At the time of our
quarterly report at the end of February
last year the consensus view was
that equities would be the asset
class of choice for 2005. However,
many of the fund management houses
cautioned that the "easy money"
had already been made. At the time,
this was (and still is) a very realistic
view, especially on the back of
strong domestic equity returns since
April 2003. The expectation was
to see the JSE All Share Index deliver
returns of between 10% and 15% for
the year - not the 47.3% actually
achieved. Again, going into 2006,
we face the same dilemma and again,
with the JSE All Share Index reaching
new highs every other day, the view
is that returns of between 10% and
12% from equities are likely to
be the order of the day. This begs
the question of how much longer
this rally in domestic equities
is likely to continue?
If we classify the current rally
in the market as being a bull market,
which we can, we will have had eight
bull markets since 1961. On average,
these bull markets have lasted 4.6
years and the average rise in the
market has been 129.6%. From the
start of the current bull market
(April 2003) to the end of February
2006, the overall return has exceeded
187%. Statistically this means that,
while the current rally has delivered
the second largest gain (with the
largest gain being 351.8% in the
bull market experienced from 1977
to 1986) it has run for approximately
20 months less than the average
period of 4.6 years.
Does this mean that the current
rally still has further to go or
should we now take heed of what
market commentators are saying,
rebalance our portfolios and modify
our expectations to more "realistic"
levels? I think that perhaps, Jeremy
Gardiner of Investec put it best,
when he said in a recent article
that "the party is not beginning,
but it's also not 4am; it's about
midnight. Enjoy it. We deserve it
and there should be another couple
of hours to enjoy, assuming one
of the Western countries that are
not enjoying our party, don't deliver
any nasty surprises."
Interest rates were increased twice
to 4.50% during the quarter ending
February 2006. This brings the number
of consecutive 0.25% increases to
14, since the current tightening
cycle began in June 2004.
In the statement released following
the most recent increase, the Federal
Reserve left the door open for further
increases this year by stating that
"some further policy firming may
be needed". While many are of the
opinion that the current interest
rate hiking cycle is nearing its
peak, rising energy prices continue
to pose upside risks to inflation.
The pressure of interest rates rising
by 3.5% in the last 18 months has
slowed the rate of consumer borrowing,
with consumer debt at the end of
2005 only being 3% higher than in
December 2004 (the slowest increase
since 1992). The annual increase
in consumer debt was 4% between
2001 and 2004, following a 7% increase
in 2001.
On 1st February Ben Bernanke became
the 14th Chairman of the Federal
Reserve, replacing veteran Alan
Greenspan who retired at the end
of January after 18 ½ years. Bernanke
stated in his first address that
the "mission" of the Central Bank
was to "keep prices stable and promote
growth and jobs". Commenting on
the economy, he stated that he expected
economic growth of about 3.5% in
2006 and growth of between 3% and
3.5% in 2007. It goes without saying
that Bernanke will be watched very
closely in the year ahead in order
to establish a sense of how he intends
making his mark in the global economic
arena.
In December the European Central
Bank (ECB) increased interest rates
in the Eurozone for the first time
since 2000. Rates, which were increased
by 0.25% to 2.25%, were lifted primarily
to keep inflation in check. Headline
inflation has remained above the
target level of 2%, largely as a
result of the consistently high
oil price. The increase in rates
was not well received by some critics,
who believe that an increase in
rates will cause a slowdown in economic
growth.
Mr Trichet, president of the ECB,
indicated that the current level
of rates remains accommodative and
is "consistent with anchoring inflation
expectations". He alluded to the
fact that, provided price pressures
did not increase, there may not
be a need to increase rates further
at this stage, as the ECB was not
necessarily starting with a series
of rate increases. However, the
ECB will remain "vigilant" regarding
developments with inflation. Rates
were left unchanged at the January
meeting of the ECB.
GDP growth for 2005 came in slightly
ahead of expectations at 1.4% and
is expected to increase to 2% this
year.
