Emerging market strength: when the answer confounds then reformulate the question!: Analytics

Lance Vogel, CIO of Analytics writes that South Africa had very positive news last week; Treasury has covered our foreign borrowing needs for the coming year by raising $2 billion in global markets.

SA issued a 10-year bond late last Tuesday that was heavily over subscribed. It has a coupon of 5.5% which is a record low for South Africa. This event has been viewed as a major vote of confidence in the country’s macro-economic policies by global investors.

The head of asset and liability management at the Treasury, Lungisa Fuzile, said after the bond issue that: “You can see that the rest of the world is saying that it now believes SA is committed to sticking to sound macro-economic polices and a sound fiscal path that will see our deficit declining and our debt-service costs stabilising in 2015 and declining thereafter”.

In the light of the ongoing problems that the EU is having with Greece, and possibly some of the PIIGS, this is a very encouraging sign for us. Foreign investors were net buyers of R76 billion of South African equities in 2009 and continue to be net buyers in 2010 to the tune of over a R1 billion a week, endorsing the global investor confidence in us as an investment destination. This is also evident in the strength of our currency and the resilience of our bond yields in the face of a number of continuing global credit and fiscal issues.

The World Bank will defend its proposed $3.75 billion (R29 billion and falling!) loan to Eskom in the coming weeks in the face of criticism from its two largest members, the USA and the UK. This loan is a crucial component of Eskom’s borrowing program as the parastatal gears up to meet our country’s growing energy demands. Opposition to the loan from the USA and the UK is based more on self-centered emissions and climate concerns than anything to do with growth, positive progress and economics. Eskom Finance Director Paul O’Flaherty said that the proposed funding would be “an economically attractive option” for SA. “Thanks to decades of macro-economic stability and prudent fiscal management, SA has the lightest debt burden of any African country. This is the first energy sector investment being made since the fall of apartheid.”

On Friday last week we received further affirmation of the adherence to sound monetary policy. The Reserve Bank’s mandate of targeting inflation will stay, although that also involves taking growth and employment into account, Deputy Finance Minister Nhlanhla Nene said. Nene thus reiterated the position of Finance Minister Pravin Gordhan who is under pressure from alliance partners to scrap the policy. Nene credited inflation targeting for the past decade’s gains.

On the subject of inflation targeting, The Economist reports that recent research findings from the International Monetary Fund (IMF) shed an interesting light on certain long-held beliefs. Early in February, the IMF’s chief economist questioned the focus of modern macro-economic policy on keeping inflation low, arguing that (developed economy) central banks should aim at an inflation rate of 4%, rather than the conventional goal of 2%. Has SA once again been well positioned (in hindsight) in spite of the pressures of “conventional wisdom”?

Furthermore, another research paper by a group of IMF economists suggests that the fund has substantially rethought its position on the use of restrictions by emerging markets on capital inflows. It concludes that controls are sometimes “justified as part of the policy toolkit” for an economy seeking to deal with surging inflows. This is surprising since IMF has historically opposed capital controls. The capital flows to emerging markets are surging again as a result of the difference between their interest rates and the very low interest rates of the “rich” world. The International Finance, a financial industry association, thinks that these flows will rise to $721.6 billion in 2010 from $435.2 billion last year.

Staying abroad, the Greek central bank governor George Provopoulos said that his country would not need foreign help to deal with its debt problems, in a newspaper interview released earlier today.  Solid demand for a 10-year, 5 billion euro bond sold last Thursday showed that Athens could raise the funds it needs in financial markets. Although Greece had to pay a “rather high” price to sell the bonds, the order book for the bond issue closed at 16 billion euro with about 400 investors involved. Greece unveiled a 4.8 billion euro austerity package last week, in the face of ongoing protests from workers who now are faced with substantial benefit cuts, amongst others, in their Easter bonuses, their holiday bonuses and their Christmas bonuses!

On the other side of the globe, CNN reports that Chinese Premier Wen Jiabao announced on Friday that it will target a growth rate of eight per cent in the economy this year, although he warned that the authorities would slow the number of new investment projects, and that the banking sector contained "latent risks". Opinion in China is sharply divided between officials who warn of the risks of rising property prices, inflation and overheating, partly as a result of the massive monetary stimulus last year, and others who believe the economy remains fragile despite the high headline growth. Mr Wen sought to find a middle path, stressing that the government would maintain a "proactive" fiscal policy and "moderately easy" monetary policy, which has been the official policy formulation for months, but also making it clear that he was aware of potential dangers.

In general, the consensus view seems to be that that economic recovery in many countries will be solid but the pace of the recovery will be slower than many investors had hoped for. Developed economy equity markets are now facing a “roadblock” as the industrial side of the recovery moves ahead with some confidence while the consumer side appears to be much more sluggish. Catalysts for further meaningful activity in the global markets must surely be a signal that the US is ready to lift short term interest rates and tangible evidence of a believable consumer recovery through sustainable growth in the earnings of consumer-related shares.

The rebound in our equity market from the lows of early February has once again pushed local ratings to very high levels. We thus remain wary of any additional exposure to domestic equities until earnings growth rises to meet the expectation of current market price levels.