(From 10 January 2012)
The demands for and supply of cash in SA have grown explosively in recent months. Is spending more robust than has been recognised?
Click below for the full report:
The economy bulging pockets 10 Jan 2012
Category: SA Economy
The SA economy: Now to sort out the supply side
(From 12 December 2011)
Spending grew significantly faster than output in the third quarter. The growth in spending by households picked up only marginally, to a 3.7% annual rate in the quarter, with household spending on durable goods growing at a highly robust 17.9% annual rate, while spending on non-durables hardly advanced at all and spending on services supplied to households grew at a pedestrian pace of 2.5%.
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The SA economy – Now to sort out the supply side
The rand and emerging markets: It all makes consistently good sense
(From 6 February 2012)
The rand has strengthened in recent weeks in response to global equity markets and in particular to the recovery in emerging market (EM) equity markets. Such responses are entirely consistent with the patterns of the exchange value of the rand since 2008. As we have often pointed out, the rand is an emerging equity market currency: where emerging equity markets go, so too goes the rand and this year is no exception.
Click here for the full report: The rand and emerging markets
The Hard Number Index: Maintaining the recovery
(From 7 February 2012)
The SA economy in January 2012 continued its strong recovery from the recession of 2009, moving forward at a more or less constant speed according to our Hard Number Index of economic activity (HNI).
Click here for the full report: The Hard Number Index – Maintaining the Recovery 7 Feb 2012
The SA economy: Unwelcome mystery – but welcome attention to infrastructure
One could not imagine anything less likely to cause a flutter in the market dovecote than a most welcome improvement in the appearance of the note issue and the symbols it presents. But the mysterious media notice on Friday afternoon of a matter of national importance to be announced by President Zuma, with the Minister of Finance and Reserve Bank Governor Marcus in attendance on Saturday afternoon well after all markets had closed had the market, our colleagues and no doubt our peers across SA imagining both the good (less government intervention in the market place) and the bad (more interference) that could be in store for us.
Click here for the full report: The SA economy after Zuma’s Speech
The RSA bond market- Operation twist in reverse
We question the usefulness of the expensive attempts being made by the RSA Treasury to lengthen the duration of its outstanding bonds. presumably this is being undertaken to avoid the danger of any refinancing problems of the kind faced by European governments. We explain why governments, including the RSA, with a central bank able to monetise government debt cannot face a refinancing problem of the Euro kind. only perhaps an inflation problem. The problem for European governments is that the ECB, because of its consitution is unable to buy the Euro bonds issued by European govwernments – though it is able to accept such bonds as collateral from borrowing member banks. Click here for full report The SA bond market – operation twist in reverse
The Economy: The ball is in the government’s court
For the full report clock below:
The economy The ball is in the government’s court
The price of electricity- losing the plot
We discuss government plans to encourage beneficiation of minerals. We argue that unwillingness to beneficiate is a market outcome rather than a market failure. We explain that is may well become a government failure as the price of the essential input for industry- electricity- is priced well above its true full cost. We argue against setting the price of electricity in South Africa to protect the balance sheet of Eskom rather than the promote the competitiveness of the economy. Click for full report
Electricity prices
The Rand this Q4 2011
This report discusses the recent behaviour of the ZAR- that is weaker than expected. According to our emerging equity market model of the ZAR. the ZAR is about 9% weaker than predicted by the model- indicaing recent SA specific influences on the ZAR.
For the full report click below
SA Operation Reverse Twist
Bond markets: Operation twist in reverse, or just bowling a wrong ‘un?
The US Federal Reserve System has been conducting operations to reduce the interest yield on long dated US Treasury Bonds, and by so doing attempting to twist the yield curve, that is buying longer dated bonds in order to reduce long term interest rates.
Meanwhile in SA, we are seeing something of a twist in reverse. We will discuss this topic further in this piece, but first some explanation of the US version.
