PIGS and a different type of flu: Analytics

Lance Vogel of Analytics writes that global markets are faced with three areas of worry at the moment. China is slowing lending, Greece is testing EU resolve and the pace of economic recovery seems slower than hoped.

Firstly, China is working quite aggressively to slow lending in an effort to contain inflation down the line. Secondly, Greece is proving to be a rather severe litmus test for the EU in terms of how the broader Eurozone will step in to help its member countries (unfortunately called the PIGS or PIIGS if Italy is included) that are down and almost out as they wallow in the aftermath of the credit crisis. Finally, questions are being asked about the pace of the global economic recovery and answers and evidence seem to be pointing to much slower-than-hoped-for event. An improved Q42009 earnings reporting season in the US is being overshadowed by these other concerns. In fact, 76% of the S&P 500 companies that have reported thusfar in the US have shown earnings growth in line with or better than analyst expectations.

On Friday, Chinese authorities told banks to boost their reserves for a second time in a month. China is currently one of the biggest drivers of the global economy and its efforts to curb the pace of its growth have led to concerns about a slowing pace of the recovery on a global scale. A stronger US dollar is not helping matters at the moment either as this feeds an increasingly attractive flight to quality strategy and it also depresses the prices of dollar-based commodities. The energy and metals sector is taking the brunt of these two developments.

The relationship between Greece and the more economically powerful EU nations is decidedly rocky now as pressure is being brought to bear on Greece to aggressively deal with its budget deficit that is forecast to be 12.2% of GDP in 2010. The Greek public has openly come out in protest at some of the measures that have already been proposed.

The EU President has called on Greece to do whatever is necessary to reduce the deficit and has added that the EU will step in to rescue that economy if the need arises but no specifics in terms of a potential rescue plan have been made public. Market concerns are also focused around the others in the pen, Portugal, Italy, Ireland and Spain and what the EU response would be if an explicit call for help comes from these economies as well. As usual, markets will wait for some form of clarity on this situation just as they did in the Dubai World wobble in December of last year. The EU has said that it will review the situation and progress in Greece next month.

While Greece and the EU battle with rescue and possible bailout issues, the investment banks in the US are battling with government efforts that are aimed at extracting appropriate returns on taxpayer money that was used to save their skins.

These efforts include congressional proposals to tax bonuses, President Barack Obama’s planned tax on the liabilities of large banks and his suggestion that banks be prohibited from using taxpayer-insured funds for proprietary trading. The message that seems to be coming through loud and clear in the US

(and to a certain extent in the UK as well) is that a price will be extracted from the recipients of taxpayer largesse in order to ensure that past mistakes will not be repeated.  This appears to be a fight that administrations cannot afford to lose.

Back at home we have our own concerns about deficits and funding and we await with interest the content of Finance Minister Pravin Gordhan’s first Budget Speech on Wednesday. Following the uninspiring State of the Nation Address by President Zuma last week, a concrete action plan and a clear picture of the extent of state funding requirement and its subsequent expenditure is hoped for. Fiscal discipline has been the cornerstone of our economic policy for many years now but the clamour from the left-wing allies of the ANC is becoming ever louder.

Following statements made by ANC leaders and spokespeople over the last few weeks, we also expect Minister Gordhan to say something about inflation targeting and also make mention of the lack of stability in, or the volatility of, the currency during his address. Speculation from BNP Paribas is that the Minister may announce a tax on short-term foreign capital inflows into our equity and bond markets. We must also remember that in its medium term budget last October, the Treasury announced new measures to relax exchange controls in a bid to cut red tape for investors and help coax the rand to a more competitive level.

In short, we expect clarity on economic policy from the Minister in his speech bearing in mind that the backdrop for this year’s budget is one of the most difficult in South Africa’s history. The task of sticking to the existing infrastructure development program (President Zuma confirmed in Davos that this focus would continue) and meeting social spending requirements after the negative impact of the financial crisis and its aftermath is daunting. Prudence is needed to protect the country’s credit rating from possible swine flu from the PIGS.

On the contentious subject of industrial policy, Trade and Industry Minister Rob Davies is expected to address the media on Thursday, when details of the sectors the government wants to promote will be revealed. Last week the Cabinet adopted an industrial policy action plan that holds the key to President Zuma’s plan of funding specific sectors that will create the jobs that he has promised. The detailed plan apparently has a specific time frame and was part of an overall strategy “to put the economy on a labour-absorbing growth path”.

The targeted sectors would include those which can supply goods and services for the public sector’s R840 billion three-year infrastructure investment program. Skeptics will be excused for saying “nice to hear”, “even better to read” but “where is the delivery?” Both the budget speech and Minister Davies’ address must be short on promises and long on plans for tangible delivery over realistic time frames.

Our equity market has had a much-needed pullback from middle of January levels as investor focus shifts from momentum to more realistic fundamentals. The earnings delivery of JSE-listed companies must now show that it matches up to the expectation that the forward-looking market has set. High ratings always put markets in a zone of instability, and so any sort of global (or regional) wobble will result in a show of weakness. Equity markets will mark time until positive evidence is delivered on an ongoing basis that earnings growth is stable and sustainable and that good numbers are not just relying on the very low base that was set after the credit crunch.