Investment Matters

Sunday January 20th 2019

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The latest Investment Matters articles are listed below.

What does the recession announcement mean for my clients?

WHY WAS THIS A SURPRISE?
Economists expected real (after inflation) gross domestic product (GDP) growth to be marginally positive. This is because Stats SA publishes advanced data on several key sectors, which allows economists to calibrate their GDP estimates ahead of the official release. However, it doesn’t release detailed numbers on the agricultural sector, so this is always a wild card. Even though it is a relatively small sector in the economy (2%), the magnitude of the decline in the second quarter (almost 30%) was enough to offset the positive contribution from other sectors. Agriculture should bounce back now that the drought conditions in the Western Cape have largely eased.

Therefore, the economy was 0.7% smaller in the second quarter compared to the first quarter – at an annualised rate. In other words, the statisticians take the actual decline (which was small) and multiply it by four to show how much the decline would have been if it persisted for the entire year.
Compared to the second quarter of 2017, the economy grew by 0.4%.

WHAT IS A RECESSION?
The definition of a technical recession is two consecutive negative quarters of GDP growth. However, there are some drawbacks to this approach, since quarterly growth numbers are often volatile and prone to revision. Stats SA makes estimates of economic activity with the information it has available. When new information emerges, it can change historic growth numbers. The recession in 1999 was revised away as was the 2017 technical recession. A better way of thinking about a recession is as a deep and prolonged decline in economic activity across a widespread range of sectors. Using this definition, the economy was clearly in recession in 2009, but the current slowdown would not necessarily qualify. There were also broad and deep recessions in the mid-1970s, early 1980s, mid-1980s and early 1990s.

The economy is not necessarily currently in a recession, as the data released last week only covers the March to June quarter, and we are in September already. If the current quarter posts positive growth, we will no longer be in a technical recession.

However, irrespective of which definition you use, these numbers confirm that the economy is under pressure. This is not new news though and the weakness has been reflected in financial markets for a while.

WHAT ARE THE IMPLICATIONS OF A RECESSION?
As noted, a recession is a prolonged decline in spending and production, usually associated with job losses, business liquidations, falling house prices and lower share prices. This combination of factors also tends to put downward pressure on inflation and interest rates.

For the government, a recession is associated with a decline in tax revenue, as well as a rise in spending on social assistance. In other words, the government’s budget deficit increases (it has to borrow more) and this acts as an ‘automatic stabiliser’ for the economy.

South Africa’s issue is that the government never closed the deficit following the 2009 recession and therefore has very little room to stimulate the economy at this time. On the contrary, the government is trying to reduce the budget deficit, hence the VAT hike earlier this year.
Similarly, though inflation is subdued and the economy weak, and the SA Reserve Bank is unlikely to cut rates because of the weak rand and general uncertain global environment.

DID THE RAND COLLAPSE BECAUSE OF THE RECESSION (OR THE LAND REFORM DEBATE)?
The recession news did not help, nor did the uncertainty around land expropriation and other policy debates. However, the recent sharp decline of the rand against major currencies is primarily due to the spill-over from Turkey and Argentina’s financial crises. The rand is one of the most highly traded currencies among emerging markets and is therefore exposed to the shifts in sentiment of investors in the financial centres in New York and London (and elsewhere). Although South
Africa has problems, we are not nearly in the same boat as Turkey and Argentina, although the sell-first-ask-questions-later mentality of many investors has lumped us in the same bracket for now. These bouts of risk aversion tend to not last very long though.

ISN’T THE GLOBAL ECONOMY DOING QUITE WELL?
It is, particularly the US and to a lesser extent, Europe. Historically, South Africa’s economy follows the global cycle. But not this time.

The channels through which South Africa should normally benefit from a strong global economy are through trade in manufactured goods, an influx of tourists, commodity prices and strong capital inflows. On them manufacturing side, our companies are less integrated in global supply chains compared to our peers and therefore benefit less from global growth. Meanwhile, the prices of our main export commodities (gold, platinum, coal and iron ore) have been under pressure, while the price of oil, our main import, has jumped.

Tourism would certainly have performed better had it not been for unnecessarily restrictive visa requirements, while anecdotally the Day Zero drought scare in Cape Town also put off visitors. Tourism should improve now, especially with the weaker rand as we go into the summer months.