The Fed has been borrowing short from its member banks to buy long dated US government debt. It has committed some US$400bn to the scheme. The Fed owns about US$1.675 trillion of US government debt or over 10% of all US debt in issue. It also holds US$841bn of mortgage backed securities issued by Fannie Mae and Freddie Mac, the government sponsored enterprises that support the mortgage market in the US. The Fed has been buying these securities in the market and the sums paid out have mostly ended up as excess cash reserves (deposits) held by banks with the Fed itself. What the Fed pays out has ended up with the Fed.
Mortgage loans in the US are typically long dated loans for up to 30 years, at fixed rates of interest linked to the yield on long dated Treasuries. The intention of the Fed is to reduce mortgage rates to encourage demand for homes and house prices. By so doing it would encourage a recovery in home building activity. Higher house prices would also help US households recover some of the equity they have lost in their homes.
According to US Flows of Funds Accounts published bty the Fed, the average US home is worth 30% less than it was in 2006. In 2005 homeowners’ equity in their homes (the difference between the market value of their homes and their mortgage liabilities) was worth over $13 trillion. The value of this equity had shrunk to $6.2 trillion by September 2011 and the share of owners’ equity in their homes from 59.8% to 38.6%. The net worth of US households has held up much better than their equity in homes over this period, having declined marginally from over $59 trillion in 2005 to $58.7 trillion in 2011. This represents 5.1 times the disposable incomes of households, which is a very high wealth to income ratio by international standards.
Without a recovery in the housing market, the prospects for US economic growth cannot be regarded as promising: hence Operation Twist. Long term interest and mortgage rates have remained exceptionally low, presumably mostly attributable to the safe haven status of US government debt in a highly risk averse world, rather than to Operation Twist itself or the quantitative easing (purchases of bonds and other securities) already conducted by the Fed.
And so to the reverse
The SA Treasury has also been conducting its own intervention in the market for SA government debt. This may be described as the reverse of operation twist. The Treasury has been very busy extending the maturity profile of RSA government debt, actively buying up short dated government securities before due date and issuing much long dated securities of both the conventional and inflation linked variety. With the yield curve in SA upward sloping and getting more so (see below) this means that for now, or until the yield curve turns flat or negative, the SA taxpayer is paying up to 2% per annum more for its longer term borrowing. This additional expense of servicing interest bearing domestic rand denominated debt of the order of R800bn might well be better incurred helping the poor or giving tax relief to businesses to employ them. Why then the rush to roll over RSA debt before it matures and especially to convert lower interest short term debt to higher longer dated debt, before it is required to do so?
Source: Investec Securities and Investec Wealth and Investment
The average duration of SA debt, that is the time it takes for investors to recover their capital through a mixture of coupon payments and principal repayment, has risen significantly over recent years as we show below. Zero coupon bonds issued at a discount have a duration equal to the time to maturity. For debt with a predetermined coupon, the higher the nominal coupon payment, the shorter the duration. The average duration of US government debt is shorter than RSA debt – somewhere between four and five years.
Were these refinancing operations of the SA Treasury being conducted in the vanilla bonds alone, one might conclude that the Treasury, in preferring long to short, had a negative view on the inflation outlook for SA. Borrowing long is a good idea when inflation turns out to be unexpectedly high – borrowing short makes sense when the market overestimates the inflation rate incorporated into long term interest rates.
However the opposite is true when issuing inflation linkers and the Treasury has been especially aggressive converting its short dated inflation linkers into much longer dated inflation linkers. If inflation was expected to rise above expectations, an issuer would much prefer issuing short dated inflation linked securities, rather than the longer dated maturities. These long dated linkers would bring ever higher interest payments and receipts as inflation rose.
At recent auctions the Treasury has been issuing inflation linkers with 20 years to maturity (for example the R202) at real yields of 2.6% to redeem the once dominant R189 that is due to mature in 2013. The R189 is currently priced to offer a negative real yield of -0.07%. Or in other words, the Treasury is now paying out something like 240bps extra to roll over this inflation linked debt, rather than waiting for this shorter term debt to mature in two years time.
