2007 :

Global Markets – 4th quarter 2007 : Standard Bank – what’s the deal?

The market was caught completely by surprise in late October when Standard Bank announced that a 20% stake in the bank was being sold to the Industrial and Commercial Bank of China (ICBC) for R37bn or R120 per share.

Most people in South Africa are unlikely to have ever heard of the ICBC, or more importantly that this bank is now “the largest bank in the world by market capitalisation”. With a market capitalisation of more than $300 billion, the bank is more than 50% larger than the heavy weight banks such as Citigroup and HSBC that we are familiar with. It is also interesting to note that the ICBC has more than “180 million retail clients (four times the entire South African population) and 2.5 million corporate clients.” The ICBC listed in Hong Kong some 12 months ago, raising in the region of $20 billion. It is reported that approximately one quarter of these funds are to be used for the purchase of a stake in Standard Bank.

The article written by Stanlib’s Patrice Rassou, who is both a Fund Manager and a Bank Analyst for the group, goes on to highlight yet another interesting point and that is the fact that this deal will be “the largest direct investment by a Chinese company anywhere in the world.” He also points out that, contrary to expectations, the ICBC has elected to invest in the financial services sector rather than in a mining / resource based operation in South Africa. He notes that “Standard Bank’s expertise in resource banking and trade finance would also have proved very attractive to a country which has become the largest consumer of many mineral commodities over the past decade.”

Standard Bank has made two notable acquisitions in emerging markets in the last year – having purchased IBTC in Nigeria and Bank Boston in Argentina. Emerging market areas of focus that the bank may wish to concentrate on include India, Russia and Brazil.

When one compares the Price Earnings Ratio of ICBC at 30x compared to that of Standard Bank at 10x, it is no wonder that our banking shares are looking relatively inexpensive relative to their offshore counterparts. Rassou comments that “SA financial and industrial shares also received a boost from this deal as investors woke up to the fact that there is life beyond the resources sector, and that if they keep on ignoring our world class financial and industrial stocks, we may find shrewd buyers like the Chinese snapping them up at relatively cheap prices while other investors gorge themselves on mining shares trading at the peak of their earnings cycle.”

Source: Stanlib Weekly Focus – issue 174. Article by Patrice Rassou, Fund Manager and Bank Analyst.

REGIONAL COMMENTARY UNITED STATES OF AMERICA

The Federal Reserve reduced interest rates twice during the quarter under review – the first rate cuts in four years. In September rates were cut by 0.50% (to 4.75%) and then again by a further 0.25% in October. As a result, rates are now at 4.5% - their lowest level since January last year. In the statement following the most recent rates announcement at the end of October, the Federal Reserve pointed to concerns of continued weakness in the housing market as well as to inflation as the main reasons for their decision.

The statement went on to say that the rate cut in September, combined with the October cut, “should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets.” The statement also stated that “the upside risks to inflation roughly balance the downside risks to growth.” The question being asked by some is whether the Federal Reserve can afford to reduce rates any further, with inflation possibly becoming a threat. Inflation has largely been fuelled by the rocketing oil price as well as a weak dollar.

It was reported recently that third quarter GDP came in at 3.9% - which was better than expected. This raises the question of what extent the impact of the sub prime issue has been beyond that within the housing market. Head of the Federal Reserve, Ben Bernanke, addressed the Congress Joint Economic Committee recently and forecast “a greater measure of financial restraint on economic growth as credit becomes more expensive and difficult to obtain.” However, a BBC article comments that he is of the opinion that the “reassessment of risk would lead to a healthier financial system.” Sub prime concerns still remain and the view is that are likely to take some time to work
through the system. As a result, the current market volatility may well continue for the foreseeable future.

