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.”
UNITED STATES OF AMERICA |
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.
EUROPE |
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.
UNITED KINGDOM |
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”.
JAPAN |
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.
SOUTH AFRICA |
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.
THE 2006 / 2007 BUDGET |
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.
GENERAL – OIL AND GOLD |
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”.
CONCLUSION |
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.