Investment Postcards from Cape Town

The October edition of the Reuters South African Survey of Economists has just been published. (The Reuters Econometer is a measure of economic sentiment drawn from a monthly poll of forecasts by leading economists in South Africa and abroad and presented in the form an index). The weightings used in the index are: GDP growth - 25%; CPIX inflation - 20%; Producer Price Inflation - 5%; Prime Interest Rate - 20%; 10-year bond yield - 5%; Rand-Dollar Depreciation - 25%.

The Reuters Econometer fell for a third consecutive month in October, falling to 235,60, its lowest level since September last year. Confidence in SA’s economy fell as demand and manufacturing capacity is seen taking longer to improve, as a result of the looming increase in power tariffs, which is expected to further restrain growth and fuel inflation. GDP forecasts have been further downgraded in the October survey, on expectation that the recovery won’t be a smooth process and it will take time for confidence to build up. With Eskom pushing for an increase in electricity prices of 45% over the next three years, a prospect the central bank said is the main upside risk to long-term inflation. Compared with September’s survey, inflation is now expected to be higher, averaging 5,79% next year and 5, 85% in 2011. The rand is now seen weakening slightly next year, compared to Septembers survey. The National Treasury and the central bank have expressed their concern about the strength of the ZAR currency and its impact on the broader economy.

Please click the thumbnail below for the full report.

Source: Sudheer Singh, Sasfin Securities, November 4, 2009.

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By André Coetzee, Kagiso Securities.

The seasonally adjusted Kagiso PMI rose to 47.6 index points in October from a revised 45.9 during September. Last month’s 1.7 index point gain is on top of a 6.4 point jump in September and confirms that SA manufacturing output is moving back towards expansionary territory.

While  it  is  disappointing  that  the  headline  PMI  was  unable  to  rise  above  the  key  50  level  in  October,  the  sub-indices  paint  a  consistent picture  of  a sector  that  is  emerging  from  a  deep  contraction  with  both  the  business activity  and  new sales orders indices  building  on September’s robust gains to reach the highest levels since April 2008.

Furthermore, the near-term demand indicators hint towards sustained improvement going forward with the backlog of sales orders index also  reaching  the  best  reading  since  2008Q2  and  purchasing commitments rising  to  the neutral  50 level  for the first  time since August 2008.  The  improved  activity  levels  were  reflected  in  a  continued  moderation  of  job  losses  in  the  factory  sector  œ  the  PMI  employment index rose for the second consecutive month. This is welcome news after Stats SA’s Quarterly Labour Force Survey showed that the sector shed 150,000 jobs during 2009Q3, more than double the 71,000 jobs lost during the first half of 2009.

After increasing  marginally in September,  the PMI price index  declined somewhat  in  October.  The index has now been below 50 for four consecutive months, in line with the actual data that continues to show producer price deflation.

Source: Kagiso Securities, November 2, 2009.

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By Cees Bruggemans, Chief Economist FNB

It can be very unsettling when hitting an air sack, and only natural to assume things won’t quickly return to normal as trouble has a way of coming in multiples.

The South African building industry certainly has reason to be suspicious of any early suggestions of recovery, given the exuberant times that lasted for several years after which the plunging descent into deep recession last year was one of the most abrupt in decades.

Yet the deeper it falls, the more likely a bottom is reached, provided shock absorbers are fully extended.

The peaking of interest rates late last year, since then shedding 500 points, certainly provided important support for the building sector.

This evidence is also starting to shine through in opinion surveys. The FNB/BER building confidence index for 3Q2009 released last week offered a series of data points all suggesting a cyclical turn underway in the building industry.

The index covers the entire building pipeline, including architects, quantity surveyors, residential and non-residential contractors, and retailers and manufacturers of building materials.

This index reached a low point of 30 in 2Q2009 (meaning only 30% of respondents expressed themselves confident), perking up to 32 in 3Q2009.

Yet these readings don’t come close to being all-time lows, with the index for instance reaching 10 in 1999.

The reason has to do with the various components of the building pipeline. There are in fact three sub-groupings that warrant closer attention.

The first sub-grouping showing distinct evidence of recovery is retailers and manufacturers of building materials. One suspects this reflects the working of the inventory cycle.

Early in the decline phase, retailers get caught as sales start to fall away and their inventories start to rise. At some point they take corrective action, reducing orders to manufacturers while trying to reduce inventory in a falling sales market. The trough is reached when sales start to stabilize, with inventories deeply depleted and retailers deciding to start re-ordering, in the process improving order levels at manufacturers. It is at this point that their confidence levels also start to rise from depressed levels.

Manufacturers of building materials reached their cyclical low in 1Q2009 with a reading of 1, subsequently improving to 29 by 3Q2009.

Retailers of building materials reached a cyclical low in 2Q2009 with a reading of 19, improving to 32 in 3Q2009.

The proof, though, is in the easting of the pudding. Building contractors have to experiencing a stabilization of falling activity levels for a cyclical turn to become believable.

On this score residential building contractors had reached a confidence level of 17 during 2Q2009, close to the cyclical lows of 1999 and 1993 and thereby providing a believable benchmark of a possible lowest reading.

The 3Q2009 reading for residential contractors was 19, slightly up on 2Q2009 and quite possibly confirming the slow tracing out of a recovery.

Such optimism is warranted, given the lead from the interest rate cycle, but also the evidence of improving property market conditions. This is evidenced by improving real estate agent sentiment according to the FNB Property Barometer, but also banks reporting more transaction traffic, and nominal property prices starting to show evidence of no longer falling (indeed lifting), all such evidence accumulating from mid-2009.