Average duration of RSA Inflation and Vanilla Bonds
Why Europe is not a good example
Why then would the Treasury be pursuing such aggressively expensive debt management? Hopefully it is not in response to the difficulties European governments and their debt managers have been seen to have in rolling over their debt with highly bunched maturity schedules. These refinancing difficulties arise because the Greek, Portuguese, Italian and Spanish governments cannot call upon the services of their own central banks to convert, without limit, interest bearing into non-interest bearing government debt- that is to say cash. Their central bank sits in Frankfurt and appears very reluctant to convert longer dated Euro debt into cash. This is not a problem for the US. If faced by any temporary reluctance to bid for longer dated Treasuries, the Fed could come to the rescue with extra cash.
So could the SA Reserve Bank, if called upon, issue rands in exchange to overcome any refinancing emergency that might show up. Rolling over debt can only become a solvency or liquidity problem when the borrowing is undertaken in a foreign currency. Rolling over debt cannot be an issue when the debt is issued in an inconvertible currency that can be created without limit by a central bank should this be forced upon a government with its independent central bank. And most important, the knowledge that in last resort, government debt issued in the inconvertible currency of the land can always be converted in to cash, would surely be enough to fully overcome fears that government debt could not be rolled over. By exchanging cash for government securities (if conducted without limits), a central bank could invoke an inflation problem. However it could also overcome any refinancing problems (as the Italians and Greeks, now without such a fallback position, are fully aware).
There is presumably a case for smoothing what may be bunched repayment schedules for maturing government debt. But there is also a case for anticipating them in advance when scheduling debt, to avoid bunched repayments making such smoothing operations unnecessary in the first place. Paying a large interest premium to do so does not make good sense; nor is long dated debt issued by the RSA necessarily superior to issuing shorter dated debt.
Long term interest rates are the geometric average of expected short rates over the same period. To think otherwise is to second guess the market in fixed interest and there is little reason to believe the issuers of debt have superior insight about the direction of interest rates than lenders have. There are however some unintended consequences of longer duration: the longer the duration the more responsive the All Bond Index will be to unexpected changes in interest rates. Adding risks to fixed interest rate bonds in general discourages demand for them.
Furthermore the recent debt management operations in the inflation linkers (which have meant additional demand for them) have made this class of bonds an outperformer over the past year. Is the SA Treasury, in its urgency to substitute long dated for short dated RSA securities (to avoid what it regards as potential embarrassments in the debt market), misreading the nature of the Euro debt problems – at the expense of the SA taxpayer? Brian Kantor
Asset Class Performance 2011 to November 18th
Earnings are growing strongly in Europe – despite slow growth
Alexis Xydias and Adria Cimino report for Bloomberg today that
“Net income for companies in the Stoxx Europe 600 Index will rise by 10.5 percent in 2012 after increasing 11 percent this year, led by carmakers such as Porsche SE and retailers including Burberry Group Plc, according to more than 12,000 analyst estimates compiled by Bloomberg. The gauge is headed for four straight years of income growth exceeding 10 percent, the longest streak since 1998, data show”, and that European profit growth
“….. will exceed the 10.1 percent estimated for U.S. companies, even though the economy in the 17-nation euro zone is expanding at one-third the pace….”
The reason that profits are growing much faster than nominal GDP in Europe and the US is that the dominant European and US companies increasingly depend on revenues and profits generated globally. Emerging market economies are doing much better and growing much faster than developed economies. They are playing catch up adopting proven technologies and through the absorption of labour from low productivity employment in agriculture to much more productive engagements in factories that fully participate in global supply chains without push back from trade unions protecting established workers. Yet wages are rising rapidly as competition for workers builds up. And these fast growing economies have not yet made promises of welfare benefits funded by taxpayers that are now proving impossible to fulfil. The cloud on their economic horizons is a meltdown in demands from Europe and perhaps the US- where the economic outlook now looks a lot more promising than a few months ago. The opportunity these rapidly emerging economies have is to rely much more on domestic rather than foreign consumers.
It is these same consumers in the emerging economies that are already proving so helpful to the profits of companies listed in Europe and the US. The willingness of these profitable global companies to add productive capacity and to employment in their home economies would be greatly assisted by a sense that their own governments are coming to grips with the necessity to spend less so as to grow faster and in this way overcome their debt problems
SA economy: Moody’s can do some good
The mood may have changed even if the SA economic facts have not. But the Moody’s negative watch can do SA good without doing any harm.
