Impact of the current account deficit on the financial markets

History is littered with examples of countries that have experienced turmoil in financial markets due to large current account deficits. Turmoil in the markets is more pronounced if the deficit is being financed by short term portfolio investments.
The classical textbook definition of a current account deficit is the difference between imports and exports of goods and services. A decline in trade balance caused by either increased demand for imports and or poor export performance, as was the case in the second quarter of 2014 according to the Reserve Bank’s latest quarterly bulletin reported last Tuesday can increase the current account deficit.

A large current account is an imbalance which is always undesirable. However, for investors to navigate the treacherous waters caused by a current account deficit it is important that they establish the source of imbalance and how it has been financed. Because being large in itself may not necessarily lead to turmoil in the markets, case in point- the US has been running huge current account deficits since 2006 without any negative repercussions on the financial markets. Although studies by the IMF have shown that large deficits are ultimately not sustainable as a result of financing problems or a change in investment patterns in a domestic economy.

In the case of South Africa, a stubbornly low savings rate has meant that the country has had to rely on foreign investment to fund the deficit since first quarter of 2006, in particular through “…a combination of direct, portfolio and, to a lesser extent, other investment flows”. This has not been a problem in the past, especially in the wake of the global financial crisis which later morphed into a full blown economic crisis resulting in ultra-loose monetary policy, circa 2008 in the US and Europe making emerging markets attractive investment destinations.
The times are changing though. Whereas in the past 6 years, the only risk to South Africa’s attractiveness as an investment destination was external- from global markets. At the moment South Africa’s macroeconomic environment is weak, implying risk may arise internally as well.

Contrast these prevailing economic conditions in South Africa with recent developments in both the US and the UK where monetary authorities have already made the commitment to put an end to their respective quantitative easing programs and are seriously considering hiking interest rates. A rate hike in the US specifically, will fundamentally alter investment options across the universe posing a threat to the attractiveness of South Africa along other emerging markets as investment destinations.
Given the scenario as described above. Is it time for investors, foreign ones in particular to dispose of their equities in SA stocks? My view is that not yet, not least because returns on capital on the JSE represents income from outside the borders from South Africa but the country despite its economic and social challenges continues to attract capital and investment inflows, the latest bulletin from the Central Bank highlights the fact that foreign direct investment has more than tripled in the second quarter to ZAR 24.6 Billion Rand from ZAR 8 Billion in the first quarter.

Given the ever widening deficit and other disappointing data, it is counterintuitive that investments especially in long term projects have increased. However, it is important to note that these inflows are a vote of confidence in the future of South Africa despite what the credit rating agencies may think. Embedded within this economic data- inflows- is a key political and social message subtly making a positive judgment call about the relative capacity of South Africa’s monetary and fiscal authorities operating within the existing political system to come up with a feasible plan to narrow the current account deficit. And this has and continues to inform my optimistic outlook on the fate of domestic financial markets.

Advertisements

Property, is it a buy, sell or hold?

The most frequent question we get from our clients about property is, should we pay the bond or invest the capital. The second most common question we get is, should we use our investment to buy an investment property and rent it out, or just leave it?

The answer to both of these questions is not clean cut. The fact remains, unlike shares, ETF’s, or Unit Trusts (like the Deton funds) which are measured and priced, property is not. This means you can physically see an increase in your investment over a set period of time whereas with residential property, there is very little data to show the same. Property is an asset, but you only realize your profits or losses once you sell the asset. This means that there is no real return value on this asset. The general thinking is that you buy a property, sit on it for a few years, and you either rent it out or you live in it, and several years later you sell it for double. This may have been the case a few years ago, but since 2007, the property market has not really moved. Once again, as stated, this may vary depending on area and depending on leverage (bonded or not), but on average, property has not beaten inflation (according to states given by ABSA bank).

So the question is, do you use property as an investment or not? Well, if you had invested R1 million in property in 2007, (7 years ago), the truth maybe that you have only received 3% or less from rental income. And the capital price hasn’t beaten inflation of 5.7% (results will obviously vary), so your R1 million is now only worth R1,500,000, provided you can find a buyer for it. And you would have received R230,000 in rental income profit, once again, provided it wasn’t bonded. So your R1 million is now worth around R1,8 million after 7 years. The real question is, what would it be worth if you were invested in the stock exchange?

Since January 2007, the JSE all share has given us over 100% return. Which is around 10.75% compound over the period, meaning your R1million has now doubled and would be worth around R2,050,000. If you consider that the JSE All share is only ranked in the middle of the Unit Trust pack over 7 years, where would you be if you had invested in a Unit Trust? Well one of the well known Equity managers in SA has compounded at a little over 14% for the 7 years, meaning your R1 million would now be worth R2,5 million. If we use the top performing Equity manager over the same period, this return would be closer to R3 million.

Remember all of these figures and values above are just looking at capital price, and would exclude any dividends on the shares. I cannot factor in the other variables on the property like monthly rates and taxes, maintenance and general upkeep of a property. Seeing that different properties have different needs, this would also be impossible to work out.

