Investment Postcards from Cape Town

By Cees Bruggemans, Chief Economist of FNB.

Another good week of data releases, suggesting economic recovery is on track, steadily climbing out of the hole that was 2008-2009.

Electricity output rose robustly further in January, indicative our electricity-intensive sectors are steadily expanding.

With only 17% of electricity consumed by households (and the paying ones trying to achieve savings), it is the remaining 83% going into industry that tells you the economy is on the recovery trail.

Bad news is that electricity output is now at mid2008 levels. Increasingly we are re-entering the strained ceiling condition. Though we can probably stretch this output condition beyond the 2010 World Cup, one already notices short local brownouts in parts of the country.

It may just be a matter of failing municipal service delivery and infrastructure, neither coming as huge surprises, but this may allow us to stretch the available electricity just a little bit further.

Besides, this is so unremarkable in its own right elsewhere in the developing world (though not in the rich world), that it probably shouldn’t draw attention. That’s the problem with having been richly blessed and this no longer matter-of-factly being the case.

Thus the nice gains now observable in mining output, with its output trend line in recent months finally off the floor and starting a long ascent (though not in gold mining). This might ultimately not get capped by world market conditions (which are remaining rather blue sky) as by our own ability to generate electricity.

On this score it is gratifying to note how haste is now apparently being made to encourage as many producers to self-generate electricity and sell into the national grid. Mention is made of over 5000mw potential. That’s good going, at least 15% of Eskom supply, and would lift the capping ceiling on our growth if it can be made available soon.

This is also important for manufacturing output where especially the heavies (iron and steel, motor manufacturing, petrochemicals) remained the big growth lifters in January. Electricity supply will remain central to these major exporters being able to continue to do their good work, with Volkswagen winning a huge new contract potentially doubling its export activity.

Though manufacturing activity dipped in a minor way in January, this was not a major surprise following the steep preceding monthly increases, with its output trend line rising nicely now, in line with export recovery globally-driven and the inventory normalization underway following panic interruptions in 4Q2008 and 1H2009.

Thus the Kagiso Purchasing Managers Index jump to 60 earlier this month wasn’t an empty gesture, but very much signaled order flows are improving over a widening front as our recovery gains momentum.

This was further borne out by one of the biggest quarterly jumps in business confidence as the RMB/BER business confidence index gained 15 points in 1Q2010, rising from +28 to +43 points.

Though early stages of economic upswings do tend to see such very large jumps (compare 2H1999), in manufacturing confidence especially given that recoveries from recessions always have inventory distortions achieving early normalization, this time it is the combined recovery of impaired exports, depleted inventories and repressed consumer durables (cars!) that are coming ashore together in a combined rush to higher levels.

The stock market also responded favourably, the JSE All Share index moving back above 28 000, though one can never be sure whether this is in response to local news or whether it is purely the global heaving doing the lifting. With risk averseness again in abeyance, and the US consumer in the ascent, stock markets are apparently again seeking higher levels.

Regarding the RMB/BER business confidence rise, it remains useful to appreciate that wholesaling readings tend to be volatile (often adding air to the index).

But the minor lift in building confidence to +30 is probably very genuine (if still depressingly low), the promising increase in manufacturing confidence to +28 very realistic, the exuberant doubling in motor dealer confidence to 60 understandable (if somewhat exuberant, given depressed conditions), but the really fascinating move is by retailers (also lifting, but from already very elevated levels, never having shown truly recessionary plunging as other sectors did).

The retailing move to +51 suggests the end (or imminent end) to the depressed retail volume trend, something that so far has taken its time coming. But many quoted retailing companies (Shoprite-Checkers, Woolies, Spar, Lewis, Mr Price) have had good results lately and something might well be stirring here.

As household income starts rising as an accompaniment to rising output levels, consumers can be expected to step up their buying, something that will also start to come through in credit data.

The cycle is very much into a new upswing. Just a pity about slowing government spending, reticent private investment and disappointing public infrastructure holdups or we could really have been steaming shortly as of old. But these growth drag anchors cannot simply be wished away. Thank goodness for agriculture windfalls and World Cup support.

Source: Cees Bruggemans, FNB, March 15, 2010.

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By Cees Bruggemans, Chief Economist FNB.

Our decline into recession was abrupt. We fell deep, perked up late and now surge belatedly in places as we play catch up off sometimes very low bases.