Given the low level to which residential building activity has fallen by now, and the lack of confidence among contractors, together with the collaborating evidence elsewhere as mentioned, it does suggest that the next stage is not even lower activity levels but indeed the start of an recovery in activity.

If building material providers, interest rates and property market conditions are leading indicators, and residential contractors are a coinciding indicator, then non-residential building contractors perform the role of lagging indicator for the industry.

The reason is simple. While a house may get build in six to twelve months from plan stage to completion, a major building may take two to three years (or more).

Residential contractors therefore register changing conditions much earlier than non-residential contractors, architects and quantity surveyors who take longer to complete their ongoing building work before being confronted by new demand falloff.

Non-residential contractor confidence fell to 33 in 3Q2009, still an elevated reading compared to single-digit lows at past cyclical turning points.

The expectation is that non-residential contractors may still register some further decline in confidence in coming months before turning up sometime next year, though we should distinguish between various market segments. Retail and industrial space may still fall off more, but office space may be more resilient.

Thus the overall FNB building confidence index in 4Q2009 could be boosted further by retailers and manufacturers of building materials and residential contractors, while architects, quantity surveyors and non-residential contractors may still keep things back a bit, limiting the overall advance, as per 3Q2009.

Only later in 2010 and into 2011 should all components of the FNB index be rising again, boosting overall building confidence higher. But this doesn’t deny that an industry turning point was probably reached by mid-2009 when going by overall confidence readings.

Source: Cees Bruggemans, FNB, October 19, 2009.

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By Cees Bruggemans, Chief Economist FNB

The forces arraigned against the Rand are rather formidable and no collapsed corporate deals seem to matter too much. The Rand is rising and will rise.

Pushing the Rand higher are the major central banks at the global centre (New York, Frankfurt, Tokyo, Zurich, London), keeping interest rates near zero and encouraging outward liquidity leakage towards faster growing and still outperforming yield destinations in the global periphery.

Pulling the Rand higher are a smattering of central banks located in the global periphery as they start increasing their rates, led by the Bank of Israel two weeks ago, but last week followed by the Reserve Bank of Australia, with others expected to follow serially in coming months.

With their growth reviving, small output gaps, house prices and employment rising and industrial activity recovering, these central banks are uncomfortable with their too low interest rates imposed during the recent global financial crisis.

As some of these periphery central banks start their tightening cycle, the world gets the message that the rate gap between global centre and periphery is going to deepen, as much from the centre’s side by keeping rates at record lows as by the periphery side where rates in places are going to rise.

As with the weather when gradients between pressure systems steepen, the air flow from low to high pressure systems increases and becomes more violent. Mere winds can turn into hurricanes as air masses move faster.

As if such increasingly powerful pull-me-push-me forces aren’t enough, our September foreign reserve data released by the SARB last week hinted at an absence of forex intervention.

The increase in reserves to $39bn was all a matter of government foreign bond issuance, IMF special drawing rights and a higher gold price revising the value of SARB gold holdings upward. But no forex buying of any note.

So whatever the world wants to do to us, it is welcome doing so as there is no active defence. Understandably so, for the National Treasury is already fighting the recession with a budget deficit approaching 8% of GDP and will this year add R200bn to the national debt.

Under these trying circumstances, the Minister of Finance has no appetite to buy another $5-$10bn in forex in an attempt to stabilize the currency.

And if all that wasn’t enough, the world from time to time indulges in inventing fantasies. An old hoary one is that somehow the world will wean itself off American Dollar dependence (this is after decades of loving it and depending on it with a vengeance).

One standby is that some other currency will take over the leading reserve currency role, the Euro mentioned most in the West, the Yen most in the East (at least in places), with the Chinese Renminbi/Yuan being the global reserve currency of the future, with a few real diehards abhorring governments of all kinds and favouring the barbaric metal relic of old (gold).

The conspiracy du jour is a wicked mixture of all these things in some weird-looking basket, with oil Sheiks ready to start pricing oil that way, and whatever next.

It is all being denied, and it all looks most unlikely, but it is gist to the speculative mills.

Whatever the truth, it doesn’t matter. More capital is weaned away from Dollar safe havens and wings its way to alternative global destinations, in the process sinking the Dollar yet deeper and elevating the periphery currencies, including the Rand.

These four processes are now increasingly working in tandem, reinforcing each other, with as yet no end in sight this side of 2011 (or 2012).

It is downright scary, all these many machinations set in motion here, potentially a lot more powerful than the biggest precious metal boom you can remember. For global capital flows are so much more powerful than commodities.

The Asian peripheries, for instance, were severely plagued last week by appreciation pressures on their currencies in the wake of Dollar weakness. This encouraged forex intervention on their part.

This brings me to the fifth force supplementing the aforementioned four.

For in this world just described, gold (and platinum) tend to get re-rated as the Dollar goes down, with gold potentially reaping a fear premium, while in the case of platinum we should watch the global car industry (with China this year becoming the biggest global car producer with 12 million unit sales, and hundreds of millions of Chinese so far still unable to fulfill this dream).

Despite others producing more gold than us (but nobody else coming close in the platinum sector), South Africa continues to have this precious metal aura clinging to its collective brow.

With every Dollar that our gold and platinum prices increase, do the global speculative juices flow yet more freely regarding our small asset markets.

It all gets reflected in our Rand (and our JSE equity and bond prices) where upward spirals are no unfamiliar thing, having been a firm feature of our firmament these past 150 years.

It greatly complicates our monetary policy environment as both inflation and growth trends are deeply affected by these external financial pressures.

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