Global Markets - 1st quarter 2003
The winds of war?

The impact of a potential US lead war against Iraq has undoubtedly dominated global markets during the quarter under review (December through to end February). From as early as September last year the Federal Reserve reportedly raised the topic of "geopolitical uncertainty" and its impact on the American economy, when announcing their interest rate decisions. In the latest monetary policy statement issued by the Federal Reserve, the current tensions with Iraq have been given most of the blame for the current economic uncertainty prevailing in the USA.

An estimated $450 billion has been committed to the war against terrorism, by the United States of America, over the next 10 years. Yale University economist, William Nordhaus, believes that there are two possible cost scenarios - the first being a low-cost, quick war, which he estimates could cost $99 billion. The second scenario covers a high-cost protracted war that could cost in the region of $1.924 trillion. These costs by Nordhaus do not include the costs of dealing with further attacks on US soil.

At the time of writing this article, uncertainty still remains about the pending war against Iraq. Many believe at this point, however, that it is a case of "when" rather than "if". The focus is currently on March 1st - the date Baghdad has been given to begin the monitored demolition of the al-Samoud-Two missiles. Both the al-Samoud Two and the al-Fatah missiles currently exceed the range of 150 kilometres set by the United Nations Security Council. According to a BBCNews.com report the al-Samoud Two missile, which is a tactical surface to surface ballistic missile powered by liquid fuel, has been tested at a range of 183 kilometres and may be able to deliver a biological or chemical warhead.

UNITED STATES OF AMERICA

In a unanimous decision at their meeting on 29th January 2003, the Federal Reserve left short-term interest rates on hold at 1.25%. Short-term interest rates are now at their lowest level in 42 years. In a statement following their meeting, the Federal Reserve stated, "oil price premiums and other aspects of geopolitical risks have reportedly fostered continued restraint on spending and hiring by businesses. However, the policy makers believe that as to those risks left, as most analysts expect, the accommodative stance of monetary policy, coupled with ongoing growth in productivity, will support to an improving economic climate over time".

The US Dollar remained under pressure during the period under review. Reasons cited for this include the fact that investors are uncomfortable with the US stance against Iraq and the potential ramifications of the war against terrorism. According to economist Lara Rhame, "the global perception is the US has the most to lose if there's a war in Iraq". Another analyst is quoted as saying "some Middle Eastern holdings of US Dollars are being switched into Euro so that they can not be frozen by US jurisdiction. It is not economics driving this move, but short term funk".

In his bi-annual address to Congress on 11th February, Federal Reserve Chairman Alan Greenspan stated that "considerable uncertainties surround the economic outlook, especially in the period immediately ahead". Despite these comments, the Federal Reserve has forecast growth rates of between 3.25% and 3.5% for the US economy for 2003. President Bush recently announced a $674 billion reflation package effective over the next ten years - one of the main features, being the proposal to abolish the double taxation of dividends from 2003/4 onwards.

Following the corporate accounting scandals and bankruptcies of 2002, corporate results generally have tended to be disappointing. According to an American analyst, "the main reason is the destruction of earnings surprise by regulation and transparency requiring repeated guidance and estimates from companies. When the company reports there is little room for surprise and "in line" results can lead to disappoint bigger than the rally triggered by a higher guidance"

EUROPE

On 5th December 2002 the European Central Bank reduced interest rates from 3.25% to 2.75% - the first rate cut in this region since November 2001. Further easing could be brought about due to a combination of the following factors: rising oil prices, a marked drop in inflation, a deceleration in economic growth and continued appreciation by the Euro.
The Euro appreciated by some 17.8% against the US Dollar during 2002 (after reaching lows of 84c against the US Dollar the currency traded at 1.08 against the US Dollar at the end of February 2003). This current trend is viewed as being more about US Dollar weakness rather than Euro strength, however. A stronger Euro is not necessarily good news for the Eurozone at this point, as it makes exports from the Eurozone more expensive and therefore less competitive. Another cause for concern is the potential impact of possible slower USA consumer spending on exports from Europe.

During December 2002, in the biggest expansion in history, 10 new countries were invited to join the European Union. These candidate countries are: Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia. It has been proposed that the accession treaty be signed in Athens in April 2003 and that the new members join the EU in May 2004. In December 2004, it is likely that Turkey will be invited to start membership talks.

UNITED KINGDOM

In a surprise move on 6th February, the Bank of England cut short-term interest rates by 0.25%, bringing rates down to 3.75% - the lowest levels since 1955. This move came as a surprise, as many analysts believed that rates were being kept at 4% in an attempt to keep housing prices and inflation in check. Inflation is currently at 2.7%, which is slightly above target. The housing market, supported by low unemployment levels and low interest rates, was a major contributor to economic growth during 2002, with housing prices having risen by an estimated 24.9% since January 2002. Concerns about the unexpected rate cut are that it may lend impetus to the housing boom, where housing prices continue to rise, and increase debt levels even further. On the other hand, the rate cut may put pressure on Sterling, which in turn could give exports a boost.

While consumers in the UK have to date remained reasonably resilient, there is mounting concern about the sustainability of the current boom in the housing market, with some analysts being of the opinion that this market may already be over stretched. The tenant market and the rents for offices in central London are falling due to the inordinate amount of development taking place. In addition, investors appear to be exercising far more care in the prices that they are willing to pay.