Moody’s has raised legitimate concerns about the risks facing economic policy makers in SA that will resonate strongly with observers not only outside but also inside government circles. The question one would have to ask is what is especially new about these threats to SA political and economic stability. Perhaps the Moody’s decision to put SA’s credit rating on negative watch tells us more about the changing world of credit and especially for credit rating agencies than it is does about the direction of SA economic policy. What is clearly especially galling to the Treasury is that Moody’s appears to have been unimpressed by the strong affirmation of the conservative fiscal policy settings outlined by Finance Minister Gordhan in his speech to Parliament in October backed up in his recently issued Medium Term Budget Policy Statement. The government has planned to maintain the ratios of government revenue and government expenditure to GDP, to reduce debt to GDP ratios and to give greater impetus to capital formation rather than improved benefits for those who work for or depend on government.
The populist threats to the conservative setting of fiscal policy or the all-important role played in the economy by privately owned businesses, both domestic and foreign, are not new and will remain an ever present in SA, as they will almost everywhere else (Switzerland perhaps excepted and Wall Street Masters of the Universe not excluded) . The greatest risk to stability in SA is slow rates of economic growth that frustrate ambitions of individuals and firms and the financial capacity of the public and private sectors. This can lead to attempts at quick fixes by politicians.
The rating agencies have long been very well aware of these dangers to the impressive conservative fiscal and monetary policy directions taken by the new SA. Aware enough, that is, to have made SA’s ascent to an investment grade credit status a long hard ride. It is this status that has now been put on negative watch by Moody’s (though not by Standard and Poor’s). But Moody’s was not entirely negative in its judgment. It did not derate RSA credit, for the following reasons as we quote below from its statement:
“To date, South Africa’s fiscal picture and economic policy parameters have remained generally in line with Moody’s expectations, hence the continued A3 rating. The South African authorities’ economic stewardship has been effective for more than a decade, during which time they brought public finances and inflation under control and significantly bolstered the country’s external liquidity position. In addition, meaningful progress has been made in raising living standards, expanding social services and physical infrastructure, and putting in place a financial support mechanism for the most underprivileged. Finally, the outlook for South Africa’s public finances has not diverged significantly from Moody’s projections when the country entered into recession in 2009, roughly the time of Moody’s last sovereign rating action, despite the rather sluggish economic recovery over the past two years….”
The Moody’s rationale for a negative watch on RSA credit went as follows and is highly deserving of serious attention especially by those in the tripartite alliance inclined to believe in quick fixes or the magic wands that are meant to provide well paid jobs for all (that current policies applied to regulate the SA labour market have so singularly And conspicuously failed to do), a fact of SA economic life well recognized incidentally by Minister Gordhan in his policy review.
To quote the rationale:
“The primary driver behind Moody’s decision to change the outlook on South Africa’s government ratings to negative is the rising pressure from society at large, as well as from within the ANC and its political partners, to ease fiscal policy in order to address South Africa’s high levels of poverty and unemployment. In Moody’s view, spending beyond the substantial amounts already budgeted in response to such demands could push debt to levels more commensurate with lower-rated sovereigns. South Africa’s direct debt and guarantees for state-owned companies’ obligations currently approach or exceed 50% of GDP. Moreover, a substantial proportion of the government budget is already absorbed by wages, social support and debt service, limiting the room for new growth-supportive spending.
“Secondly, Moody’s is concerned that economic growth will be somewhat slower than previously expected in the years ahead due to a weaker global economy, depressing any rebound in South African employment levels over the coming years. This would in turn aggravate existing frustrations over the lack of economic opportunities. Moreover, job creation in this environment would not be enough to absorb new entrants to the labour force nor reduce the already high levels of unemployment. In Moody’s opinion, this situation poses risks to political stability over the longer term. Thirdly, Moody’s believes that the political leadership’s unwillingness to definitively reject demands from certain segments of the political spectrum for more activist policy interventions is harmful to South Africa’s economic prospects, in particular private investment. The agency also says that nationalisation of the mines and/or other sectors — however unlikely to happen — would not achieve the stated aim of accelerating progress on black economic transformation. Instead, such moves are more likely to do the opposite, reducing the country’s attractiveness to both local and foreign investors, and encouraging the outward migration of citizens and businesses. Such actions would in turn raise the risk premium on government debt, further inflating the already-rising costs of debt service. Overall, Moody’s believes that the next two years will be especially challenging for South Africa’s political system, with the potential for further pressures emerging for the established economic policy framework during this period.”