Still makes growth performance feel good where it shows.

Though expectations about World Cup foreign visitors are being revised lower, there will still be a party atmosphere this winter, adding to GDP.

Also, with so much summer rain, up country looking very green and the maize crop already estimated at 13mt (possibly exceeding this), we could well have an agricultural surprise this year, also adding to GDP.

Star performers this past week were the Kagiso Purchasing Managers Index breaching 60 like a knife cutting through (soft) butter and new car sales up 21%.

The Kagiso index, after extremely sharp falls in late 2008, is now belatedly showing a steep rise, tracing a sharp V-pattern.

Manufacturing order flow must be recovering strongly, with the outlook looking more normal than at any time these past 18 months (indeed catching too many purchasing managers unawares?) to get this kind of enthusiasm going.

Still, what is on display is probably the full force of a normalizing (abnormally abrupt) inventory AND export adjustment.

That is both unprecedented and extremely powerful.

Usually cyclical declines aren’t a mistake. Cycles have downswings for good reason. Upswings go too far, too many things get out of line, globally things turn down, inflation (and interest rates) rise domestically and an inventory adjustment is underway while exports disappoint. This takes time playing out.

This time around the global sell-off was extremely intense and abrupt as financial events made people around the world jumpy and defensive, preparing for the worst.

You don’t get 30%-50% industrial sell-offs in a matter of months because somebody is having a bad day. Instead, we are into extreme events.

Canceling the panic was just as extreme. Global changes of mind can regularly be observed in financial markets, but it rarely happens in the real economy. But it did this time once the policy aggression connected, the banks were visibly saved and people started breathing again.

It was surprising, though, to see our industrial and export response being so late and muted while many countries overseas were early and vigorous. But even latecomers finally feel the global waves lapping around their feet, drawing them into the rebound.

Our export levels haven’t fully recovered yet. Monthly exports went from $8bn (August 2008) to $3.7bn (January 2009) after which gradually recovering to $6bn by December 2009.

Clearly we are rebounding, especially noticeable in heavy industry, even if metal prices and contract spats (and electricity tariff increases) are lately clouding the local prospect.

By far the biggest manufacturing push probably came from a normalizing inventory cycle, with stocks bare, destocking rapidly falling off and purchasing managers seeing the order flow improving in coming months.

Still, there remain deep concerns about the state of the consumer, especially real income and the willingness to replace expensive durables and anything involving credit.

The credit cycle has probably turned, but it remains for now subdued. Going by housing survey data and transfer duty paid, the property market turned mid2009 with a nice bounce, much of it cash-assisted.

Meanwhile after a good 15% year-on-year January start, new passenger car sales have followed through even more strongly in February with a 21% lift.

There are a few distortions here, especially rental company frontloading World Cup fleet ordering (possibly ’stealing’ orders in 1H2010 they would otherwise have placed in 2H2010). Also there was one particularly vigorous new car launch, its demonstration effect apparently very strong.

Yet even when these special effects are allowed for, there is an underlying momentum discernible in new car sales now that promises more lift. As it is off an extremely depressed base, upside surprise may at some point be expected, if only because the car population isn’t getting any younger and the postponed replacement elastic has to start snapping back sometime.

Electricity output surged higher in January, now equaling mid-2008 levels, nearing an inevitable ceiling, ere long capping growth through 2014.

More evidence is wanted about retail sales volumes turning positive and credit starting its comeback.

Household income needs to turn positive and the anxious mood of the past year needs to lift. Current global events (Dubai debt, Chinese property, Greek foibles, Euro indigestion, anxiety about central bank exits) mustn’t be confused with spectacle of bankrupted global banks and the world reacting fearfully, as happened in late 2008.

That was a REAL crisis. Today we are back to spectator sports. It isn’t the same thing and anxiety levels are gradually dropping.

Not necessarily for exporters facing a Rand possibly breaching 10:€, 11:₤ and 7:$ shortly or a construction industry facing project deficits, cutting its cloth accordingly.

But generally feel-good factors may slowly keep reviving as companies leave the cyclical trough behind and refocus on improving earnings.

The cyclical worst is over. Now for the catch up.

Source: Cees Bruggemans, FNB, March 8, 2010

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Source: Jeremy Nell, February 11, 2010.

