Month: September 2012

SA economy: Retail strength

There would appear to be some disappointment with the retail sales numbers for July 2012, details of which were released on Wednesday. We would argue by contrast that sales volumes in July confirmed a strongly upward trend in sales that began in May 2012, gathered strong momentum in June and was well sustained in July 2012. Retailers and their shareholders have every reason to be satisfied with this sustained revival in sales volumes.

The highly satisfactory longer term and shorter term trends in recent sales volumes are shown below. It will be seen that retail volumes have recovered significantly from their recent recession which hit a trough in 2009. In constant 2008 retail prices sales volumes in July 2012 (at record levels as may be seen) were some 17.3% above their lows of October 2009.

The real (CPI) adjusted earnings per share of the General Retailers Index of the JSE has clearly benefitted from the strength in sales. Real Retail index earnings per share have responded even more strongly than sales volumes, having risen nearly 40% from their April 2010 lows – though they have still to exceed pre-recession real levels of earnings.


These differences in interpretation of the state of the retail trade sector owe everything to the period of time over which growth is measured. The year on year growth rates, comparing levels this month to the same month 12 months before, are highly smoothed estimates. They can easily miss much of what has transpired through the year. A year can be a very long time in economics as well as politics. The value in looking at retail sales trends over a shorter period than a year is particularly apposite this year.

Retail sales volumes grew strongly in the final quarter of 2011; they were especially buoyant in December 2012 when seasonally adjusted – as they have to be given the strong seasonal influence on sales. This is especially important in the Southern Hemisphere when Christmas spending is combined with summer holiday spending. The seasonal adjustment factor is 1.36 for December and 0.96 for August. That is to say: December sales can be expected to be about 36% stronger than the average month and July sales about 3.3% weaker than the average month.

The growth in retail sales volumes of 4.2% year on year was reported by I-Net Bridge as being well below market consensus that expected a 7.2% rise in sales volumes. The sales volumes reported were based on a new sample survey of the retail sector, making consensus forecasts perhaps less relevant than they usually are.

Based on these new sample sales volumes, seasonally adjusted as they have to be to make good sense of them, the level of real sales volumes in July were only up a marginal 0.1% on June 2012. However June 2012 was a very good month for retail sales volumes. Moreover estimates of sales in June 2012, applying the new sample estimates, were also revised upwards providing a higher base from which growth in July was estimated.

These trends are well captured by annual growth measured on a three month rolling basis. After rising sharply in late 2011, the rolling three month growth in the seasonally adjusted sales volumes fell off sharply in the first quarter of this year and then recovered strongly. The current year on year growth rate in the seasonally adjusted volumes is a robust 5.9% (not 4.2% as per the unadjusted numbers) while the rolling three month growth rates, having risen to over 10% in May and June, have receded to a 7.3% annual pace.


This momentum in retail sales volumes in July is highly consistent with other economic indicators we have reported upon. Retail sales volumes, like unit vehicle sales and the value of notes in circulation, when seasonally adjusted, were no higher in May 2012 than they had been in December 2011. Retail sales volumes, vehicle sales and cash in circulation had similarly demonstrated very strong growth in late 2011,

The economy therefore would seem to have a little more life in it than is usually recognised. Household consumption spending grew very slowly in the second quarter, at a less than 3% rate. It would appear that spending growth has picked up since then and perhaps a lot more so for the merchandise supplied by retailers and motor dealers. This is in contrast with the demand for services by households. Low rates of inflation have helped encourage demand for goods; while much faster inflation of the prices of services (as much as 10% per annum faster) has discouraged the demand for services.

The difference between year on year changes in the CPI (headline inflation) and more recent trends in consumer prices has also become vey significant recently. While year on year the CPI was up very marginally from 4.9% to 5%, recent trends in the CPI have been much more favourable. On a three month rolling basis CPI inflation slowed down to below 3% p.a in August, the result of a succession of very small monthly increases. The CPI increased by 0.24% in August 2012 from 0.325% in July, 0.24% in June and 0.08% in May 2012. Retail goods inflation, as represented by changes in the retail goods deflator, slowed down almost completely in the three months to July 2012, as we also show below.

