The old adage “It ain’t over ’till the fat lady sings” is perhaps appropriate when looking at the current state of global markets and the world is beginning to wonder when she is likely to take a bow and move off centre stage. In the last six years there have been five crises that investors have had to contend with. The first was the South East Asian crisis in 1997, followed closely by the Russian Debt Default in 1998. In 1999 investors were given a temporary respite and were able to breathe a sigh of relief. This was to be short-lived, however, as in April 2000, the TMT bubble burst. In 2001 the world watched in horror as the events of September 11th unfolded in the United States. The United States have remained in the spotlight with corporate and accounting scandals being the centre of attention during the first three quarters of 2002.
Historically investors have always taken comfort in the fact that, in the United States of America, the standards of corporate governance have been amongst the highest in the world. However, the recent spate of companies whose corporate governance have been called into question have tested the levels of investor trust worldwide. Enron was the first to make headlines with an accounting scandal, followed more recently by WorldCom.
Other companies currently under investigation include Tyco, ImClone, Qwest, Martha Stewart, Global Crossing, Dynergy, Halliburton and CMS Energy. Sam Waksal (former ImClone CEO), John Rigas (former Adelphia CEO) and Dennis Kozlowski (former Tyco CEO) are all currently under investigation.
Two former top executives of WorldCom were arrested and charged with fraud by the FBI in front of journalists and television cameras on 1 August 2002, making headline news. John Ashcroft, US Attorney General has said that, if convicted each of the men will face up to 65 years imprisonment. These Wall Street scandals have served to further unnerve already fragile investors and undermine the US Dollar and shares in US companies, impacting severely on global sentiment.
In the words of John Ashcroft “Corporate executives who cheat investors, steal savings and squander pensions will meet the judgement they fear and the punishment they deserve.” The high-profile arrests that have followed those of the WorldCom executives have all occurred in front of news cameras, sending a clear and unequivocal message to all Americans, and in fact to the rest of the world, that the US Government is actively and aggressively pursuing corporate offenders
CEO’s of companies that reflected revenue greater than $1.2 billion in the latest fiscal year throughout America were given to the 14th August 2002 to attest to the correctness of all financial statements. In addition, all these CEO’s were required to each personally attest to the correctness of these financial documents, being threatened with imprisonment if any of the information was subsequently found to be incorrect. These measures should help enormously in addressing investor fears and perhaps put a stop to any more unpleasant “creative accounting surprises”. These measures having now been put firmly in place, perhaps more relevant issues like economic numbers and corporate earnings will be allowed to once again take centre stage.
We now take a look at some of the major economic regions around the world.
The Federal Reserve kept interest rates on hold during the quarter and repositioned their policy stance to “easing” from “neutral” at their meeting held on 13th August 2002. This “easing” stance enables them to ease rates before their scheduled September 24th meeting, if necessary. The initial reaction to rates being kept on hold at the August 13th meeting took the markets into negative territory after seeing strong gains during the four days preceding the Fed meeting. These gains were fuelled mainly by market expectations that the Fed would once again cut rates at their August 13th meeting.
However, it appeared as if investors and analysts alike were quick to review their initial dissatisfaction at the Fed’s decision, taking comfort from Alan Greenspan’s view that the US economy is currently robust enough to make a rate cut unnecessary at this stage. In addition they took comfort from the easing bias taken by the Fed, together with their willingness to reduce rates if necessary.
In addition, inflation is currently benign – with low inflation giving the Fed further scope to ease rates. The current view is that inflation is expected to average 1.6% for 2002 and 2.4% in 2003. Avoiding deflation is a lesson that the USA has learnt well from Japan. A weaker US dollar combined with increasing capacity utilisation should help inflation stabilize rather than turn negative.
In July 2002, the revised GDP figures for 2001 were announced reflecting three quarters of negative growth – confirming that the economy had in fact undergone a recession last year. Mark Vitner, senior economist at Wachovia Securities commented as follows: “It confirms that this recession in 2001 was not particularly mild or as short as some folks had thought. We were expecting at least two negative quarters, and the fact we had three is a little bit of a surprise. That helps explain why we’re having so much difficulty generating some positive momentum right now. The economy was weaker than we thought.“
Lower than expected second quarter GDP numbers came in at a 1.1% quarter-on quarter growth rate. In addition, the first quarter growth rate of 6.1% was revised down to 5%. Despite all the bad news, the economy has grown for three quarters in a row.
It is interesting to note that private businesses increased inventories by $1 billion in the second quarter, after having decreased inventories by $28.9 billion and $98.4 billion during the first quarter of 2002 and last quarter of 2001, respectively.
During July 2002 the Euro reached parity to the US Dollar – for the first time since February 2000. While this achievement held a measure of technical importance, it was significant from a psychological point of view. This Euro strength was the main factor contributing to the ECB holding refinancing rates at current levels. The Euro has risen by more than 12% against the US Dollar since the beginning of the year – this has served to stifle any fears of a rise in inflation, while on the other hand giving exporters some cause for concern and prompting them to consider a shift in productivity. The benefit from this shift is that it will force European producers to address one of the main areas that have resulted in the Eurozone traditionally trading at a discount to the United States for so long.
For the tenth month in a row the European Central Bank kept interest rates on hold at 3.25%, with the chief economist of the bank confirming that the bank is following a “wait and see” policy. With equity markets having continued their volatile trend, it is expected that rate hikes are likely to be off the agenda for the remainder of the year. This is despite the fact that the Eurozone PMI (Purchasing Managers Index) figures continue to point towards economic expansion. ECB projections for 2002 GDP growth are currently between 0.90% and 1.5% – expectations are that GDP will strengthen further to a range of between 2.1% and 3.15% in 2003. The ECB is quick to add, “despite this rather positive outlook, the assessment of the short-term dynamics of real economic activity is still surrounded by uncertainty.”