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By Neels van Schaik of Alphen Asset Management.

Significant rallies in stock prices usually draw in huge amounts of new cash towards the peak. That is how stock markets work and that is how human nature works. Given the rally we have witnessed since the market lows in November 2008, investors find themselves in a predicament.  Is this the correct time to be buying stocks?

Commentators and investment pundits have flooded the media with articles and information regarding the state of the world economy and the uncertainty the world faces regarding government debt, geopolitical instability, consumer deleveraging, and the rest of the jargon that goes with it. This is held forward as a key reason why you have to be cautious to commit new capital to the market.

Although all these concerns are valid, you will very seldom, if ever, find a period where global macro forces are in such a state of equilibrium that capital commitments to stocks can be done with any degree of certainty. We can let our minds drift back to the late 1940’s, when Europe was completely broken after World War II and capital was scarce. Looking at the world and the future at that point in time could not have inspired too much hope for investors.

Another example is the seventies which saw one of the worst periods for stock investments. Between 1970 and 1978 the S&P500 delivered a cumulative capital return of 7% and adjusted for inflation a complete annihilation of capital. By the end of 1978 any investor in stocks could have been excused for not having too much optimism on the outlook for stock returns, given the returns over the preceding eight years.

The world has become a very small place and investors and consumers are even more bombarded now with information on financial markets on a daily basis. I am not sure that all this information necessarily adds value to investment decisions though.

We would recommend that the investor’s sole justification for being exposed to stocks, or not, should be the price of the companies looked at, relative to the value of those businesses. This is why we deem a bottom-up approach as the best way to construct a portfolio. This will focus your attention much closer on the investment and valuation criteria you look for in an individual business and on finding the companies that adhere to these criteria.

Looking at the valuation criteria that we believe are very important, we currently consider the market to be fully valued to expensive, and we would caution investors against committing new capital to the stock market in any aggressive way. Investors need to realize that a very important way of measuring risk is the possibility of permanently losing capital, and this is related to the price you pay for any asset. Permanent loss of capital can be avoided through a conservative investment approach and avoiding overpaying for companies.

That is why investors should, in an almost perverse way get excited about market corrections, as these are the ideal buying opportunities, as opposed to after the market has rallied 50%. This approach obviously requires patience and diligence and you can be wrong for long periods, but in the long run will be more rewarding than the low real returns and possible capital erosion that will result from the alternative approach.

The companies we do own, we believe, have not fully discounted their full earnings potential and the high and consistent returns they generate on their invested capital is not fully discounted in the valuations of the companies. Also, we favour companies where the dividend yields are attractive and sustainable.

The most important aspect of investing though is finding a process that is sound and logical and that is consistent in the results it generates. It is also important to realize that no-one has access to the Holy Grail of investing (although some might believe they do), and your estimate of a company’s value at any point in time is your best assessment of the information at your disposal. Some investors might look at different factors, but the most important issue is to stick to the process that works for you.

As John Maynard Keynes once said “it is better to be roughly right than precisely wrong”.

Source: Neels van Schaik, Alphen Asset Management, February 24, 2010.

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By Cees Bruggemans, Chief Economist of FNB.

It isn’t a done deal yet. The final decision is for the SARB Governor and her Monetary Policy Committee. But the data is shaping benignly for another rate cut. As for the risks to the forecast, that is for the MPC statement to indicate. We will know in a month’s time whether the prime interest rate will see 10%.

It has been an interesting week.

Nersa granted Eskom a 25% annual tariff increase, doubling the cost of electricity these next 24 months. But that particular number has been in the SARB forecast all along, removing the huge uncertainty (and possibly sufficiently moderating the second round risks) mentioned as an obstacle to a rate decision last time.

CPI inflation for January came in at 6.2%, slightly below consensus. The main drivers were food disinflation and certain services (banks, funerals, insurance, uncannily well grouped together).

Services inflation moderated further to 6.8%, and core CPI inflation at 5.8% fell to within the target.

The outlook is for a rapid runoff in inflation through midyear, going well below 5%, with a renewed up-tick thereafter through late next year, but probably staying within the target zone.

The GDP growth data for 4Q2009 was better than expected at 3.2% annualized, confirming the recovery, but the detail didn’t yet confirm a broadbased movement.