Interest rates remained unchanged
at 4.5% during the quarter under
review. Commenting after the most
recent meeting of the Monetary Policy
Committee (MPC) in February, Ian
McCafferty - chief economic advisor
at the CBI, stated "The Bank has
chosen to follow a steady course.
This is particularly understandable
given current mixed economic signals.
The MPC should stay alert to further
weakness in the economy and must
remain on standby to cut rates in
the coming months". Rates were last
cut in August 2005 when they declined
by 0.25%. Inflation is at 1.9%,
which is just inside the 2% target
level. The latest quarterly inflation
report released in mid February
indicates that inflation is expected
to remain fairly close to the target
rate over the next 24 months.
The Ernst and Young Item Club forecast
GDP growth of 2.3% this year, compared
to a disappointing 1.7% growth rate
in 2005. Commenting on the growth
number for 2005, Peter Spencer,
the chief economist of the Ernst
and Young Item Club stated "growth
is still well below par - just hitting
the Eurozone average - and with
consumer spending dropping and pressure
piling on exports to take up the
slack, we could be in for a bumpy
2006". Consumer spending increased
by the lowest rate in 10 years in
2005 - by 1.3%. Last year the Club
criticised Gordon Brown for not
creating incentives for the public
to spend rather than to save.
The Centre for Economics and Business
Research (CEBR) expects house prices
to rise in the region of 4.4% this
year compared to 5.1% in 2005. The
group expects the slowing economy
to impact on house price growth
later in the year. The biggest mortgage
lenders in the United Kingdom -
Halifax, expect house prices to
rise in the region of 3% this year.
According to the Office for National
Statistics (ONS) the jobless rate
at the end of December was at its
highest level in 3 years (5.1%)
- up from 4.8% at the end of the
previous quarter. However, Employment
Minister Margaret Hodge appears
to be less concerned. She has commented
that the latest figures reflect
a "mixed picture". She went on to
say "I remain…. quite optimistic
that the underlying trends seem
to me to be pretty robust".
Sadakazu Tanigaki, Japan's Finance
Minister, is optimistic that the
region will overcome deflation by
the end of this year. Speaking at
a conference in New York recently,
he said "Japan is back - I'm delighted
that I can deliver the good news
of the revival of our economy".
He said that the benefits of strength
in the corporate sector were benefiting
the household sector by way of rising
wages and employment. "These positive
developments surrounding the households
have led to a pickup in consumer
spending".
Deflation, which is a sustained
decline in prices, causes consumers
to delay spending in anticipation
of even lower prices. This results
in a collapse in consumer demand.
The sharp movements in the Nikkei
index are often blamed for the decade
long period of deflation that has
plagued Japan since 1995. Between
1980 and 1999, the Nikkei index
rose from 7 000 to 35 000. By 1992,
the index had dropped to 16 000,
which lead to a sharp decline in
spending and, as a result, output.
For the next three years, inflation
declined sharply as a result of
rising unemployment and poor growth.
By 1995, inflation had been replaced
with deflation. And so the turbulent
cycle of deflation began - low growth
fuelled more deflation, which resulted
in higher real interest rates. These
in turn lead to even lower output.
To solve the problem, Japan could
not rely exclusively on macroeconomic
remedies; structural reform was
also required. Based on the optimistic
reports by Mr. Tanigaki and various
data being reported from the region,
it appears as if Japan may finally
be nearing the end of the deflation
struggle, with confidence once again
gradually being restored in the
economy of this region.
The unemployment rate declined to
4.4% from a level of 4.6%, and wage
increases were the highest in 18
months. Consumer prices rose by
0.1%, year on year in both November
and December - the first increases
in two years. As stated in our last
report, the Bank of Japan have made
it clear that they will not attempt
to normalise monetary policy until
there is no further evidence of
deflation.