The clean up operations after the recent floods in Europe are likely to cost hundreds of millions of Euros. In addition, Germany has stated that the much awaited tax cuts are to be postponed due to the funding required for the flood damage mop up operations – this is likely to run into figures in excess 15 billion Euro’s.
Despite having been one of the better performing regions this year, the economy in Japan remains weak. Further reforms are needed, with existing reforms still being slow to materialise. In addition, no meaningful restructuring has actually taken place. After the closure of Japan’s latest parliament session, Prime Minister Koizumi stated that the country’s stagnant economy might well force him to relax key reforms. Domestic spending is extremely weak and consequently, government spending may be the catalyst to either return the economy to the 11-year decline or support the current fragile recovery.
Following the recent performance of Japanese stocks analysts are becoming more upbeat about the region. This can also be attributed to low share valuations in certain sectors, combined with the increasing excess money supply. In addition, early evidence suggests that the longstanding deflationary pressures that have troubled Japan’s economy and financial system may be diminishing. However, this news has been overshadowed to a large degree by the negative sentiment currently afflicting global markets.
The Bank of England, like the European Central Bank, left interest rates on hold during the second quarter of 2002 (currently at 4%, and having remained at these levels since November 2001). Current equity market weakness, together with recent Euro strength, were two of the main factors motivating this decision. The BOE have indicated that consumer spending is likely to slow due to “slowing growth in disposable incomes and the recent sharp falls in equity wealth.”
Analysts are of the opinion that the cost of borrowing is likely to remain on hold until the BOE have a clear sign that the economic recovery is firmly on track. In addition, it is likely that inflation in the UK (currently at 1.5%) will remain below the 2.5% target levels for some time.
It came as no surprise when the Monetary Policy Committee increased domestic interest rates by a further 1% at their meeting in June 2002, bringing the total rate increase for the year to 3%. Tito Mboweni cited several factors that posed a threat to inflation, including public sector wage increases, the Rand exchange rate and the high growth in money supply and credit extension.
The inflation numbers indicate that the Reserve Bank’s 2002 inflation target of between 3% and 6% will not be met and it is possible that, despite having had rate hikes totalling 3% this year, these inflation targets may well not be achieved in 2003. There are currently divided views in the market place about whether or not South Africans can expect a further interest rate hike this year – most analysts are of the opinion that with inflation expecting to peak in October and then decline moving into 2003, it is unlikely that SARB will find it necessary to raise rates again. However, with the recent volatility exhibited by the Rand due largely to emerging market jitters and the effect of the new Minerals Bill on foreign investor sentiment, this may not be the case. Another disappointment was the annual increase in CPIX to 9.9% in July – up from 9.8% in June – well above the July consensus forecast of 9.6%. This was the ninth successive month that this index remained outside the target range of between 3% and 6%. The next meeting of the Monetary Policy Committee is set for 11th and 12th September 2002 and the outcome regarding interest rate movements is bound to be interesting.
The much-awaited Myburgh Report on the rapid decline of the Rand at the end of last year (some 39%) was released in early August. The report failed to find any specific reason for the massive plunge by the Rand in 2001. In the words of Justice Minister, Penuell Maduna, “In the main both reports have been unable to single out clearly the reason behind the slide in the Rand.” However, Christine Qunta who compiled the minority report proposed legal action against Nampak and Deutsche Bank for supposed contravention of exchange control regulations. Both companies have denied any misconduct in this regard.
GDP figures for the second quarter of 2002 were released on 27th August 2002. These figures came in at an annualised 3.1% (above forecast of 2.7%) from 2.2% in the first quarter.
The Rand depreciated by 9.84%, 15.26% and 15.99% against the US Dollar, Euro and Sterling, respectively during the last quarter (1 June 2002 to 30 August 2002).
In our last report we stated that two wildcards in the economy were the price of gold and oil. At the end of May 2002 the gold price was 326.55 $ per ounce and ended this quarter at an unexciting 313.90 $ per ounce, retracing some 3.87% over the period. This can be attributed mainly to the US Dollar retracing some lost ground during the quarter under review.
The oil price recorded an 18 month high on 20th August 2002, moving above $30 per barrel (from 23.75$ per barrel at the end of last quarter) on the back of increased concerns that a war in Iraq would impact on the oil supply. Fuelling these fears is the fact that the United States of America has been considering an attack on Iraq for some time now as this Middle Eastern country is thought to be harbouring “weapons of mass destruction”. The oil price ended the quarter at 27.47 $ per barrel (a rise of some 15.66% over the quarter).
Chief Investment Officer of Matrix Asset Advisors, David Katz, perhaps best sums up the prevailing mood in global markets “Three years ago, you had irrational exuberance. Currently you’ve got irrational despondency”. With continuing conflict in the Middle East, corporate accounting scandals and bankruptcies, ongoing tensions in Pakistan and fears of more terrorist attacks in the United States, there is little wonder that investor sentiment is currently at record lows. However, the news is not all bad – below is a list of projected regional GDP numbers for 2002 and 2003. While the “recovery” is fragile and not as robust as analysts had first anticipated, based on current GDP forecasts, the forecast numbers do not look as bad as current sentiment perceives them to be.
“An economic forecaster is like a cross-eyed javelin thrower – they don’t win many accuracy contests, but they keep the crowd’s attention.” – Unknown
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.