Instead, only two sectors (manufacturing and government) contributing one-third of GDP between them was responsible for three-quarters of the increase in GDP during 4Q2009.

And these two boosters aren’t necessarily sustainable, with the Finance Minister last week announcing the intension of slowing real government spending to 2% annually, while the deep manufacturing dip of a year ago now saw positive inventory and export rebounds, which are mainly givebacks.

A remaining concern is the 50% of GDP showing further declines or only minor recoveries, with stagnation a feature, when looking at mining, retail trade, wholesale trade, motor trade, hotels, transport, storage, communication, financial and business services, with agriculture still going down steeply.

It suggests the bulk of household consumption spending and business activity generally remains constrained.

On the positive side as national income rises, some of these sectors will benefit as well. So growth momentum should gradually recover even as inventory, fiscal and export boosts eventually moderate or even fall away.

And the world cup impact and an agricultural boost in 2010 on account of the good summer rains could also add to GDP growth in the short term.

But generalized growth will probably remain a slow recovery, with credit access and usage more restrained then in previous upturns and increased public tariff charging in coming years eroding disposable income.

Thus there are two important drag anchors weighing on the economy, keeping recovery slow beyond the immediate inventory, fiscal and export boosts.

Activity levels of important sectors of the economy remain well below a year ago (mining, manufacturing, the various trades, financial and business services), indicating considerable lingering slack, also confirmed by employment and capacity utilization surveys.

Importantly, the state of the economy does not suggest an imminent resurgence of inflation pressure. SARB presentations to Parliament this week also emphasized that imported inflation this year should be minimal, wage settlements were expected to be lower, the fuel levy announced in the budget should not upset the inflation trajectory, and the Rand would likely be a neutral influence, also in terms of risk.

Thus the sentiments per the last MPC statement were mostly repeated, with really only the (great) uncertainty about the Eskom tariff increase remaining the one big outstanding risk. And on that score such concerns should now have been tempered by the 25% Nersa decision, still big but within the projected forecast of the SARB.

It all is taking shape. Inflation about to fall back within the target zone and projected to remain there these next two years. Most risk factors looking pretty benign. The one big uncertainty (and risk?) pretty much removed. And the economy now nicely recovering, but it all being mostly short-term effects so far, with underlying final demand probably recovering only slowly, much resource slack remaining and traditional boosters to rapid growth resurgence (credit, exuberance) generally missing in action.

Given that fiscal policy has provided all the accommodation it can offer to a struggling economy, and that the recovery process could do with some more assistance, with inflation and the risks governing its outlook mostly benign, there could be scope for another 0.5% rate easing, prime dropping to 10%.

We should know in a month’s time, a long waiting period to the next MPC during which much may happen. And so we wait and watch, whether events and data change the outlook or by then confirm this still early assessment.

Source: Cees Bruggemans, FNB, February 24, 2010.

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By Cees Bruggemans, Chief Economist FNB.

Growth in GDP (total goods and services produced in the economy, excluding inflation) speeded up in the 4Q2009, confirming the recovery gaining strength.

In the first quarter of recovery (3Q2009) GDP growth (annualized) was still only 0.9% but in the 4Q2009 this accelerated to 3.2%, considerably faster than consensus expectations (+2.6%) of nearly all economists.

When excluding volatile agriculture, the remaining 98% of GDP recovered at an already much faster rate, by 1.8% in 3Q2009 and by 3.8% in 4Q2009.

Thee two ’star’ performing sectors (manufacturing and general government) contribute only one-third of GDP but produced three-quarters of the GDP increase during 4Q2009 indicating a still relatively narrow recovery path.

Manufacturing grew by 10% annualized in 4Q2009, primarily boosted by inventory changes and export recovery. General government spending grew by 7% annualized, reflecting aggressive fiscal policy support for the economy.

Much further down in the growth performance rankings, so-called ‘average performing sectors’ (basically matching overall GDP growth) were the small construction sector growing by 3.6% and personal services growing by 3.1% annualised in 4Q2009. Together these two sectors contribute 10% of GDP.

A very large group of economic sectors, contributing 40% of GDP, can be described either as ’stagnant’ (so far) or as ’stragglers’.

Mining output still fell heavily in 3Q2009, bounced impressively in 4Q2009, but so far with no clear recovery path. Its trend suggests stagnation until it can decisively break out topside.