Where does the above leave us with a rising interest rate cycle and bonded property? The truth is, we are in a rising interest rate cycle, and we could see rates going up by another 2% over a 24 months period. While this increase helps our clients with interest bearing investments, it doesn’t help the man in the street with debt. This means the higher the Prime rate, the better “return” you receive by paying off a bond. So with this being said, what sort of return could you see from paying off debt? With the current Prime rate at 9.25%, and a potential 1-2% increase over the next 24 months, this could mean you could see a return of up to 11.25% if you have the capital to pay off your bond. While this return is not a bad return, it is not a compound return, as such, a return of 10% plus compounded over 5-10 years on the JSE would still beat this 11% return. If we start seeing rates return to the 13-15% levels, then there may be an argument for debt consolidation versus Equity investments. But while the Equity space is giving 5-6% dividend yields and capital growth in the teens, my view is that Equity is still the place to be.

So based on the above, where does this leave us? Do we now sell our properties we live in and go rent? Do we sell those investment properties and give the profit to your trusted investment manager at Deton Private Wealth to invest? Well I guess that is the million-dollar question, and it is definitely one that could be argued all day, but do we really have time for that? Personally, we are not big fans of residential property as an investment, and feel that over the longer term, Equity will outperform cash and Commercial Property. Another factor that you would need to consider is if you require an income, could you break a corner of your gingerbread house off to eat if money is tight?

Deton Chronicle 08/10/2014

QUOTE OF THE WEEK  

Money can’t buy happiness – but somehow it’s more comfortable to

cry in a Porsche than in a Corolla.

Unknown

  FROM WITHIN DETON: 

There has been a reasonable amount of panic amongst some clients over the fund’s performances of late. To fair, we have been warning of the potential for short term volatility quite a bit over the past few months, so this should not have been a total shock – we have entered a very scratchy period in the global economic arena (as discussed in more detail below). Is this a crisis? No, we don’t believe it to be the beginning of the end. In fact, we actually welcome a correction as things have become a little bit to “frothy” of late.

On the positive side, this correction also presents buying opportunities. In the words of Warren Buffet: “be scared when everyone is greedy and be greedy when everyone is scared”. We have been scared and thus had quite a lot of protection in the funds, as everyone out there was being greedy. Now that there is a bit of a panic, we see an opportunity to do some shopping.

But just how have we faired amidst all of this since the peak in the JSE Overall Index on the 29th July to date, and have we done what you pay us to do? We believe we have, and the numbers stack up as follows (note that I have NOT included the Balanced portfolio, as this has only just kicked off, so not enough data for that):

29/07/2014

CURRENT

JSE

52242

48712

-6.76%

STABLE

10502

10470

-0.30%

MANAGED

10761

10694

-0.62%

EQUITY

10689

10572

-1.09%

GLOBAL

10180

10374

1.91%

So I would hazard a guess that we HAVE done our job, with the equity fund only falling 1.09% VS the JSE at 6.76%. Please note, however, that should you be drawing an income, you WILL see slightly different returns depending on how much you are drawing.

I trust that this eases your minds somewhat?

GLOBAL SNAPSHOT

Current

Weekly change

Monthly Change

Annual Change

JSE ALL SHARE

48712

48875

51610

43726

-0.33%

-5.62%

11.40%

DOW JONES (USA)

16719

16805

17111

14777

-0.51%

-2.29%

13.14%

FTSE (UK)

6496

6558

6835

6437

-0.95%

-4.96%

0.92%

DAX (GERMANY)

9086

9382

9758

8592

-3.15%

-6.89%

5.75%

ZAR/US$

11.24

11.24

10.67

9.96

0.00%

-5.07%

-11.39%

ZAR/POUND

18.02

18.25

17.41

16.04

1.28%

-3.39%

-10.99%

ZAR/EURO

14.19

14.2

13.94

13.55

0.07%

-1.76%

-4.51%

BRENT CRUDE OIL

91.01

94.12

100.28

109.64

3.42%

10.19%

20.47%

GOLD

1212

1209

1259

1324

0.25%

-3.73%

-8.46%

It does not take a rocket scientist to see that it is not just us at home who are under pressure. Europe, in particular, is not looking very pretty right now!

GLOBAL MARKETS

According to Reuters, US markets closed slightly lower in volatile trading on Monday, with the S&P 500 index failing to hold above a key technical level as there were no real catalysts to support the market, while traders nervously turned their attention to the start of earnings season due to the recent Dollar strength and continued weakness in the Eurozone.

The week saw some good news on the housing front in the US. Home prices were up 0.6% in July, but the annual growth rate slowed down, rising 6.7% yoy. This, in fact, was a good report since home prices are starting to outpace inflation and every tick up translates to more upside for home owners who have been underwater for some time now. The ADP payroll report showed that private sector hiring picked up in September, adding 213 000 jobs, the 6th consecutive month in excess of 200K in job growth. Fundamentals in the US continue to strengthen.

The IMF said it expects the Federal Reserve to start raising interest rates in the middle of next year, a projection that’s in line with the median estimate of economists surveyed by Bloomberg. The U.S. central bank has held the federal funds target rate near zero since December 2008.