The most important factor restraining growth in SA over the next 12 months are not the structural weaknesses of the SA economy or the populist threat to property rights and fiscal policy settings. It is the European government debt crisis and the threat it poses to global growth and sothe demand for SA goods and services, including services supplied to tourists. The behaviour of the rand and so the outlook for inflation and its impact on interest rates paid on debt issued by the RSA is completely dominated by these global forces. RSA specific political or monetary policy influences on these important influences on the growth outlook and the willingness of SA firms and households to invest or spend are conspicuously absent. It is not the Moody’s watch that moved the rand yesterday but higher yields on Italian government debt.
Hopefully these facts of economic life have been well appreciated at the Reserve Bank sitting today to decide on the repo rate. As the Monetary Policy Committee (MPC) of the Bank pointed out in its latest statement, the SA economy is being held back by a lack of foreign and domestic demand. The short term outlook for the global economy has deteriorated. The outlook for the domestic economy is not conspicuously improved, at least according to Moody’s. The Reserve Bank can only hope to stimulate domestic demand by lowering interest rates. It cannot expect to have any predictable influence on foreign demand or the value of the rand (and so on the outlook for inflation) with its interest rate settings.
That lowering interest rates might do some good in promoting essential economic growth and so reducing SA risks (without doing any harm in the form of more inflation) should make a decision to cut interest rates an obvious one. If it was not altogether obvious at its last September meeting, it should be obvious today. And the Moody report would, it may be hoped, have made it even more obvious: the risks to the SA economy are not inflation (over which the Reserve Bank has no influence in the short term) but to growth, over which interest rate settings may have some influence. However the market place yesterday was not expecting a 50bps cut. This is despite the short term Forward Rate Agreements having shifted significantly lower over the past week, raising the probability of a 50bps cut to over 50% within three months. The probability of a cut today was still only about 20%.
We can hope the Reserve Bank will get it right and that the market has misread its better intentions. Brian Kantor
Hard Number Index: Noteworthy change
The economic signs from the Hard Numbers in October (vehicle sales and the note issue) provide some encouraging confirmation of the improving state of the SA economy.
The Hard Number Index of Economic Activity in South Africa (HNI) continued its upward trajectory in October. This indicates that the economy – based on two hard numbers for October, unit vehicle sales and notes in circulation – maintained a positive rate of growth in October. The direction of the economy (forwards or backwards) is shown by the HNI: when it moves higher the economy is moving ahead; when lower it is going in reverse. The economy, according to these up to date and hard numbers, is clearly moving ahead. The speed at which the economy moved ahead in October may however have slowed down, as we show below.
The changing speed at which it moves forward is indicated by the growth in the HNI. The speed of the economy slowed because vehicle sales in October 2011, while very strong compared to a year before, were down on September sales that were extraordinarily strong that month. However the other half of the HNI is made up of the notes issued by the Reserve Bank. These are issued in response to the demand for notes by banks and the public adjusted for the CPI. These growth rates have picked up very strongly in recent months. (See Below)
It may be seen below that the demand for and supply of notes has picked up significant momentum this year and that the pace at which notes are being issued is accelerating. Notes are held by banks in their branches and ATM machines and by the public in their wallets and purses to facilitate their spending intentions. It would therefore appear that at month end October, spending was gaining momentum. These trends will have to be confirmed but only much later by official estimates of retail activity. The most recent statistic of this kind for the retail sector is only for August 2011. These latest indicators confirm for us that the economy, after a slower patch in the second quarter, has picked up momentum.
