Global Markets - 3rd quarter 2003
Is spring in the air?

Spring is usually synonymous with hope, fresh beginnings and the anticipation of good things to come. If the breath of fresh air that has been blowing through global markets since mid March is anything to go by, it would not be out of place to wonder whether markets are indeed entering a new season, after having endured a harsh winter that has lasted (so far) some 36 months.

Since the "lows" reached in mid March 2003 it has been encouraging to see the improvements in the indices set out below:

Factors that have contributed to the improvement in markets include: the unexpectedly swift resolution to the USA led war in Iraq, earnings numbers having mostly surprised on the upside and the continued resilience of consumers in certain regions.

Despite the fragments of good news that have started to emerge, there remain factors (some negative and some, as yet, unclear) that are likely to continue to serve as a headwind to the sustained improvement of global markets. Accordingly, while the improvements seen to date are encouraging, we need to bear in mind that markets are unlikely to continue improving at the pace seen since mid March - it is more likely that, if these early signs of improvement are to be trusted, a more gradual improvement in markets is possible.

So, is it possible that the early signs of spring are here, and if so, are they here to stay at least for a while? What is important to remember is that, even if the seasons are changing and spring is here, it is unlikely that we will avoid some cold wintry spells in the months ahead.

UNITED STATES OF AMERICA

Source: CNNFN.COM

The Federal Reserve reduced short-term interest rates to 1% (from 1.25%) on 25 June 2003 - rates are at their lowest levels since 1958.The last reduction in interest rates was made in November 2002 (of 0.50%). Following this announcement Tim Stewart, chief currency strategist for Morgan Stanley in New York commented that, "this cut certainly wasn't as dramatic a move as it could have been, and at the margin it's positive for the dollar providing we see positive US growth numbers continuing to come through". In line with expectations, rates were kept on hold at the August 12^th meeting. Following on from the last meeting of the Federal Reserve, Banc One chief economist said "The Fed is fully aware that a slowly recovering economy needs to be nursed carefully back to health before the doctor sends the patient home."

The provisional second quarter GDP numbers surprised analysts on the upside coming in at 2.4% quarter on quarter, annualised, compared to the revised first quarter number of 1.4%. This was well in excess of the market expectation of 1.5%. While this is very encouraging, it is important to bear in mind that defence spending contributed 1.69% of the total of 2.4%. Durable goods made a larger than expected contribution to this figure, boosted by incentives for car purchases.

Consumers have already begun to receive the benefits of the tax rebates, which should augur well for future consumer spending. In addition, most noticeably during the last two weeks of the quarter under review (but in fact since June this year), the US Dollar has strengthened against the Euro on the back of stronger growth expectations in the USA as well as on positive news flow.

Deflation is a risk that remains a concern, although perhaps less so now than a few months ago. Deflation, which is a continuous fall in the general level of prices, makes consumers reluctant to spend in the anticipation of the price of goods becoming cheaper.

EUROPE

As anticipated in our last report, the European Central Bank reduced interest rates sharply at their meeting on June 5th in an attempt to stimulate sluggish business activity in the Euro-zone. Rates are currently at 2%, following the recent 0.50% reduction, with further cuts expected during the second half of this year. The firm Euro (largely as a result of US Dollar weakness since early last year), which continued to impact negatively on exports from the Euro-zone, has also served to weaken corporate profits in the region. The Euro ended the quarter under review at 1.10 to the US Dollar, which is softer than at the previous quarter end (1.18) largely as a result of weak growth in the region and amid perceptions that the Euro-zone is likely to lag the USA in a global recovery. Economic activity has been inhibited by the combination of a firmer currency and comparatively high interest rates for some time.

Inflation remains benign and within the target range of below 2%. The year on year consumer inflation number for July was 1.9%. However, deflation concerns in both France and Germany persist.

The recent improvement in certain data coming out of the USA has been good news for the Euro-zone as there is a view that, should a global recovery be led by the USA, this should serve to boost business sentiment in the Euro-zone region, which in turn should boost exports and encourage new investment. Unfortunately, however, because the US Dollar has depreciated the most against the Euro (more than 33% since last February), the Euro-zone region has suffered the impact of the weaker US Dollar the most. The weaker trend of the Euro against the US Dollar in recent weeks should prove to be good news for the region and its exports.

UNITED KINGDOM

The Bank of England kept short-term interest rates on hold at 3.5% following their meeting on 6th and 7th August 2003, after having reduced rates by 0.25% at their July meeting. Rates are now at their lowest level since January 1955. Rates were reduced in July on the back of slower consumer demand and a lacklustre global recovery. Recent figures have indicated however, that the UK economy is showing renewed resilience.

Second quarter GDP growth, which rose by 0.3%, was well below the quarter on quarter expectation of 0.60%. This was disappointing, after the first quarter growth numbers indicated that the economy grew at it slowest pace in 11 years. Inflation is currently at 2.8%, which is slightly above the target rate of 2.5%.

In our last report we listed the five economic tests that the United Kingdom would need to pass in order to join the Euro. In a statement at the House of Commons in June, Chancellor Gordon Brown stated that the government's view was that only one of the four tests had been met. Accordingly, it is possible that a referendum may be held next year in order to decide the matter.
JAPAN

Despite facing many challenges, the Japanese economy has begun to show some resilience by expanding 0.6% quarter-on-quarter for the second quarter, following a 0.30% increase in the first quarter. It is disappointing to note, therefore, that the general view still appears to be that the new governor of the Bank of Japan has failed to action policy initiatives of any significance, in spite of being more flexible on policy issues than his predecessor.