“The slack in the economy, well-anchored inflation expectations, and downside risks to the outlook imply that the current accommodative monetary policy remains appropriate,” according to the fund.

The euro area will grow 1.3% next year, slower than the 1.5% pace predicted in July, after a 0.8 percent gain this year, according to the IMF.

“We see the major risk in the stalling of the euro zone,” IMF Economic Counselor Olivier Blanchard said in an interview on Bloomberg Television. “The risk of recession is there,” he said, adding that European authorities should increase infrastructure spending to boost growth. If inflation doesn’t improve in the currency bloc, the European Central Bank may need to do more to stave off deflation, including the purchase of sovereign bonds, according to the fund.

In Europe, the ECB president, Mario Draghi, missed a critical opportunity to expand QE to sovereign debt purchases. Meanwhile, the Eurozone’s economic powerhouse, Germany, posted a contraction in its manufacturing sector, a precursor to recession. The ECB also kept its main policy rate unchanged and disappointed investors who had hoped for a commitment to ECB balance sheet expansion.

LOCAL MARKETS

Back in South Africa, the continued bullish US economic data has put pressure on EM currencies, particularly the ZAR. However, the rand climbed as much as 0.9% against the dollar on Monday as investors applauded the appointment of respected technocrat Lesetja Kganyago to succeed Gill Marcus as central bank governor.

South Africa’s August trade and budget balance data reflected notably wider-than-expected deficits, highlighting that the country’s twin deficit problems remain severe. The BER consumer confidence index (CCI) reversed course and fell back to -1 in Q3 2014, which indicates that consumers’ rating of the outlook for the national economy and their own household finances deteriorated compared with the reading in Q2. On a more positive note, the manufacturing PMI printed above 50 for the first time since March 2014, signalling that operating conditions continue to improve gradually.

The gold price traded above the $1,200 an ounce level in Singapore on Tuesday, following some profit-taking in the US Dollar, but bullish sentiment over the US economy, as well as the possibility of higher interest rates kept investors on their toes. Gold was last trading at $1,204.60, with the platinum price quoted at $1,242.00, while palladium is trading at $768.10.

SEYMOUR SAYS…. 

THE MAGIC BANK ACCOUNT

OK, this is not a traditionally insightful comment from young Seymour around financial markets etc., but it was forwarded to me by a friend and I felt that I just have to share it with all of you – CALL ME A SOFTIE IF YOU LIKE!

The author is unknown, and it was found in the billfold of coach Paul Bear Bryant after he died in 1982.

Here we go – Imagine that you had won the following *PRIZE* in a contest: Each morning your bank would deposit $86,400 in your private account for your use.  However, this prize has rules:

The set of rules:

  1. Everything that you didn’t spend during each day would be taken away from you.
  2. You may not simply transfer money into some other account.
  3. You may only spend it.
  4. Each morning upon awakening, the bank opens your account with another $86,400 for that day.
  5. The bank can end the game without warning; at any time it can say, “Game Over!”
  6. It can close the account and you will not receive a new one.
    What would you personally do?
    You would buy anything and everything you wanted right? Not only for yourself, but for all the people you love and care for. Even for people you don’t know, because you couldn’t possibly spend it all on yourself, right?
    You would try to spend every penny, and use it all, because you knew it would be replenished in the morning, right?
    ACTUALLY, This GAME is REAL … 
    Each of us is already a winner of this *PRIZE* –  We just can’t seem to see it.

    The PRIZE is *TIME*
  1. Each morning when we awaken, we receive 86,400 seconds as a gift of life.
  2. And when we go to sleep at night, any remaining time is NOT credited to us.
  3. What we haven’t used up that day is forever lost.
  4. Yesterday is forever gone.
  5. Each morning the account is refilled, but the bank can dissolve your account at any time WITHOUT WARNING…
    SO, what will YOU do with your 86,400 seconds? Those seconds are worth so much more than the same amount in dollars. Think about it and remember to enjoy every second of your life, because time races by so much quicker than you think.
    So take care of yourself, be happy, love deeply and enjoy life! Here’s wishing you a wonderful and beautiful day. Start spending….
    “DON’T COMPLAIN ABOUT GROWING OLD!
    SOME PEOPLE DON’T GET THE PRIVILEGE!”

LIGHTER SIDE

  “4 Worms In Church”

A minister decided that a visual demonstration would add emphasis to his Sunday sermon. Four worms were placed into four separate jars.

  • The first worm was put into a container of alcohol.
  • The second worm was put into a container of cigarette smoke.
  • The third worm was put into a container of chocolate   syrup.
  • The fourth worm was put into a container of good clean soil.

At the conclusion of the sermon, the Minister reported the following  results:

The first worm in alcohol ……….   Dead;

The second  worm in cigarette smoke …….. Dead;

Third  worm in  chocolate syrup ………… Dead;

Fourth  worm  in good clean soil …………Alive

So  the  Minister asked the congregation, “What  did you  learn from this demonstration?”

Maxine  was  sitting in the back, quickly raised her hand and said . ..  .

“As  long as you drink, smoke and eat  chocolate, you  won’t  have worms!”

That pretty much ended the  service!