The JSE lost 7% last week, recovered dramatically on Monday and Tuesday, only to fall out of bed again on Wednesday, bleeding 3% just in morning trade.
The latest credit extension numbers were higher than expected at 24,9%, resulting in analysts’ consensus for a further rate hike this month, which was looking likely anyway as the rand collapsed from R6,80 to R7,20 to the dollar.
And, if that was not enough, trade deficit numbers came in worse than expected, doubling to R5,3-billion.
This week’s market panic seems to have been driven by fears that the United States sub-prime market collapse is having a contagious effect. Australian investment bank Macquarie brought out a statement that one of its funds has been negatively affected by the sub-prime fallout, resulting in the share falling 10%. This has meant foreigners have fled the emerging markets for safer investments and hence the sell-off on the JSE.
But is there more to come? Mark Appleton, chief investment officer at Barnard Jacobs Mellet Private Client Services, says although the housing market in the US is causing major turmoil, it is unlikely to be a precursor to a major recession in the US economy.
Appleton says it is important to remember that our market is not overpriced at a current forward price to earnings (P/E) ratio of 13 times and that, relative to bonds, equities remain well valued.
Paul Hansen, director at Stanlib, agrees. “We still think the market is well valued. The only risk to our market is if the economy fades out and if earnings expectations of 17% to 20% are not realised.”
But Hansen says even an economic slowdown will not result in a bear market as we are still at reasonable valuations. He says one has to look at the big picture and that the economy, both locally and in the US, is looking robust. The US is on a forward P/E ratio of 15 times, which is below average for the past 10 years and therefore is not demanding. More importantly, as in South Africa, earnings yields in the US are higher than bond yields, favouring equities.
Hansen says nine out of the 10 bear markets started when bond yields were higher than earnings. He says the US has a lot of ammunition to deal with any fall-out in consumer spending as a result of the housing crisis because interest rates are at 5,25% and the Fed could start cutting rates to stimulate the economy.
With regard to the JSE, Hansen says last year in May we saw a fall-out of 18%, from which the market recovered. So far the market has corrected by about 7%, so there could be further short-term weakness, but not a total blowout.
Appleton shares that view and says volatility is expected to continue providing brave investors with buying opportunities. With regard to the recent credit extension numbers, Appleton says both the trade balance numbers and increased credit extension numbers are disappointing, although a rate hike was factored into the market a while ago already.
Appleton is not particularly concerned about the rand’s volatility as its recent strength is attributable to the speculation about Nedbank being bought out and higher commodity prices. Going forward, Appleton expects the dollar to weaken as further rate movements in the US are expected to be down.
Rate hikes: how much more can consumers take?
Goolam Ballim, chief economist at Standard Bank, says at the beginning of the interest rate cycle last year, not even the Reserve Bank was expecting to increase rates by 300 basis points, which is what the total rate hikes will be if the Reserve Bank hikes rates again this month. At the time, consensus was for a total rate hike cycle of 200 basis points.
Ballim says the Reserve Bank was compelled to hike rates in June after the inflation figures breached the 6% target significantly for three months. He believes a further rate hike in August will be a tipping point for consumers and we will see a significant decrease in borrowings for consumption.
At the same time banks’ non-performing loans will increase, although Ballim points out this will be a normalisation of levels of non-performing loans, which are coming off an extremely low base. At the moment non-performing loans make up 0,5% to 1% of bank loans compared with nearly 2% a decade ago.
Although there might be an increase it will not put any major strain on the banks’ profitability.
Although consensus is that there will be another rate hike, Ballim argues that it is not a done deal. Despite credit extension numbers coming in higher than expected, when it is broken down into household borrowings it suggests that households are losing their appetite for consumption.
Analysts argue that the Reserve Bank has to put up rates purely to maintain its credibility, but Ballim believes this was done when the Bank moved quickly and decisively to increase rates in June following the breaking of the inflation target.
“The cost of money has risen 24% since June last year. A further rate hike would increase it to 29%.” Ballim says, once a consumer has factored in the impact of rates, with increases in essential expenses such as transportation and food costs, the consumer is under enough pressure already and the Reserve Bank might take that into consideration. — Maya Fisher-French