A sense of inflation trending down (as per the rolling three months growth rates in the CPI) or trending up (as per the year on year growth rates) leads to implications for the inflation outlook and so perhaps to interest rate settings. That monthly increases in the CPI were very high in the early months of 2012 means that there is every chance of a sharp decline in the year on year inflation rates in early 2013. Monthly increases in the CPI in late 2011 were by contrast very subdued, meaning that the year on year headline rate of inflation is likely to rise in the months immediately ahead.

These month by month blips in the headline inflation rate should surely be ignored. It is the underlying trend that will be either friendly or unfriendly for the longer term trends in the CPI. And this trend will be dominated by the rate of exchange for the rand – over which interest rates and monetary policy have no predictable influence if again past performance is the guide.

The notion that year on year headline inflation should lead the direction of interest rates in SA – rather than the state of the domestic economy – is an idea that has fortunately lost credibility at the Reserve Bank if not yet in the media. Brian Kantor

Equity markets: Is it time to rotate into the cyclical stocks?

A defining recent feature of the JSE and other stock markets this year has been the very good performance of the defensive stocks, especially those with attractive dividend yields and balance sheets to support growth in dividends. By contrast, the performance of the cyclical stocks – especially mining companies – has been very poor both absolutely and relatively, when their performance has been compared to the defensives.

We show below the relative performance of the Resource, Financial and Industrial Indexes between 1 January and 18 September. As may be seen, in 2012 the Financials and Industrials on average have gained about 30% on the average Resource counter listed on the JSE.

Such outcomes are very understandable in a world of exceptionally low interest rates, coupled as they are with grave doubts about the strength of any global cyclical economic recovery (from which metal and mineral prices and the profits of mining companies would stand to benefit).

This outperformance was reversed on 13 September when Fed chairman Ben Bernanke and the Federal Open Market Committee announced QE3. The Fed plans to inject an additional US$85bn of cash into the US monetary system each month through additional purchases of mortgage backed securities and US government bonds. The intention is to keep interest rates as low as possible for as long as it might take to revive the US economy and employment or at least until 2015.

The question therefore is not whether or not the Fed will achieve its objective of low interest rates. This it will surely do thanks to its freedom to effectively create as much cash as it deems appropriate and also to twist the yield curve accordingly, that is borrow short and lend long if necessary, to hold down long rates relative to short rates (which are close to zero and will surely remain so for some extended time). The question is whether continued low interest rates can stimulate a more robust economic recovery. If they can then the underappreciated cyclical stocks would especially stand to benefit.

The stock markets on Thursday and Friday last week reacted as if it was truly time for the cyclical stocks. They gained materially against the Financials and Industrials. There also appeared to be some rotation on the JSE away from the Industrials and Financials. On the Monday these trends were partially reversed as we show below.

Our own view, expressed on the day after Bernanke fired his bazooka, was that the promise of a further extended period of low interest rates would continue to make secure dividend yields well above money market rates still appear attractive, given the absence of any assured cyclical recovery. Playing defence, we thought, might remain the best policy in these new circumstances. It seemed clear to us that pumping money into the system would be helpful to asset prices generally – but perhaps not especially helpful to the cyclicals. Still more highly accommodative monetary policy might not, we surmised, provide the quick fix for the global economy. It has not done so to date. The jury will remain out on this for some time we think – or until a global cyclical recovery appears much more likely.

Global monetary policy: Ben signals his intentions and the markets like what they are told

Ben Bernanke fired his Bazooka yesterday. He pledged the Fed to further purchases of securities in the market without effective limit and for as long as it takes. The Federal Open Market Committee (FOMC) indicated net injections of cash of the order of US$85bn a month for as long as it takes. The indication from the FOMC is that

“…exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015”.

The asset markets were pleasantly surprised by the scale of the intended interventions in the asset market as well as their unlimited nature.

The key paragraph of the OMC statement read as follows:

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative. The Committee will closely monitor incoming information on economic and financial developments in coming months. If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.