The Reserve Bank however has never seemed to regard the narrow or broader definitions of the money supply and its growth as an objective of policy or of interest rate settings. Its decisions to lower short term interest rates at its meeting this week not are unlikely to be influenced by the accelerating growth in the note issue. Furthermore the growth in broader money (to September 2011) remained rather modest when viewed on a year on year basis. This may be so, but if interest rates are cut this week, this may add some pro-cyclical impetus to monetary policy. Brian Kantor
Money supply and credit growth: Confirming a more positive picture
Money supply and bank credit numbers have been updated to September 2011. The year on year growth rates have recovered from their cyclical lows of late 2009 but appear to have stabilised in the 6% range. Broadly defined money supply covers almost all of the liabilities side of the balance sheets of the banks; while credit extended to the private sector accounts for almost all of the assets held by banks and so the growth rates are bound to be almost identical.
A closer look at the bank statistics over the past three months reveals a somewhat more encouraging picture. On a seasonally adjusted basis both money supply (M3) and bank credit have picked up momentum.
When these statistics are converted into a rolling quarter to quarter annualised rate of growth we observe a strong recovery to growth rates of +10% from the slower rates of growth realised earlier in the year.
Mortgage credit demanded and supplied (accounting for about half all bank lending) however remains highly subdued, with growth rates tending lower rather than higher. House price inflation leads mortgage credit supplied and it would appear that the housing market remains in the doldrums.
The money supply and credit trends confirm our impression from vehicle sales, activity at retail level and the growth in the narrowly defined money supply (notes in circulation) that the SA economy has rather more life in it than is perhaps generally recognised. We await data on the note issue and vehicle sales in October, due to be released this week to give us a more up to date impression of the current state of the economy.
Retail sales: Share prices may be telling us more than retail sales
The volume of retail sales in August 2011, reported yesterday, was over 7% ahead of August a year before. This would seem to represent quite robust real growth in the top lines of SA retailers. However a year is a long time in economic life and especially in the retail business for making sales comparisons. Even a week and especially a week around Easter or more so Christmas when sales are highly concentrated may prove to be a very anxious and long period to wait for reports from the tills.
In the figure below we show annual and smoothed annual growth in retail sales volumes. As may be seen, these trends appear to be pointing lower. However when we seasonally adjust sales on a moving three month period these quarterly growth rates spiked significantly higher in August – providing a much more encouraging signal about sales growth.
This growth in sales may well have been assisted by a low rate of retail inflation. Retail prices are 3.25% higher than a year before while on a seasonally adjusted basis retail prices have risen by only 1.33% over the past three months. The annual rate of retail price inflation has ticked up while the quarter to quarter rate has slowed down.
We show below that retail prices have been rising at a significantly slower rate than prices in general, the inflation of which has been much augmented by higher administered prices, that are taxes on consumers by another name. In a real sense these price trends have made retailers more competitive for the household budgets strained by higher charges for electricity and petrol.
However as we also show prices in general, including at retail level, follow the trends in the prices of imported goods. Imported goods represent the cutting edge of competition in SA and so the prices of imports lead prices lower and higher as the exchange rate strengthens or weakens. The state of global supply and demand is also reflected in the US dollar prices paid for imported goods. Lately the rand has weakened as have commodity prices on expectations of slower global growth.
The net effect has been a rising trend in the prices of imported goods that may not reverse until the rand recovers some of its lost ground. The outlook for inflation in SA has deteriorated accordingly but it is not an inflation rate that the SA Reserve Bank or higher interest rates can have any influence over. The case for higher interest rates can only be made when the upward pressure on prices emanates from excess domestic spending rather than temporarily higher prices driven by a weaker rand.
Despite a satisfactory state of demand at retail level, the SA economy deserves encouragement rather than discouragement from monetary policy settings. It would appear that the Reserve Bank remains of this mind, despite the usual genuflection to the inflationary dangers of inflationary expectations (for which there is simply no SA evidence).
A further source of encouragement for the view that retail sales are growing consistently well is the performance of the SA retailers on the JSE. As we show below the returns on the JSE General Retail Index have provided a very good leading indicator of retail sales volumes. Returns have picked up recently, as may be seen below. As may also be seen, such positive signals of retail sales volumes and the earnings to follow are provided by the outperformance of retail shares. Retailers have been doing significantly better than the JSE as a whole. Thus the prices attached to the shares of retailers (especially relative to share prices in general) may tell us more about the state of retailing in South Africa, and in a much more up to date way, than the retail sales statistics themselves.
