2008 and the house of cards

Chief Investment Officer of Analytics, Lance Vogel writes that the year 2008 will go down as one of the most memorable in the history of the modern economic world. Those people operating in financial markets, and in particular the investment business, will look back on 2008 as the best example of how the proverbial pack of cards can collapse.

From something as simple as a collection of moderate houses in which people were expected to live, raise families and grow old, a fearsome toxic beast was created in the USA that eventually destroyed trillions of dollars of wealth, brought the world's biggest government to its knees, annihilated companies with illustrious histories and left a trail of broken careers and personal aspirations in its wake.

The combined evils of fear, greed and irrationality have led to events that will enter the text books of future investment classrooms. We thought initially that the problems at American Insurance Group (AIG) were huge, but the recent bailout of Citigroup has eclipsed everything as they announced that $306 billion was at stake. The captains of the three biggest US motor manufacturers appeared in front of Senate hearing committees as they pleaded poverty and held out the begging bowl so that General Motors (GM), Ford and Chrysler would be able to continue to operate into 2009. The shares in GM fell to a 50-year low. The financial market woes spared nobody and even led to a sharp contraction in merger and acquisition activity as company share prices were hammered by panic and forced selling.

The negotiations between BHP Billiton and Rio Tinto have now been called off as the anticipated merged entity with an expected market cap (in May this year) of $299 billion saw its valuation drop by 50%. This turmoil is reflected in the observation that in 2008 thusfar, the MSCI World Index has fallen by 40% (in dollar terms) and the MSCI Emerging Market Index has fallen by 60%.

As the after-effects continue to wash across the globe, leaving many economies in or on the brink of recession, global leaders are acting in concert in an attempt to limit the extent of the damage.

South Africa has been protected from the direct effects of the credit crisis by a combination of strict exchange controls (that supposedly stopped us from investing in the "toxic assets") and the National Credit Act (of 2007) that put a stop to any ongoing or future indiscriminate lending. Our banking system and financial institutions stood strong amidst the global hurricane and local consumers were already in the midst of a two year cycle of increasing interest rates that seem to have had the desired effect of curbing spending.

The extent to which tight monetary policy has been successful is reflected in the domestic bond and cash markets. These markets have signalled the top of the interest rate up-cycle and are pointing to significant interest rate cuts next year as inflation is expected to fall dramatically as the prices of commodities, such as oil, also tumble. The jokers in this pack continue to be the uncomfortable size of our current account deficit and the tendency for the rand to suffer bouts of periodic weakness. However, our Finance Minister and representatives of National Treasury continue to assure us that these risks are possibly overplayed.

The indirect effects of the sharp global economic downturn and the resulting recessionary conditions are of concern. The rapid fall in commodity prices and the wholesale removal of consumer's discretionary spending has had a dramatic negative impact on company earnings both offshore and locally.

Not only has our equity market been the victim of a global de-rating but the poorer profit outlook has also taken its toll on share prices. That said though, valuations on the JSE are now very attractive and once the volatility subsides and some element of rationality returns to the marketplace, good investment opportunities abound. Coupled with the very positive outlook on inflation and interest rates, we should not be too tentative about re-entering the equity market as we go into 2009.

We must also not forget that the local infrastructure development program must go on. With the 2009 Confederation Cup approaching fast, and the 2010 World Cup Soccer event following closely on its heels, we cannot afford to miss a beat as the world watches us closely as we gear up to host these two important events. Fortunately, progress in this respect is tangible, however painful the experience is for motorists and commuters in Johannesburg and elsewhere, as they negotiate the impossibly cluttered roads where projects such as the Gautrain, the Bus Rapid Transport System, the Integrated Transport System and the soccer stadiums forge ahead noticeably.

Further afield the construction of the La Mercy airport north of Durban is well underway, and the ground works have begun for our two newest coal-fired electricity generating stations. Kusile near Witbank and Medupi near Ellisras will use modern, cleaner technology in projects that will cost an estimated R160 billion. Work has now also started on the new (R9 billion) Itala Pump Storage System in the northern Drakensberg region. Progress on such projects can be seen and the effects of our infrastructure development efforts are being felt by many South Africans.

As if financial market turmoil was not enough for us, the local political environment has provided dramatic twists and turns for almost a year now. The post-Polokwane happenings have been nothing short of a gripping soap-opera with the initial Mbeki/Zuma showdown culminating in an unexpected, yet major split in the ANC with the formation of the new COPE party. The elections next year will be watched with great expectation as the ANC and COPE go head to head and with COPE looking at the DA as a possible swing-factor partner. Our wish is that whatever the outcome, peace will prevail. Thereafter we wish for rapid, focused and effective delivery of government services.

Just as in 2003, we will go into 2009 with painful memories of the previous year but with quiet confidence that we still have a solid platform on which to re-build meaningful economic growth and restore bruised consumer confidence.