Same applies to the very large financial and business services sector, except its output ups and downs are far milder than in mining, with some hope that early 2010 will see growth slowly accelerating as credit growth starts it gradual comeback.

Transport, storage and communication lifted out of its mild recession from mid-2009, but its quarterly gains have remained very small, well below the gains of its boom years and also very much sub-par to the average GDP performance, earning the sobriquet ’straggler’ - ready to get promoted to average (and eventually back to star rankings) if only its growth can decisively pick up (of which so far no sign).

Then there are still the heavily underperforming sectors whose output fell steadily throughout 2009, together contributing just over 15% of GDP.

Agricultural output fell nearly 12% annualized in 3Q2009 and another 7.5% in 4Q2009. Less dramatic declines were recorded by the retail, wholesale, motor and hotel trades, their output declining by 1% in 3Q2009 and a further 0.7% annualised in 4Q2009.

This composition of the GDP growth performance during 2H2009 on the output side of the economy highlights key aspects of the recovery profile.

Growth is prominently led by industrial inventory and export boosts and steady government commitment. Although construction still made a good showing, its growth momentum is probably dwindling.

In contrast, everything dependent on or supporting the household sector and business activity generally either did poorly (the trades) or straggled (financial and business services and transport, storage and communication), between them contributing 50% of GDP.

So one notices outperformance in one dimension while still clear underperformance in another, even though the rising GDP output means more income, probably a start with modest job gains in manufacturing (if the Kagiso Purchasing Managers Index is to be believed) and this in turn assisting the gradual lifting of household consumption out of recession as time goes by.

It doesn’t help that the primary sectors remain stuck, with mining yet to benefit from the global liftoff, probably for very industry specific reasons. Meanwhile agriculture could be brewing a positive surprise for 2010 following all these summer rains, potentially shortly re-entering the star ranks (if only for a season).

There is yet more good news besides agricultural prospects and the impact of the World Cup at mid-2010.

Whereas industrial manufacturing output dropped by 16% between 3Q2008 and 2Q2009 (on account of aggressive inventory destocking and partial export collapse), the rebound so far in 2H2009 has been (very) late and still only modest, a bare 4% gain from the cyclical trough. More is therefore still to come in 1H2010. How much we will find out the hard way. But this booster has yet to show its full support to GDP recovery.

Lastly, when casting our eyes a year back, what does the rearview mirror tell us?

Overall, the year 2009 witnessed a 1.8% decline in GDP. If we exclude agriculture, the decline was only 1.5%. If we allow for future revisions these next three years, the 2009 GDP decline may turn out to have been somewhere between 1% and 1.5%. Still bad but not as horrific as elsewhere in the world.

Interestingly, some sectors are still way below their peak activity levels (with a lot of resource slack showing) while others kept on steaming throughout 2009.

For instance, in 4Q2009 sectors operating still well below year ago levels (and contributing 60% of GDP) were mining (-5.9% y/y), manufacturing (-5.4% y/y), the various trades (-3.1% y/y) and financial and business services (-2.4% y/y).

In contrast, sectors well ahead during 4Q2009 compared to a year ago (and contributing a quarter of GDP) included construction (+7% y/y), personal services (+5.4% y/y) and government (+4.1% y/y).

So yes, the recovery is still narrow but gaining strength, and probably gradually broadening, with various sectors probably adding yet more growth momentum to GDP in early 2010, also slowly transforming the operating conditions for the still straggling or underperforming sectors.

But there remains a lot of resource slack and sector underperformance which beyond the initial inventory and export recovery boosts may not have fully recovered their normal self yet - the real focus needs to be on final demand, meaning household consumption, government consumption (with the budget promising a slowdown to 2% growth) and fixed investment (probably negative in 2010).

Once we factor in slow credit growth recovery and an analysis of spending growth (demand), bearing in mind the influence of expectations on durable goods replacement and private fixed investment, the economy continues to labour under numerous restraining drag anchors.

It is therefore right that fiscal policy remains so very supportive, even if elsewhere in the public sector increased charging these next three years will provide quite a headwind to private demand.

As to monetary policy, it has to take into account both the outlook for inflation and the risks thereto when looking forward, including the likely state of the economy. It for now is recovering, but narrowly.

Source: Cees Bruggemans, FNB, February 23, 2010.

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