The global economy is still the main determinant of performance on the JSE. In this note, we break the JSE into three main categories, interest rate plays, commodity plays and rand hedges, and look at how these are likely to perform according to certain global and SA market conditions.
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From the global economy to the optimum SA portfolio
The risks of investing in emerging market foreign currency denominated debts have continued to recede as the Eurozone debt threat to global financial markets has diminished. RSA sovereign debt is no exception in this regard. The credit default swap (five year) risk spread on RSA debt was 202 bps at the beginning of 2012 – it is now nearly 30bps lower. The spreads on Russian and Brazilian debt have declined similarly as we show below, with Brazil continuing to enjoy a significant debt premium over RSA debt.
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SA bonds and the rand 21 Feb 2012
It seems clear that the retailers listed on the JSE are not expected to realise long term growth in earnings at anything like the rate at which earnings have been delivered over recent years. However they are no more demandingly valued today than they have been over the past 10 years. JSE retailers have provided excellent returns over the past year and they may well continue to do so.
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Retailers and the JSE Jan 2012 Monthly View
Stats SA has confirmed the strength of retail sales volumes in December 2011. Strong intimations of this had been provided by cash in circulation and by the trading statements of the retailers themselves – and indeed by the share prices of the retailers themselves to which we have drawn attention.
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Retail spending we told you so 17 feb 2012
(From 20 January 2012)
The Monetary Policy Committee (MPC) kept rates unchanged, as expected. We would suggest that this reveals a more dovish, growth sensitive tone with a further strong emphasis on the cost push nature of inflation (to which the Reserve Bank should not be expected to react).
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Interest rates MPC stays in the hole 20 Jan 2012
(From 13 January 2012)
SABMiller and the SA government have in recent days been able to take advantage of the appetite for fixed interest lending by borrowers with favourable credit ratings. The government was able to raise US$1.5bn of 12 year money at 4.665%. SABMiller plc was almost simultaneously able to raise over US$7bn in a variety of maturities at significantly better terms: $1bn maturing in 2015 at 1.85%; $2bn at 2.45% maturing in 2017; $2.5bn of 10 year money at 3.75% (compared with the 4.665% the government paid for 12 year money); and an additional $1.5bn of 2042 notes with a yield of 4.95%.
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Global bond markets 13 January 2012
(From 11 January 2011)
The quality of the Naamsa unit vehicle sales statistics for December 2011 has been damaged to a degree by the refusal of Daimler-Benz to release their December sales to Naamsa, citing (rather strangely) European competition authority concerns. Presumably the competition authorities could not object to the firm announcing its own sales – the practice in the US. However a “conservative” Naamsa estimate of 920 unit Mercedes sales in December has led Naamsa to estimate total unit sales of 45 200 in December 2011. To misquote Shakespeare: The vehicle sales number doesn’t alter when it alteration finds, or “Benz” (bends) with the remover to remove.
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Vehicle sales 11 January 2012
(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?
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The economy bulging pockets 10 Jan 2012
(From 23 December 2011)
The ECB has finally acted as a lender of last resort (without limit) to the European banks, who had been threatened by the weakness in the European Government bonds they hold. These bonds are now being used as collateral by the banks for three year money from the ECB at 1% per annum.
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Talking Point A New Year Wish
(From 14 December 2011)
The big new story in the currency markets is not the weakness of the rand or the strength of the dollar – but the weakness of the euro. The euro, which was worth as much as 1.417 US dollars on 27 October, is now trading at close to 1.30
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Currencies Structurally weaker euro
(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
(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
(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
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
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
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The economy The ball is in the government’s court
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
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.
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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
Published in Sunday Independent November 20th 2011
Brian Kantor
15th November 2011
It is surely clear that the SA economy can do with all the help it might get from lower interest rates. It is not getting that help from the Reserve Bank because the inflation outlook has deteriorated. The inflation outlook however has deteriorated because of a weaker rand. And the rand is weaker for reasons completely out of the influence of the MPC – that is the Euro debt crisis.
The MPC should know but seems not to recognize that interest rate settings in SA have no predictable influence at all on the exchange value of the rand. The correlation between changes in interest rates and the changes in the value of the rand is close to zero- that is there is no observable influence of changes in interest rates on the exchange value of the rand. And therefore interest rates have no predictable influence on the prices paid for imported and exported goods that have such a strong direct bearing on consumer prices in South Africa. Moreover over the past twelve months, since the MPC last cut interest rates, the rand has been all over the place, driving inflation in one and then the other direction.
The evidence is overwhelming, no doubt awful to contemplate for those with a text book view of monetary policy in South Africa is that interest rates and therefore monetary policy settings have not had any meaningful influence on inflation outcomes in SA. And moreover they cannot be expected to have any predictably anti inflationary purpose until the rand responds to SA, rather than global forces. This surely cannot be predicted to happen any time soon.
Like it or not monetary policy can only influence aggregate demand in South Africa. Its impact on the price level has been and will be overwhelmed by moves in the rand. Thus higher interest rates, especially when accompanied by a weaker rand and the higher prices that follow, can only mean less spending and less output and employment in South Africa- without having any helpful influence on inflation or the outlook for inflation that will be dominated by the outlook for the rand. By not lowering rates or even, heaven forbid at this stage of the business cycle, contemplating raising them, because the inflation rate might breach the inflation targets, the MPC has burdened the SA economy with less growth and no more or less inflation.
And should the Reserve Bank response to this critique take the form that monetary policy must fight not just inflation but inflationary expectations, it should also be recognized that there is also no evidence of this in South Africa. Inflation may have affected inflation expected in South Africa, even though inflation expected has been remarkably stable, suggesting that such effects have been of small magnitude. But there is no evidence of any feedback or so called second round effects effects. That is more inflation expected leading to more inflation. This has not happened perhaps because the theory is faulty but much more obviously, because inflation in SA follows the exchange rate and does not lead it. ( See Below)
South Africans have been called upon to make sacrifices in the form of slower growth for lower inflation or at least inflation in line with inflation targets that in the light of our recent monetary history make no sense at all. A new narrative for SA monetary policy is long overdue. This does not have to mean more inflation or more inflation expected. This would neither be desirable or inevitable. If the narrative explains the facts of the matter that inflation is dominated by exchange rate movements, over which SA has little predictable influence, and monetary policy was set accordingly, it would mean faster and more sustainable rates of growth. This faster more sustainable and predictable growth would attract more capital to South Africa to fund this growth. This would mean a stronger rather than weaker rand over the long run- and so less rather than more inflation over the long run.
But this narrative would mean recognizing that inflation targeting for South Africa- given the openness of its financial and currency markets to unpredictable global forces – has not been a sound basis for monetary policy.
Retail inflation- led by import prices – a mix of global prices and exchange rates – heading higher