Will these additional actions (QE3) work to revive the US economy and reduce the unemployment rate to a natural 5% or so within the next few years? The answer must be not necessarily so, given that highly accommodative monetary policies to date have not worked very obviously to reduce the unemployment rate below a stubborn 8%, with many more potential workers discouraged from looking for jobs (though how poorly the US economy would have looked without the accommodative actions to date can only be speculated about).

Persistently low interest rates and continuous injections of cash into the securities markets cannot do any harm to employment prospects. Nor can very low interest rates (as far as the eye can see) do anything but support the property market generally and related construction activity (unless these exceptional monetary measures were considered dangerous to the long term health of the economy and so undermine business and household confidence. This does not seem to be the present danger at all).

QE3 is likely to be very positively received by US business. However the boost to confidence necessary to strongly revive the spending plans of US business will have to be taken by the politicians after the elections. Better economic news from Europe and Asia would also be confidence boosting, but clarity on the outlook for Europe and China may not be imminent.

Monetary stimulus is helpful to asset markets. Higher asset prices support pension plans and encourage households to spend more. Low interest rates )that are expected to stay low) add to the argument for equities – especially those that come with dividend yield.

What sectors benefit?

The further question then is what sectors of the equity markets stand to benefit most in a still more friendly monetary policy environment? The case for the defensive stocks, that is those that pay dividends and have the balance sheets to maintain dividends, is most obviously improved.

The cyclical stocks, while not prejudiced at all by easy monetary policy and low interest rates would benefit most from a cyclical recovery itself. This, as we have suggested, is not a certainty in the short term: until a cyclical recovery clearly manifests itself, the outlook for commodity prices appears uncertain.

For undemandingly valued JSE listed cyclicals that would ordinarily benefit from of higher operating margins from SA specific rand weakness, this takes some of the wind out of their sails. The stronger rand in a world of persistently low interest rates (likely to extend to SA) is helpful for the interest rate sensitive stocks on the JSE.

The conclusion one comes to is that Bernanke, while helping equity markets, has in our opinion not yet improved the case for cyclical over defensives. The time for the cyclicals will come when the outllook for a global cyclical recovery appears more certain. Brian Kantor

The SA economy: In a holding pattern

The SA economy was in a holding pattern in the second quarter, helped by infrastructure spend, capital inflows and a sympathetic Reserve Bank

The SA economy did better on the demand side than it did on the supply side in the second quarter of 2012. Statistics on domestic expenditure, only now released by the SA Reserve Bank, complete the national Income accounts for the quarter. They show that Gross Domestic Expenditure (GDE) grew by 4.7 % in the second quarter at a seasonally adjusted annual rate – compared to GDP that grew at a 3.2% rate.

The fastest growing component of demand was Gross Fixed Capital Formation (GFCF) that grew by 5.7%. Households increased their spending on consumption goods by a pedestrian 2.9%, but household spending on durable goods (vehicles and appliances etc) and semi- durables (clothes etc) grew much faster than this while spending on non-durables (food) and especially services grew much slower: spending on services actually declined.


No doubt relative prices and, to a lesser degree, extra credit played a large part in these outcomes. Food and service prices rose faster than the prices of cars, appliances, clothes and perhaps especially services provided by municipalities. Consumers adjusted their spending accordingly, as they have been doing for some time. The Reserve Bank shows that the household debt to disposable income rose slightly after this ratio had fallen for an extended period. Thanks to lower interest rates, the debt servicing to disposable income ratio has stabilised at a very low 6%.

Where is the infrastructure spend?

This is a question often asked. The growth in spending on infrastructure is very apparent in the numbers. Capital expenditure by the government and the public sectors grew very rapidly in the quarter: by 9.1% pa and 15.75 pa respectively. Perhaps the impact is not easily seen or felt because of its high import content.


When spending rises faster than output, imports grow faster than exports and the balance of trade deteriorates. The major contributor to the very large current account deficit (which ran at a annual rate of over 6% of GDP in the second quarter) was a weaker trade balance. Export volumes nevertheless grew at a good rate of 5.9%, while imports grew even faster at a 9.7% real rate. Yet while export volumes grew strongly, prices for minerals and metals realised on global markets were less favourable, leading to a decline in rand revenues from the mining sector. Mining sector output in fact recovered very strongly from a low base in the quarter, so making an unusually important contribution to GDP growth in the quarter.