JAPAN

The Japanese economy remains troubled. As stated previously, the consensus view is still that an upturn in Japan is largely dependent on exports and foreign demand, as this economy is almost solely reliant on foreign demand. Over the period under review, the Yen strengthened considerably against the US Dollar, which impacted negatively on exports and in turn on equities. Because an appreciating currency jeopardises exporters' earnings growth, the Japanese government currently favours a weaker Yen, as it makes Japanese exports more competitive. Deflationary pressures were once again induced by the combination of a stronger Yen and weaker exports.

Many analysts were surprised to learn that the Japanese economy had grown by 0.50% during the last quarter of 2002. Average real GDP is expected to improve to levels of 0.50% for 2003. The recent economic stimulus package proposed by the United States should bode well for Japan in that it is likely to help support external demand for Japanese exports.

SOUTH AFRICA

The appreciation of the Rand during the course of 2002 and during the first two months of 2003 has dominated the South African market. During 2002, the Rand recovered by some 39.6% against the US Dollar and by 17% against the Euro on the back of a decline of over 37% against the US Dollar during 2001. Some of the key reasons for the improved performance in the local currency include: the large interest rate differentials between South Africa and major industrialised countries which has served to attract foreign inflows, the weaker US Dollar, Zimbabwe no longer attracting too much attention, the demand created by exporters repatriating their funds in a shorter time frame than usual. Furthermore, the forthcoming listing of Telkom in Johannesburg and New York, together with the Cricket World Cup has served to improve sentiment towards South Africa.

There are several factors, however, that could put pressure on the Rand during the coming months. The Rand, being an emerging market currency, would be vulnerable should the war against Iraq materialise, as heightened geopolitical pressures are likely to cause a shift in global sentiment. In addition, domestic interest rates are likely to start coming down from June while international interest rates are expected to rise, thereby reducing the interest rate differentials and making our markets less attractive to foreigners. Repatriations by exporters could start to decline as a result of the inhibited global environment. Foreign direct investment (rather than speculative investment when foreign investors take advantage of temporary factors like interest rate differentials), on the whole, is extremely weak - this is caused largely by concerns over ongoing issues such as crime, HIV AIDS and the high unemployment rate. One of two factors need to be present for South Africa to become competitive as an emerging market in order to attract foreign direct investment - either an inexpensive currency or a conciliatory labour market. With the domestic labour market being fairly inflexible, the only remaining draw card for foreign direct investment is a cheap currency, which is presently not the case. South Africa continues to face significant competition in these areas from countries like Mexico, Turkey and China.

After four 1% interest rate increases during 2002, the consensus view is that domestic interest rates are expected to decline by between 2% and 3% during the second half of the year. Some analysts are hoping that interest rates will start declining as early as March, but Tito Mboweni, Governor of the Reserve Bank, has made it clear that the fight against inflation may result in interest rates remaining higher for longer. In January, CPIX (headline inflation excluding mortgage costs) was 11.8%, marginally lower than the December figure of 12.4%. However, this number was above consensus estimates. The CPI figure for January came in at 13.7% - down from 14.4% in December. While it appears as if inflation has peaked, it is believed that the Reserve Bank is likely to adopt a cautious approach when it comes to the timing of the interest rate cuts this year.


2003/4 BUDGET

The recent budget, which was well received, held few surprises. As expected, interest exemptions were increased in an attempt to encourage savings - for people under the age of 65 the interest exemption has been increased to R10 000 from R6 000, while for over 65's it has been increased to R15 000 from R10 000. Tax on retirement funds was reduced to 25% from 18%. In additional the tax brackets were adjusted, with the top threshold increasing from R240 000 to R255 000.

Minister Manuel announced a foreign exchange amnesty for investors who have money abroad illegally in contravention of Exchange Control regulations. Investors who wish to repatriate these funds, may do so subject to an Exchange Control penalty of 5%. Those investors who wish to leave these funds abroad may do so subject to an Exchange Control penalty of 10%. This has been done in an attempt to encourage the repatriation of funds held abroad in a contravention of Exchange Control regulations. The window period in applying for Exchange Control amnesty relief runs from 1 May 2003 to 31 October 2003. In addition, income tax amnesty relief is available for failing to disclose income and / or capital gains from foreign sources arising before 28 February 2002.

CONCLUSION

The fact that global markets have now experienced three years of negative returns in a row is a rare event. Only twice since 1871 have global markets ever experienced 4 consecutive years of negative returns. The possible USA lead war against Iraq continues to serve as a dampener on global markets and on investor sentiment alike. Global markets are unlikely to improve until this uncertainly has been removed.

The price of Brent crude oil rallied during the quarter fuelled by continued global uncertainty brought about by the impact that a war with Iraq could have on world oil supplies, the rising tensions in North Korea and the recent strike in Venezuela (currently the world's fifth largest oil exporter). The Brent crude oil price ended the quarter at $33.48 per barrel, increasing by 24.50% from the previous quarter, after testing highs last reached during Gulf War in 1991.

The gold price rose considerably during the quarter under review - from $317.80 an ounce to end the quarter at $346.75 an ounce. Much of this can be attributed to economic and finance issues (e.g. the weaker US Dollar and the ongoing banking crises in Japan), together with mounting geopolitical tensions and their potential impact on global equity and currency markets. The increased aversion to risk has at times prompted a flight to gold - which has once again resumed its safe-haven status. During the quarter under review, both gold and platinum touched 6 and 23 year highs, respectively.

This report is based on information sourced from various institutions, both local and international. The report reflects a variety of views and is not intended to convey investment advice. Please consult us to obtain specific adt porvice relevant to your investmentfolio.