The Hard Number Index: Better than might have been expected
The official numbers for notes in circulation at 30 September, as well as new vehicle sales for September 2011 have been reported, allowing us to update our Hard Number Index (HNI) of the state of the SA economy. According to the HNI, economic activity in SA maintained its faster momentum in last month, at more or less a satisfactory constant speed as we show below. Given that many commentators had been expecting decelerating growth, this outcome must be regarded as good and encouraging economic news. The SA economy has, according to our HNI, headed in the direction of faster rather than slower growth in the third quarter.
We had noted in our previous report that the supply of and demand for notes had picked up momentum in August. The note issue is a very good indicator of spending intentions by consumers and one that is particularly useful as an economic indicator because it is so up to date. The growth in demand for notes continued to increase in September with actual growth rates now well above 10% p.a with the growth trend accelerating rather than decelerating. These growth numbers, when adjusted for inflation, are also revealing a marked upward bias. SA households would appear to be willing to increase rather than rein in their spending.
New vehicle sales in September also revealed a robust growth trend. The growth trend in new unit sales, which had weakened in the second quarter, has reversed course very decisively. On both an actual and seasonally adjusted basis, new vehicle sales have headed higher. Also encouraging is that export sales have remained very strong at nearly 26 000 units sold while the demand for commercial vehicles, particularly heavy vehicles, is showing especially strong growth. This indicates a willingness of SA business to add to its capacity to produce goods and services. Brian Kantor
Hard Number Index: Has the gloom been overdone?
With the release of unit vehicle sales and the size of the note issue for August 2011 we are able to update our hard Number Index (HNI) of the state of the SA economy. As we show below the HNI confirms the SA economy is maintaining its growth momentum. The HNI for July and August 2011 show very little change. The economy appears to moving ahead at a constant speed.
The HNI is an equally weighted mix of vehicle sales and the notes in circulation, adjusted for inflation. The vehicle sale cycle has turned lower – while still indicating good growth. As we reported previously vehicle sales in August recovered well from July 2011 levels – however this pickup in sales was not enough to reverse the declining growth trend.
As we also show, the HNI provides a much more up to date measure of the current state of the SA economy than the Business Cycle indicator, released by the Reserve Bank (which is only updated to May). As may be seen the HNI and the Reserve Bank Indicator tuned up in the same quarter of 2009. It may also be seen that the Reserve Bank indicator turned lower in May 20011; though the subsequent progress of the HNI strongly suggests that this economic activity indicator will have followed the HNI higher since then.
However what was negative for the HNI on the vehicle front was made up almost completely by the strength in demand for extra notes by the public and the banks. Adjusted for inflation, this growth in the note issue has picked up good momentum as we show below. This trend must be regarded as a very helpful one for the SA economy. Growth in the demand for and supply of notes indicates an improved willingness of the public to spend more. It has proved to be a very good indicator of the state of the SA economy. It suggests that the gloom about the prospects for the domestic economy may be overdone.
New vehicle sales: Business boost
The producers and distributors of new vehicles enjoyed significantly improved trading results in August 2011. Domestic sales were up to 51 436 from 45 686 units sold in July 2011. On a seasonally adjusted basis this represented an impressive increase of 5 471 units in the latest month after flat to declining sales on a seasonally adjusted recorded after March 2011. This recovery, if sustained, would see monthly sales of between 46 000 and 48 000 units to August 2012. This would be regarded as a very satisfactory outcome for the largest contributor to manufacturing output in SA.
The recovery in August 2011 sales arrested but did not reverse the declining growth trend that became apparent earlier this year.
Sales to businesses, including passenger car sales to rental car companies, new light commercial vehicles, bakkies and minibuses, were particularly strong, while sales of medium and heavy trucks were especially buoyant in August. Export sales of 24 835 units were recorded in August which must also be regarded as satisfactory given uncertainties about the sate of the global economy.