EUROPE

The European Central Bank (ECB) kept rates on hold at 4% during the quarter under review. This was widely anticipated by the market due to the sub-prime credit concerns which first unfolded in the USA in August. As a result, no further interest rate increases are expected this year, as the ECB adopt a “wait and see” approach. Commenting on this, Holger Schmiedling from Bank of America stated “the strong euro and the persistent dislocations in the money and credit markets will likely force the ECB to keep rates on hold for the foreseeable future.” This is likely to provide some welcome relief to the region after experiencing eight interest rate increases in the last two years.

The European Commission has forecast a growth rate of 2.2% for 2008, following their forecast of 2.6% for 2007. The Commission anticipates that growth in the EU is likely to slow into next year largely as a result of “a weaker US economy and problems in the global financial markets.” Despite rising inflation levels [year-on-year inflation rose to 2.6% in October], inflation is expected to average 2% this year, rising slightly [to 2.1%] in 2008. According to Monetary Affairs Commissioner, Joaquin Almunia, “clouds have clearly gathered on the horizon with this summer’s turbulence in the financial markets, the US slowdown and the ever-rising oil prices. As a result, economic growth is becoming more moderate and the downside risks have clearly increased.”

UNITED KINGDOM

The Bank of England (BoE) kept rates on hold at 5.75% during the quarter under review. Rates have remained steady since July this year, following five increases over a period of twelve months. The sub-prime concerns have been far reaching, and have “spread to the wider global loans market as banks, which were exposed to sub-prime debt, become far more cautious about whom they lent money to.”

Commenting on the issue, David Kern said that “simply keeping rates on hold today is not enough, if the decision is interpreted as a mere short-lived postponement. The MPC must acknowledge that
further interest rate increases should now be off the agenda, at least for the time being.” Northern Rock is the most notable example of a UK based bank impacted on directly by the slump in the global credit market.

The latest reports indicate that inflation is at 2.1%, which is slightly above the 2% target set by the BoE. In recent months there has been a concern about the rising pressure brought about by higher food and petrol prices. The latest inflation number has reduced the chances of any reduction in interest rates at this stage. Evan Davis, economics editor for the BBC, commented that “at the moment, anything above target severely complicates the management of the economy over the next two or three years. Just as doctors find it harder to give a heart by-pass to a patient with renal problems, a central bank finds it harder to deal with an economic slowdown and falling asset prices, while there’s inflation lurking around in the system.”

The strong Pound relative to the US Dollar has made British goods more expensive abroad. This trend has impacted negatively on exports from the region. In addition, a clear trend of rising imports is emerging. Commenting on this, George Buckley from Deutsche Bank said “the rise in import volume growth at a time when export volume growth is falling is a concern. The question is what happens going forward. If domestic consumption weakens quicker than world trade, then we could see this balance improve.”

JAPAN

The Bank of Japan (BoJ) kept interest rates unchanged during the quarter under review. The last changes to interest rates were made in February when a 0.25% increase was announced, bringing rates up to their current level of 0.50%. Inflation is expected to average 0.10% for 2007 and rise to 0.50% next year.

Early reports indicated that, in the third quarter, the Japanese economy grew at an annualized rate of 2.6%, which is better than expected. However, there are concerns about the potential impact of slowing US growth and a weaker US Dollar, as these factors are likely to curb the US demand for exports from the region. Recent figures indicate, however, that exports to Europe and China are rising, with China “set to overtake US as Japan’s biggest export market.” The question now, is whether the rising demand from China will be sufficient to offset the declining demand from the US region.

Unemployment in Japan is currently at 3.8%, which is the lowest in the group of G7 countries. Improving employment levels continue to have a positive impact on consumer confidence, and as a result, an improvement in consumer spending is becoming apparent. According to Norinchukin Research Institute’s Takeshi Minami, “... data showed that the economy bounced back from negative growth in April to June. But the outlook for the next rate rise will depend largely on the outlook for the US economy.”