The outflows on the current account were fully matched by net inflows of foreign capital of R48bn. This is not a coincidence – it is much more like two sides of an equation. Without the capital the rand would have been much weaker, prices of imported and exported goods would have been much higher and demand for imports lower.

The economy would also have grown at a still slower rate without support from foreign investors. This makes the current account deficit and the accompanying capital inflows much more of an opportunity than the problem that it is so often and simplistically portrayed as. It is economic growth in SA that drives the returns on capital and the interest rates that attract foreign capital. Less growth means inevitably less capital attracted. Faster growth attracts more capital. Had growth in SA been even slower in the second quarter the current account deficit would have been smaller and capital inflows smaller. The rand might then have been even weaker (it lost 4.8% of its traded value in the second quarter, having gained 4.4% in the first) and inflation higher. These clearly would not have been desirable outcomes.

That much of the growth in imports was attributable to capital formation – which adds to the economy’s growth potential – is therefore helpful in attracting capital. Also helpful is that foreign currency debt issued by the SA government and the banks remains at manageable levels and has shown very little growth. A further helpful factor is that foreigners have shown a strong appetite for rand denominated debt, upon which default is technically impossible. Since there is no limit to the number of rands the SA government (via the Reserve Bank) could create to pay off rand debts, this demand for rand denominated debt represents a vote of confidence in SA’s fiscal conservatism and in the strength of its banking system.

The banks raised nearly US$9bn of rand denominated debts from foreign lenders between the first and second quarters. The private sector outside of the banks reduced their foreign debts over the same 12 months.

There are clearly upper limits to the liabilities SA and South African households and businesses can incur. What these limits are, are not known. Until they are known and a lack of foreign capital becomes an actual problem for the economy, it makes no sense to sacrifice growth for fear of reaching these limits. In fact slower growth would in all likelihood exacerbate, rather than help resolve any lack of capital inflow.

If the economy picks up momentum over the next 12 months (hopefully stimulated by faster global growth and higher export volumes and prices) returns on capital invested in SA business will improve and interest rates may well rise. These trends will attract foreign capital and the rand would very likely strengthen in what will be a more risk-on environment.

If the economy fails to pick up momentum in the absence of a recovery in the global economy, domestic demand will need and get encouragement from perhaps lower interest rates. A weaker rand would seem likely in such less hopeful circumstances. Should growth rates remain unsatisfactory over the next 12 months, the Reserve Bank is no more likely to feel restrained in its interest rate settings by the current account deficit than it has been to date. The best monetary policy reaction to the current account deficit or capital inflows is one of benign neglect. The Reserve Bank seems capable of ignoring the balance of payments. Brian Kantor

Global markets: A harbinger of a new Spring – or a one day wonder?

On Thursday Mario Draghi spoke and the markets liked what they heard about the outlook for Europe. The judgment was that taking on more risk in the markets might well be rewarded. On Friday we saw a most unlikely set of outcomes in response to a healthier appetite for risk taking. That risky currency, the rand, gathered strength. Resources on the JSE benefitted particularly, despite (or rather because of) the rand strength associated with strength in underlying metal and mineral prices that are linked to an improved outlook for the global economy.

As we have noted often before, resources only benefit from a weaker rand or are harmed by a stronger rand when this occurs for SA specific reasons. Only then do they behave as rand hedges. Ordinarily they are rand plays – doing best when the rand strengthens – for global growth reasons.

SA financials are also mostly rand plays – doing better when the rand strengthens and the outlook for lower inflation and interest rates improves with rand strength. But surprisingly on Friday SA Financials lost ground. While JSE Mining was up 3.75% on the day, the JSE Fini15 lost 0.8% of its value. Financials and banks offshore had a very good Friday by contrast, as we show below:

Given the improved appetite for taking on risk, the large losers on Friday were the globally traded, highly defensive counters. These are the shares that have been coveted for their dividend yields and prospects of special dividends in a world of very low interest rates. For example British American Tobacco lost R14 or approximately 3% of its opening value on Friday. On the FTSE the stock was down 1.5%.

