MEDIA STATEMENT
For immediate publication
27 May 2009
STATEMENT BY: Dave Mohr, Chief Investment Strategist, Citadel
Recession confirmed
The debate is now over. Official GDP statistics confirmed yesterday that the SA economy has been in recession since the second half of 2008. Now the key question is whether it’s going to be a V-, U-, W- or L-shaped cycle. We believe current trends and developments in the world and local economy strongly suggest a W-shaped cycle.
Internationally there are three forces behind a W-shaped cycle. Firstly, the credit crunch driven collapse in economic activity post the Lehman bankruptcy was huge. From these depressed levels some rebound in activity is almost inevitable. As the desperate policy measures implemented to avoid a financial meltdown meet with some success and the banking system stabilises, some recovery in activity is taking place. In the media and research reports this rebound is called the “green shoots” of recovery. Although we recognise the “green shoots”, we are not convinced it’s the start of a V-shaped cycle.
There are two other major obstacles in the way of a V-shaped cycle. Firstly, households everywhere borrowed too much in recent years and savings ratios fell sharply, in many economies to zero and even negative. With prices of the assets bought by these loans now falling, households are starting to save again. This is called the “Shift to Thrift”. A deepening recession and surging unemployment rates are also encouraging higher savings rates. Such new found conservatism will cap the strength of any recovery in household spending for some time.
Thirdly, the radical policies implemented to avoid a full scale financial and economic meltdown will inevitably have some negative consequences. Near zero interest rates, printing money, accelerating government spending and letting budget deficits surge, will exact some toll on future growth. To mitigate the risks associated with these radical measures, they will have to be reversed as soon as the economic situation starts improving. Higher interest rates, draining central bank liquidity, pushing up taxes and servicing higher debts will increase the probability of a W-shaped cycle.
If the international economy follows a W-shaped cycle, the local economy will most probably follow suit. The events of the past year confirmed that the world economy is more integrated than ever via trade and capital links. The recent GDP numbers show the pain inflicted on our export producing sectors, mining and manufacturing, by the slump in the world economy. The GDP numbers also illustrated the effects of the world recession on the services sectors.
A popular local argument in favour of a V-shaped cycle is the much talked about infrastructure expansion program and accelerating government spending. Although both forms of spending will undoubtedly ease the pain, it is highly unlikely to result in a V-shaped cycle. Firstly the construction and government services sectors only comprise 16.7% of GDP. Secondly, the latest SA Reserve Bank numbers show that infrastructure spending already doubled in the last three years in real terms. Much of the infrastructure spending growth is already captured in latest GDP data.
At the same time government spending is already surging ahead at a rate of 16%. From already high levels of government and infrastructure spending, maintaining or accelerating these growth rates will be difficult, particularly against the background of a rapidly rising public sector deficit.
The popular case for a V-shaped cycle strongly rests on the impact of the interest rate cuts since December last year, as well as expected further rate cuts in the second half of 2009. We agree that rates are likely to fall further, probably by a full percentage point tomorrow. However, recent increases in commodity prices, if sustained, could well delay the next cut longer than generally expected.
Interest rates always work with a lag of somewhere between twelve and twenty four months. The first interest rate cut was barely six months ago. So it’s too early in the interest cycle to expect a sharp spending recovery. Furthermore, there are some factors at play that could stretch the lag, even beyond twenty four months.
Household debt doubled between 2004 and 2008 and household savings rates collapsed. Given the severity of the local recession and rising unemployment, many local households could follow their international counterparts in the “Shift to Thrift”. In such a scenario the lag between a fall in interest rates and a revival in spending could be much longer than usual.
Furthermore, the balance sheets of households have been damaged by the implosion of equity prices, as well as a slide in property prices. An increasing number of local households probably now have negative equity, i.e. their outstanding debts exceed the current valuation of their assets. Such households will not rush to take on new debts at the lower interest rates. However, not all households have negative equity and with the local recession currently not as severe as in many developed economies the “Shift to Thrift” will probably not be as dramatic as for example in the UK and the USA. Any evidence of a revival in household borrowing will however rule out further interest rate cuts.
Forecasting is always difficult – particularly when it is about the future! The current synchronised world recession is unlikely to result in a strong and sustained recovery. A W-shaped cycle is more likely. Locally the recession is in full swing and a W-shaped cycle, strongly influenced by world trends, also looks like the most likely scenario. In such a scenario interest rates are expected to fall in the short run, then stall and probably resume their downward trend thereafter, falling below the lows reached in 2005/6.
ISSUED BY: CITADEL
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Daleen Cornelissen
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