ‘unusually uncertain’. That certainly applies to some countries, and to some sectors.

But how unusually uncertain is South Africa’s new business upswing really? Is there reason for worry? And what policy action may we still expect, if any?

No two business cycles are ever quite the same. Their upswings, peaks, downswings and troughs all differ, mostly minutely but sometimes more than average, in length, amplitude and rate of change.

Any deviations from the known ‘norm’ are mostly nothing major. But given all this talk about our recent recession, its abruptness and depth, and an upswing that feels fragile and mediocre, is there reason for concern that times remain unusually unsettled?

I detect at least six anomalies in the current upswing, not all of which may be recognized as such. It leads to conflicting implications.

The overall impression is one of ‘normalcy’ (itself apparently a surprise), with some sector upside bias and some sector downside bias, with if anything the downside bias risking being overwhelmed by upside events.


Anomaly One: Overall RSA business cycle remains ‘normal’

It may not strike as self-evident, with many complaining these are unusual times, but our business cycle is showing nothing out of the ordinary overall.

Using BER business opinion data, making up the RMB/BER business confidence index, one gets a nice proxy for the economy’s progression (confirmed by real GDP data).

If there was anything unusual it was the slow ascent of the upswing during 1999-2004 (previous upturns in business confidence peaked twice as fast). Also, that expansion lasted much longer (twice the average length of modern times, half of it at peak intensity).

From reaching a cyclical high in late 2007, not out of line with previous cyclical peaks, cycle termination came by way of shock, business confidence thereafter plunging.

Some 18 months later, in mid-2009, business confidence hit bottom, not quite as low as the average of foregoing business cycle troughs these past 40 years, but close enough to qualify as a ‘normal’ (if mild) trough.

Since 3Q2009 the economy has been in recovery mode, and overall business confidence with it, by 3Q2010 reaching 47, which was double its 23 low of a year earlier.

This rate of progress was normal, with the turning point in business confidence just ahead of the actual business cycle turning, and thereafter advancing in a manner closely resembling previous cyclical upturns.

If there was anything unusual, it was the trough not being as low as average (contrary to general impression), but this is explained by one specific sector (retail).

Verdict: this is a normal business cycle turning, somewhat mild going by averages, but descent and new recovery fully in line with ‘normality’, though accompanied by a number of sector anomalies.


Anomaly Two: Manufacturing is having a normal cycle.

As for the business cycle overall, it may come across as peculiar to describe manufacturing as having a normal cycle, with the Rand so strong and so many people describing manufacturing stress as exceptional.

Yet manufacturing is having a very average rebound so far, both in terms of BER opinion data and StatsSa output data. Peaking out, going into the downswing, bottoming, entering recovery and now taking off. None of it is really out of the ordinary compared with previous cycles.


Anomaly Three: Motor Trade off the charts

Something rather startling happened in new motor vehicles. This confidence index went from hero to zero. But is that really unusual in a sector known as a shock absorber for the economy because of its flexible replacement cycle?

The motor trade also had extreme cycles in 1976/77 and again in 1985 when its business confidence trough also hit zero.

Yet these cyclical peaks and troughs are not out of the ordinary. Besides a relatively slow and long ascent and long stay in peak territory (1999-2006), the descent was also long, driven by an extraordinary long postponement of replacement.

When recovery came from late 2009, the trade had been heavily shaken out. As the replacement cycle started its (long) normalization in 2010, the rapid rebound in car sales favoured the reduced numbers of motor dealer survivors, causing their confidence to rocket back to 80 in the shortest possible time by 3Q2010.

Verdict: long replacement delay, leading to major motor trade shake out and zero confidence, now followed by the start of normalization of replacement demand driving car sales higher, creating joy for the remaining motor dealers. From here it is business as usual as a rapid recovery takes hold.


Anomaly Four: Prolonged building slump

Something out of the ordinary has been happening here all right. First a progression of building cycles losing amplitude in the 1970s, 1980s and 1990s as lack of political confidence, intensifying economic stagnation and rising inflation and interest rate levels zapped the industry.

Then a few years into the new political dispensation post-1994 the tide turned, with structurally collapsing inflation and interest rates. Thus the 1999-2007 building boom reached grotesque cyclical proportions, in terms of exceptional height of the peak in building contractor confidence, its extended condition, and thereafter the fatal plunge.