These developments on Friday helped reverse a long running saga on the JSE of underperforming resource counters and strongly outperforming producers and distributors of consumers goods with strong balance sheets paying dividends that are likely to be sustained.

Investors globally on Friday clearly rotated away from demandingly valued defensives to cyclically dependent stocks and financials that appear undervalued by their own standards. Why SA financials should have failed to benefit from this switch and rand strength may be regarded as something of an anomaly. Is this the start of something potentially very big – the reversal of the defensive trends that have dominated market performance over the past 12 months, or merely a minor correction of such trends? Our position has been to maintain a moderately risk on exposure to equities generally with a bias in favour of defensive dividend payers. A few more days like Friday would help concentrate our minds, perhaps leading us to a somewhat different, more risk-on conclusion. Brian Kantor

The Eurozone: A declaration of monetary independence

Mario Draghi asserted the independence of the European Central Bank (ECB) to act as the independent central bank of Europe and to be the responsible guardian of the “irreversible” euro. This declaration of independence was supported by all but one of the governors of the ECB.

The bank’s government bond buying campaign is to be concentrated on maturities of less than three years to maturity. These purchases, now called the Outright Monetary Transactions (OMTs) will be conducted without any limit other than constrained by the judgment of Draghi and his colleagues. These purchases of all government bonds linked to the euro will not be inhibited by inferior credit ratings, nor would the ECB claim any seniority of its claims against borrowing governments ahead of private lenders. This is an important principle designed to draw private sector support for the bond market. ECB support for the market in distressed government bonds is conditional, that is on the condition that those governments seeking aid from Europe, the ECB and the IMF abide by the conditions set for such support. The “conditionality’ of ECB was strongly emphasised, no doubt to address likely criticism that the programme represented a soft option for hard pressed European states unable (so far) to convince the market place that they can continue to meet their obligations to creditors.

Predictably, the plan did draw criticism from the Bundesbank as representing fiscal assistance to governments and therefore was not within the mandate of the ECB. No doubt it was this German viewpoint that has so delayed the assertion of ECB independence and its ability to do, in practice, what it takes to protect a financial system in times of crisis. What it takes to solve a financial and banking crisis, as the Fed has proved recently, is quite simply the exercise of a central bank’s power to print money without limits, other than those set by its own judgment as to how much extra cash it will takes to solve a crisis. Once the crisis is resolved (hopefully, with excellent timing), it will then take back the cash from the banking system that could otherwise become inflationary (as excess supplies of money over the demand to hold money, inevitably become).

Sterilisation

Draghi did say that the automatic money supply effects of its bond purchases – crediting the banks with extra deposits at the central bank – would be “sterilised”. In other words, they would be countered by simultaneous ECB bond sales. Presumably, if the banks choose to hold excess cash reserves(as they have been doing to a very large extent in the US and Europe) sterilisation would not be called for.

Draghi was firm and forthright that his plan fully confirmed to the mandate of the ECB that charges the Bank with achieving monetary stability for Europe. Monetary stability, according to Draghi, demands the survival of the euro and the integration of the currently “fragmented” European monetary system. These are essential components of monetary stability and his ability to enter the bond markets without restraint is essential to this purpose, according to Draghi.

An integrated Eurpean monetary system would mean similar interest rates and costs and availability of credit in all the European centres of finance. It would also have to mean well co-ordinated fiscal policies and banking regulations and a unified European banking system. Europe will work towards this – monetary stability and the irreversibility of the euro to which the ECB is committed allows time for the European project – the European Union – to be completed.

It will take time, maybe lots of time, to be realised, but Draghi has acted to reduce what he described as “tail risk”, that is to reduce the perhaps small but catastrophic possibility of a banking and financial collapse in Europe.

It has taken a long time for the ECB to assert itself as a fully independent central bank. The almost immediate reactions to the Draghi plan were highly favourable. Risks came off, to the advantage of the bond, equity and currency markets, including the rand. If the market is convinced that the ECB could do what it would have to do in a time of crisis then maybe the markets in euro debt and interbank loans will calm down enough to avoid the ECB from actually exercising its powers. The bazooka is loaded: it may not have to be fired.