The markets were taken completely by surprise in September, when Prime Minister Shinzo Abe announced his resignation. Following his announcement he stated that “the people need a leader whom they can support and trust.” Commenting on the news, Koichi Haji (chief economist at NLI Research Institute) said “it’s a huge surprise. He said he would risk his job in passing the anti-terrorism law, so I don’t know why he is resigning before making the effort.”

SOUTH AFRICA

The Reserve Bank (SARB) raised domestic interest rates by 0.50% during the quarter under review. As a result, the Prime Lending Rate and the Repo Rate increased to 14% and 10.5%, respectively. This brings to seven the number of rate increases in the current cycle, which started in June 2006 – a total overall increase of 3.5%.

The consensus view in the market now is that there is a better than average chance that the SARB are likely to increase rates again at their meeting in early December. There is ongoing debate as to whether another rate hike is necessary at this stage. One view is that there is evidence that spending is slowing sufficiently and it is likely that the impetus from the last seven rate hikes will continue to have the desired effect for some time to come. Another argument is that, while this may be the case, inflation has remained above the top end of the target band (6%) since April and is likely to remain above this level well into next year. The difficulty, of course, is that to a certain extent exogenous factors such as escalating food prices (up 12% year to date) and the rocketing oil price (having surged by more than 50% this year) are to blame for the current inflation impasse – and that these factors won’t respond to higher interest rates, whether locally or abroad. Some market commentators believe that the target band is unrealistic and that the top end should be expanded to 7%.

A recent article in the Business Day stated that the “Bank has predicted that inflation will peak at an average 6,8% in the first quarter of next year – but that was at its last policy meeting last month, and its forecasts are likely to be revised upward.” Commenting further on the matter, the article went on to say that “another lurking inflation gremlin may rear its ugly head early next year. Eskom wants to raise its tariffs 18% in the financial year starting in April, and 17% the following year – increases which could contribute 0.70 points to inflation.” A recent report by Lehman Brothers forecasts that inflation is likely to peak at 7.8% in February, and they “expect CPIX to fall back to the target range, but only in the third quarter of next year”, which is “a quarter later than the central bank’s forecast of the second quarter.”

Economists at Standard Bank have reported that “the cost of money is 12 percent higher than at the beginning of the year and 33 percent higher than when rates were at their lowest in June 2006”. The article further comments that “clearly, the higher interest rates have had a marked effect on the affordability of residential property as shown by the large increase in the cost of servicing a mortgage. ..…. This reduced affordability will tend to decrease the demand for residential property by consumers and may lead to a moderation in the growth of house prices.”


GENERAL – OIL AND GOLD

The oil price continued on its upward trajectory during the quarter under review, ending the period at $89 a barrel, compared to $72.20 a barrel at the end of August. The weaker US Dollar, combined with continued supply fears and disruptions, have been the main drivers. Commenting on the weaker Dollar, a BBC article stated that “the weaker dollar has been driving up oil prices because some investors have been using the commodity as an alternative to holding dollars. On the other hand, it makes oil relatively cheaper for anybody outside the US.”

The gold price rallied sharply during the quarter, ending the period at $793.35 an ounce, compared to a close of $673.25 at the end of August. Commenting on the sharp increase, a recent report on iafrica.com stated that “while gold has acquired the habit of moving in tandem with strengthening oil prices, it is particularly concerns over the crumbling dollar that are said to be behind gold’s recent gains.”

Speculators are beginning to wonder whether gold is now likely to reach the $850 an ounce level - a level last recorded in January 1980. “Gold hit an all-time high of $850 an ounce in January 1980, when investors rushed to buy the metal in the face of high inflation, sparked by strong oil prices, the impact of the Iranian revolution, and Soviet Intervention in Afghanistan.”


CONCLUSION

With this being our last report for 2007, we would like to take this opportunity to wish you and your family a peaceful and happy festive season. Please take note that our offices will be closed from midday on Friday the 21st December 2007 and will reopen at 08h00 on Thursday the 3rd January 2008.