The Monetary Policy Committee (MPC)
left interest rates unchanged at
their most recent meeting held on
the 1st and 2nd of February. This
is the tenth consecutive month that
interest rates have remained unchanged.
The current consensus view is that,
while interest rates are likely
to remain on hold during 2006, factors
such as Rand weakness and sustained
high oil and food prices could increase
the chances of an interest rate
hike.
The MPC expect inflation, which
remains benign and within the target
band of between 3% and 6% to follow
a "more moderately rising trend"
this year. Factors that currently
pose a threat to the inflation scenario
include higher food and oil prices,
together with strong domestic demand.
Conversely, factors such as low
global inflation, the strong Rand
and acceptable unit labour costs
have had a positive impact on the
domestic inflation outlook.
Government has targeted a growth
rate of 6% by 2012. In line with
their new growth target, government
intends increasing spending, particularly
on a range of infrastructure investment
programmes. These programmes will
provide more jobs, which in turn
should result in increased spending
and consequently improved company
profits.
Trevor Manuel delivered
his 10th budget speech on the 15th
February, the focus of which remained
on improving delivery and infrastructure
as well as upliftment of the poor.
Moderate tax relief was announced,
with the majority of these benefits
being focused on the lower to middle
income groups. Some of the pertinent
highlights, effective from 1 March
2006 (2007 tax year), are listed
below:
- Tax on retirement funds has
been halved to 9% from 18%.
- The domestic interest exemption
for taxpayers under the age
of 65 increased to R16 500 and
to R24 500 for taxpayers over
the age of 65. The foreign interest
and dividend portion of this
exemption has increased from
R2 000 to R2 500.
- The primary rebate increased
to R7 200 from R6 300, while
the secondary rebate remained
unchanged at R4 500.
- The offshore investment allowance
for individuals over the age
of 18 has been increased to
R2 million from R750 000
- Transfer duty has been removed
on houses below R500 000. A
rate of 5% applies to values
between R500 000 and R1 million,
with a rate of 8% being applicable
above R1 million.
- For under 65's the threshold
for tax-deductable medical expenses
has increased to 7.5% of taxable
income (previously 5%).
- The donations tax exemption
has increased to R50 000 from
R30 000.
- The estate duty exemption
has increased to R2.5 million.
- Primary residence exclusion
from Capital Gains Tax has increased
from R1 million to R1.5 million.
- The capital gain exclusion
for natural persons and special
trusts has been increased to
R12 500 from R10 000 per tax
year.
The oil price ended the quarter
under review at $59.22 a barrel,
which is marginally higher than
$52.33 a barrel at the end of the
previous quarter.
The gold price spiked during the
quarter, ending the period at $557.75
an ounce after reaching 25 year
highs of $570 an ounce during the
period under review. This is sharply
higher than the levels seen in the
previous quarter. Despite patches
of weakness over the period, mainly
as a result of profit taking and
funds adjusting their positions,
certain analysts are expecting gold
to test levels of $600 an ounce
later this year. Factors that have
impacted negatively on the price
over the short term include easing
oil prices, recent strength in the
US Dollar and expectations of further
interest rate increases in the US.
John Meyer, a London based analyst
for Numis Securities, commented
that "market participants view the
downturn as a correction for consolidation
before gold resumes its upward progression.
Many players expect prices to test
$600/oz plus, although for the time
being, the market appears to be
holding back to see how low prices
will fall before a recovery takes
place".
Prudential Fund Managers have been
invited to present to our clients
on Thursday evening, the 18th May
2006 at the Redlands Hotel. The
presentation will take place at
17h00 for 17h30 and invitations
will be posted out in April. Ashburton
have once again been invited to
present on international markets
and market trends in the last quarter
of this year. We have requested
that the presentation take place
in October and we notify you of
the date once this has been confirmed.
QUARTERLY QUOTE
"All great things are simple, and
many can be expressed in single
words: freedom, justice, honor,
duty, mercy, hope."
Sir Winston Churchill
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.