Fired or not, the markets can return to the still difficult task of forecasting the state of the global economy (Europe included) without the same fear about the tail risk of a European financial break down that the ECB has addressed. Brian Kantor

SA listed property: Running on technically enhanced blades?

The Property Loan Stock (PLS) Index has again performed outstandingly well this year to date, realising returns of over 40%. It has also enjoyed an exceptionally good quarter to date with returns of over 16%. The Index has moreover significantly outperformed the bond market as may be seen below.

The gap between RSA bond yields and the trailing dividend yield on the PLS Index may be regarded as a way to rate the listed property market. One can presume that the lower this difference in yields (currently negative), the superior the rating enjoyed by the property stocks. Presumably also, the lower the trailing dividend yield on the PLS Index, then the faster the dividends paid are expected to grow.

As we show below the yield gap between RSA bond yields and the initial trailing property dividend yield has narrowed markedly over the years. This yield gap stabilised at about a negative one per cent per annum after 2008, indicating very little of a rerating until very recently, when over the past month, the yield gap narrowed sharply (that is became distinctly more negative) to the advantage of PLS valuations.

In the figures below we show the performance of the PLS in the form of index dividends per share as well as the growth in these distributions. These dividends have grown consistently and continued to increase through the recession of 2008-2009. Their growth was particularly rapid in 2008. Growth in dividends fell off in 2009 and has since managed to keep pace with inflation. Real CPI adjusted PLS dividends have stabilised since 2008 and are expected to continue to do so. Nominal dividends are currently growing at about 6% per annum – compared to inflation (currently about 5%) and is expected by the bond market to average about 6% over the next 10 years.

The current PLS trailing dividend yield of 5.66% represents a record low. Should PLS dividends continue to match inflation (as they are confidently expected to do at least for the next two years) this would correspond to a real yield of the same 5.66%. We have long argued that a real yield of 5% should be regarded as appropriate for the sector, given its risk character.This real 5% would represent an expected risk premium for investors in the PLS Index of about 2% over inflation linked government bonds that normally could be expected to offer about a real 3%.

Current RSA inflation-linked yields have however fallen far below the 3% real yield that might be regarded as a normal real return on a default free, inflation risk free government bond. The yield on the 10 year RSA197 has however fallen to a record low 1.53% real yield.

Compared to a certain real 1.53%, a prospective 5.7% real yield from the PLS Index may still appear attractive. If dividends distributed keep pace with inflation, this initial 5.7% converts into a real 5.7%. This prospective extra real return over and above the return on the government inflation linked bond (currently about 4%), may still seem be more than enough to cover the risk that PLS dividends will not be able to keep up with inflation. This extra 4% real risk premium is still well ahead of the 2% risk premium (5% less the normal 3%) that we have argued should be sufficient to the purpose of attracting funds to the PLS sector.

The conclusion we come to is that until real interest rates on the long dated inflation linkers in SA normalise towards the 3% p.a rate, the PLS counters (that promise a real return of over 5% per annum) may still appear attractive. Brian Kantor

New vehicle sales: Maintaining a brisk pace

New vehicle sales were at a highly satisfactory level in August 2012. Unit sales have maintained their recovery from somewhat depressed 2012 Q2 levels. Actual sales were up from 54087 units in July to 56253 units in August 2012. On a seasonally adjusted basis unit sales were up by 1831 units.

It should be noticed that on a seasonally adjusted basis sales are well up on a year before but are little changed from sales levels (when seasonally adjusted) realised in December 2011. Given the surge in sales that materialised late in 2011, this higher base of sales will make year on year growth comparisons (currently 9% p.a) more onerous in the months to come.

Yet if currently favourable trends persist, the retail sector of the motor industry could look to a monthly sales rate of 56 000 units this time next year, compared to the current rate of 52 600 new units now being sold. This would represent a growth trend of about 7% that, if realized, would be regarded as highly favourable for this sector of the economy. Clearly, lower and stable rates of interest are helping to sustain this important sector of the SA economy. Brian Kantor