Vehicle sales thus continue to be one of the SA economy’s brighter spots. That growth in demand seems now to be coming more from the investment decisions made by businesses is very welcome given the weakness to date in the willingness of the private sector to add capacity.
Vehicle sales, house prices and credit: Operating below potential
New vehicle sales in South Africa in July rose from 44 880 in June to 45 703 units sold. On a seasonally adjusted basis this represents a marginal increase of about 70 units. As we also show below, the new vehicle cycle has clearly peaked and if present trends continue the level of new vehicle sales will remain more or less at current levels and growth will turn marginally negative (off its higher 2011 base) by early 2012.
In 2010 SA Households increased their spending on durable consumer goods by 24% off a very depressed base. This growth in the first quarter of 2011 was maintained at a very robust 21.5% annual rate helped by particularly buoyant sales of new vehicles in March 2011. The impetus provided to the SA economy by increased sales of new vehicles and perhaps also sales of other durable consumer goods, is losing momentum.
Such lack of momentum is also revealed by very tepid growth in the supply of bank credit and money to June 2011, a trend confirmed by the results reported by the retail banks this week. The revenue line of the SA banks is growing very slowly because house prices and so demands for additional mortgage loans have increased at a very modest rate and growth in the supply of money and credit may be slowing down rather than picking up.
These trends in vehicle sales, house prices and credit and money supply suggest that the SA economy will operate below its potential for some time to come. The potential stimulus to growth from the global economy and exports now also seems less likely to provide additional strength to incomes and employment. The MPC after its July meeting told us that it had not even considered lowering interest rates only raising them- a temptation that was strongly resisted as we were also told. Given these updates on the SA economy it should have considered lowering interest rates
US earnings: The benefits of going global
A Wall Street Journal Report today by Kate Linebaugh and James Hagerty, Business Abroad Drives U.S. Profits, points to way foreign operations of leading US corporations have contributed to the very satisfactory second quarter earnings season now well under way in New York. One third through the earnings reporting season for the S&P 500 companies, earnings are the highest they have been in four years.
These S&P 500 earnings per share may well exceed $100 for the 2011 calendar year. The drivers for this earnings growth however, as the report points out, is not the struggling US economy, but the off shore operations of these companies.
About three quarters of the companies that have reported so far have done better than analysts expected. As the WSJ report states, “…Many of them – ranging from manufacturers Honeywell International Inc. and Caterpillar Inc. to drug maker Abbott Laboratories – raised their earnings forecasts for later in the year.
The report refers to the bellwether industrial giant GE that reported a 21% increase in earnings to $3.8bn for the second quarter. Yet US revenues in GE’s core industrial businesses shrank about 3.4% while international industrial revenue soared 23% to $13.4bn, accounting for about 59% of the company’s total industrial revenue. This translates into growth in capital expenditure and employment offshore rather than on US shores making the US economic recovery less likely to benefit from the financial strength of US corporations, many of whom have a strong global footprint.
We have been firmly of the view that the most compelling way to gain exposure to the global economy is via the companies listed on the S&P 500. The valuations of these companies appeared very undemanding of earnings growth, trading as they do well below their average price to trailing earnings multiples (which averaged as much as 21 times between 1980 and 2011). The current trailing S&P 500 earnings per share, calculated before higher second quarter earnings have been reported, is US$81.31. This puts the S&P on a trailing 16.5x earnings and a prospective forward PE of under 14 times earnings to be reported in the first quarter of 2012.
This advice has proven apposite as we show below. Since 1 January 2011, the S&P 500 has gained almost 7% (to 23 July) while the MSCI EM is flat and the JSE in US dollars is 2.5% weaker than on 1 January 2011.
However as we also show, S&P earnings year to date have significantly outpaced the share market index, adding to the case for investing in the S&P 500. We remain firmly of the view that the S&P 500 is still very undemanding of future earnings growth and even less demanding than it was. And the unsatisfactory state of the US economy can be expected to continue to keep down interest rates in the US (and so the competition for equities from fixed interest income)
To view the graphs and tables referred to in the article, see Daily Ideas in the Daily View: Daily View 25 July