So the building boom of this past decade was itself totally extraordinary in a four decade period, going by expressed building confidence.

But the ending of the boom has been as extraordinary. For the trough of the past year in building contractor confidence is nowhere as low as what could be termed ‘average’, this despite the steep falloff in activity and the shakeout among builders and developers, and the deep moroseness observable everywhere in the trade.

One telling remark about opinion surveys is that only the survivors keep participating. And if some haven’t gone under because they salted away some buffers, they may not yet have given up hope of seeing a ‘normal’ recovery coming into view.

So the high trough may simply be a reflection of the remarkably rich building cycle that preceded it.

More ominously, the building cycle tends to bottom and turn up BEFORE the broader business cycle. Not this time, with the building data and building contractor confidence still very weak a full year after the broader business cycle started turning up.

Also, the building sector tends to bottom a year into an interest rate cutting cycle. Well, we are already approaching the two year mark (this coming December) and the building industry has yet to convince it has turned the corner.

This seems to be a function of overhangs. Not only household debt, but housing and durable consumer stock generally. A new sobriety seems to have taken hold, as much at banks restructuring their credit criteria as among many overextended households.

This is making for a very deep and elongated playout. Indeed, for some it seems like a recession that could be turning into a long depression as it takes forever for households to deleverage while banks stick to their new found disciplines (Credit Act and common sense assisted).

There certainly is a major household adjustment underway, but it may not last as long as what is generally feared. But first let’s just have confirmation about the obvious.


Anomaly Five: Credit gone crazy and now shaking out

This is no longer news. Too much debt was taken up and a new National Credit Act was launched. An inflation scare and interest rate shock sunk the local business cycle, but global financial crises doubled up as a fearful reaction set in, changing credit behaviour and inviting a deep and prolonged debt deleveraging.

Nearly two years into a deep interest rate cutting cycle, with prime now 6% down from its 15.5% peak, and yet household credit is still only growing by 4% annually and overall credit by 2%.

But then household debt as share of disposable income has peaked at 82% and is now down to about 75% (if one extrapolates known data). That’s not yet enough, bearing in mind the working of the National Credit Act, the way the banks have adjusted their credit practices and the way households also seem to have adjusted their buying and debt patterns.

The view has taken hold that changing all this will take a long time. But one has to be careful not to extrapolate to zero. For the upside bias may take hold earlier than imagined, especially with real incomes recovering, debt receding, interest rates way down (and likely to stay down, possibly through early 2012) and asset markets recovering (improving wealth effects).

On this score look for inspiration in the next anomaly.


Anomaly Six: Retail surprises with its vitality

Small shopkeepers may have failed in droves, as you would expect in a major recession as discretionary purchases dwindle, but also strengthening the larger retailers, especially the chains, despite defensive trading down. And with the survivors continuing to participate in opinion surveys, why should one be surprised by an upbeat story while the retail data really did go negative?

Yet this retailing cycle was way different from what went before, indeed the past decade in many ways the inverse of the preceding decade, to such a degree that one can ask whether there really is a cyclical norm in RSA retailing at present?

Retail business confidence in 2008/09 barely fell below the neutral line (50) whereas a plunge towards 10-20 would have been ‘normal’.

This is not easily explained, with retail volumes and SARB consumption data all showing real declines.

Yet it dovetails perfectly with observed FNB/BER consumer confidence data. The recession was real, but seems to have bypassed greater numbers of consumers than is usually the case in recessions, with the recovery in sentiment early and vigorous.

The deepening financial heartache and unemployment pain did not this time show up as strong as usually is the case in down cycles in BER retail confidence or FNB/BER consumer confidence readings.

If this comes across as unreal, the pain was felt mainly by retailers going out of business (and no longer registering their voice) and was perhaps concentrated among the minority of consumers expressing a lack of confidence.

But this was not unique. It happens every cycle as this is how these surveys are structured.

This suggests retailers and consumers in the main experienced this cyclical trough and recovery differently from how many others outside these niches did.

It furthermore suggests an earlier and more vigorous consumption comeback than perhaps foretold by markets, credit, jobs and other more strained sectors.

Source: Cees Bruggemans, First National Bank, September 14, 2010.

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