Notwithstanding the many economic challenges, however, the latest reading of the Tankan Survey (measures manufacturing confidence) is the best since March 2001. This increase in capital spending and manufacturing has given a long awaited boost to economic activity. In addition, the Japanese economy has benefited from the increasing demand for its goods by China.

Japan has also been a beneficiary of the positive data starting to emerge from the USA. The recent improvement seen in the Japanese equity market, which has helped improve confidence, has been fuelled to a large degree by foreign buyers rebalancing the Japanese assets in their portfolios. However, the absence of both Japanese retail and institutional buyers in the market is apparent. As can be seen by the movement in the Nikkei since mid March this year, certain equity stocks have delivered a strong performance.

SOUTH AFRICA

Markets were surprised by the sharp 1.50% cut in domestic interest rates by the Monetary Policy Committee on 12 June 2003, with economists largely having expected a 1% drop. This was the first domestic interest rate cut in 21 months, following four 1% interest rate hikes during the course of 2002. At the August 14th meeting, a further 1% interest rate reduction was announced, which was in line with expectations. This brings the total reduction in short-term interest rates to 2.5% in the last three months.

CPIX, which came in at 6.6% year on year for July was disappointingly higher than the 6.4% year on year figure for June 2003. This unexpected rise in CPIX was brought about primarily by the increase in food prices (7.5% on an annual basis) and housing costs (10.6% on an annual basis). CPIX is currently close to the target range of between 3% and 6% and is still expected to fall for the remainder of the year, despite the slight increase in the July number. Furthermore, while this should still leave the Monetary Policy Committee room to decrease short term interest rates further during the next few months, there is speculation now that the extent and speed of the decrease will be more gradual and that there is a possibility that domestic interest rates may stay higher for longer. In the words of one economist "the downward trend of the CPIX is being slowed down. The likelihood of an interest rate reduction of more than 1% is decreasing". Domestic growth for 2003 is expected to be disappointing and has again been revised down - the result of a firmer currency, which has impacted on exports, and high levels of inflation that prevailed over the past number of years. GDP growth for the second quarter was a disappointing 1.1%. During the first six months of 2003, economic growth slowed to 1.5%, from 3% during the last six months of 2003.

During the quarter under review (1 June 2003 to 31 August 2003), the Rand strengthened against all three major currencies ending the quarter at R7.38, R8.11 and R11.66 to the US Dollar, Euro and Pound, respectively. This was surprising in that, a declining interest rate environment in South Africa has often (but not always - remember 1998 following the Asian crisis) been accompanied by depreciation in the Rand. In the current environment of relatively high domestic interest rates compared to the United States and Europe, which has encouraged a lot of foreign speculative investment into the country to take advantage of our high interest rates, it would not be out of place to expect the Rand to depreciate once our domestic interest rates start falling, as this serves to narrow the gap between our interest rates and those in the countries of the foreign speculators. However, so far, this has not been the case. A number of reasons could provide the answer - firstly, domestic inflation is once again under control and the gap between our inflation rate and that of our major trading partners has narrowed. Other contributing factors could include better growth prospects for 2004 than 2003 and the fact that overall policymaking has been viewed as sound resulting in South Africa being seen in a more favourable light by the international community. We must caution, however, about the potential negative effect that the weakness in the Euro-zone economy (South Africa's largest trading partner) could have on domestic exports, with this region being South Africa's largest trading partner. In addition, the inflation outlook, while currently positive, does have certain risks. These risks include high administered prices, recent wage settlement rates of approximately 10% as well as a combination of strong domestic demand with muted domestic production.

A firmer Rand, however, is not necessarily good news for everyone. The export sector has been hardest hit by the firmer currency and the weakness in Europe, and this in turn has served to slow domestic growth considerably in 2003. Accordingly, with exports on the decline, South African imports on the increase and with no real foreign direct investment inflows evident, it is only a matter of time before the Current Account once again records a sizeable deficit, if this trend continues. There is a view that, by year-end, the Current Account deficit is expected to be in the region of R11 billion, increasing further in 2004. According to recent statistics, the Current Account recorded a deficit of 0.50% of GDP in the first quarter. This could, once again, put pressure on the Rand and make the currency vulnerable.

GENERAL

The price of Brent crude oil increased during the quarter to end the period at $30.39 per barrel, from $26.51 per barrel at the end of the previous quarter.

The gold price remained range bound over the quarter - ending the quarter at $376.50 an ounce, compared to $365.95 per ounce at the end of May 2003. The current upward trend in the gold price began in early 2001 after the Federal Reserve began its series of interest rates cuts. The gold price has continued to climb as USA short-term interest rates have moved lower - low interest rates make the opportunity cost of holding gold low. In addition, the current liquidity in global markets combined with low short-term interest rates and a weak US Dollar have helped to sustain the gold price at these higher levels.

CONCLUSION

In May 2003 we were pleased to launch our website www.finlaw.co.za. Following on from recent advancements made to our website, clients will be in a position to access their personal portfolio details and fund valuations directly from our website via a secure process from the end of August 2003.

Just a reminder to all farming clients and those clients who have second properties - the deadline for obtaining valuations on your properties is the end of September 2003. This valuation (which should be a valuation as at 1 October 2001) is not mandatory, but it is advisable that it be done for possible future Capital Gains Tax requirements.

On a final note, for anyone who is in a dilemma about the amnesty issue (both the income tax and exchange control amnesties), think long and hard about the consequences of not applying. It is well worth doing and a small price to pay for future peace of mind. Ensure, however, that you obtain the appropriate advice for your personal circumstances and that the application form is completed correctly - you only have one opportunity to get it right.

QUARTERLY QUOTE
"Don't try to buy at the bottom and sell at the top. This cannot be done - except by liars"
Bernard Baruch (My Own Story - 1957)

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 advice relevant to your investment portfolio.