British investment strategists have predicted a turnaround in South Africa’s economic fortunes, writes Shaun Harris
Don’t break out the champagne, sorry, sparkling wine, yet, but a reversal in the economic fortunes of the current world powerhouse and a fallen Eastern giant could bring vast benefits to South Africa. Optimism about the global economy in general and emerging markets, particularly the partial emerging market of South Africa, has investment strategists in London predicting that Diagonal Street could beat Wall Street for the first time in a number of years.
Turks at Merrill Lynch in London are also calling commodity stocks the only game in town, welcome relief for those sectors of the Johannesburg Stock Exchange that have taken a severe beating over the past couple of years.
But to get back to the beginning, Merrill Lynch says that, contrary to earlier fears, the Western world has benefited tremendously from the Asian crises.
“Conventional wisdom says cheap Asian imports and weak Asian export markets would hurt Western economies and stock markets,” says Trevor Greetham, global strategist for Merrill Lynch in London. “We would argue the opposite. After all, the last Asian crises turned out to be surprisingly positive for Western financial assets. The Dow and Dax are both up 50% since Thailand devalued.”
So if China devalues, as many international bankers expect, and Asia, pushed by Japan, relapses into a broad slump, the United States would benefit. Falling commodity prices would probably push US inflation even lower than it currently is, giving the Federal Reserve good reason to cut interest rates further.
But what if Japan recovers? Well, says Greetham, the rest of Asia would probably follow. And if an Asian recovery is stronger than expected, it would push back the need for Chinese devaluation and would boost the profits of stocks dependent on global trade.
That could spell trouble for Western financial assets. “The world economy would be in a synchronised upswing for the first time since 1994,” Greetham says. Rising commodity prices (and we’ve seen an upswing since Greetham made these comments a few weeks ago) would put upward pressure on US inflation, forcing the Federal Reserve to tighten credit to slow the US capital- spending boom.
Merrill Lynch is following the above scenario, and is accordingly overweight in non-US equities, especially Asian equities. The investment house still likes US bonds and is bullish on British and Japanese equities, but definitely does not like US equities. The key to its cautious stance towards the US is two-fold. Firstly, Greetham says strong growth in US shares has had more to do with low inflation and low interest rates rather than superior earnings from US companies.
The second fear is that the US economy is being driven by a high capital-spending programme funded by foreign capital. “The US is starting to look like Thailand did in 1997. Capital spending is way above savings, with a large current account deficit of nearly $70-billion,” Greetham says.
With the US boom being funded by foreign investors rather than from domestic savings, repatriation of foreign funds, especially the yen, is likely to cause both the Dow and the dollar to weaken. “There is little evidence in the US of the real estate speculation that characterised Asia’s bubble. But there could be an asset price bubble in the stock market itself,” Greetham says.
So if there is a full-blown recovery in Asia it will spell trouble for Wall Street and the US economy. But what does this have to do with South Africa?
Greetham believes he has the answer. “The world economy looks set to surprise on the upside in 1999 to the benefit of emerging markets like South Africa. The slowdown could come in 2000, but this time with the US and not Asia bearing the brunt of it.”
Therefore, if Japan recovers – and though strong growth does not yet seem a prospect Greetham believes last September’s pessimism could mark a low point in the economy and the Nikkei – South Africa could be a major beneficiary. Apart from his ability as a global strategist, Greetham’s views on Japan bear weight because of his knowledge of the country. He is fluent in Japanese and well versed in the culture.
After two years of suffering under the emerging markets tag, it will be a pleasant change to gain some advantage from the “developing” status the rest of the world accords us. This time around it might even be fun to be labelled an emerging market.
Some of the signs are already evident. Greetham believes economic optimism is rising in South Africa, now as high as during the demutualisation fever of early 1998. More important, though, is that a stronger world economy this year would mean rising commodity prices, an improved balance of trade, lower interest rates and stronger domestic growth for South Africa.
A recent poll of fund managers, says Greetham, found that 72% were buying commodity and resource stocks, the strongest buying interest seen in 10 years.
For local investors, this means getting back into the domestic equity market. Playing the commodities game is both specialised and risky, probably best left to the professionals though there are a number of specialist equity funds focused on resources. But the amateur private investor might find good value in general equity unit trust funds, currently out of vogue.
Maybe it is time to open the sparkling wine, after all – the biggest risk might turn out to be nothing more than a hangover.