2009 started in the midst of a dark crisis, but ended in relative calm and a growing optimism about the year ahead. For South Africans, the prospect of a Soccer World Cup and now almost completed infrastructure upgrades are lifting spirits. This despite the turnaround in the fortunes of our national cricket team (when this article was written last year we were 2-0 up in an away series against Australia, while this year we have just been comprehensively beaten by an England team full of rejected South African players).
On the global stage the emergence of China and India as true economic powerhouses and engines of global growth appears to have created opportunities and prospects sufficient to offset those that have been lost through the now rapid decline of the Western economies. As a result 2010 is shaping up to be a year of opportunity for those that are able to think globally as the world economy shifts east and south.
However it is wise when attempting to forecast not to be overly influenced by the mood of the moment. Few would have forecast an equity bull market in 2009 during January of that year (we did!) but a cold review of the numbers showed that it was highly likely, despite the prevailing panic at that time. Similarly, there are many indications now that the major markets are overvalued and should be due for a correction in 2010. In the same way that investors were overly pessimistic in the first few months of 2009, they have become irrationally optimistic about the recovery.
2009 was certainly not light on drama. We had the worst financial crash in living memory, and some of the biggest banks in the world effectively came under state control. Unless Joost van der Westhuizen is voted Role Model of the Year, it is hard to see how 2010 can offer anything more surprising.
Despite this, it remains certain that we will not be able to forecast the events of the coming year with complete accuracy in this article. Our approach is to summarise our forecasts for trends and events that are already on our radar screen and which we believe will play an important part in defining 2010. The goal is to stimulate thinking and introduce possibilities rather than to get everything “right”.
2009 Scorecard
The scorecard for our 2009 forecast is characterised by some “big hits” on the macro issues and some completely inaccurate punts on the smaller issues. Our global economic forecast was basically spot on. We expected the credit crisis to continue into 2009 for the Western economies, with new lending extremely limited as banks worked hard to rebuild their capital. We also expected these economies to struggle to pull out of recession despite the huge fiscal and monetary stimulus that was injected by their governments.
We also expected the emerging markets, in particular the BRIC countries, to continue to grow. We even accurately forecast an 8% GDP growth rate for China as a result of its massive fiscal stimulus. In line with this we predicted an H2 rebound for the resources sector.
Less accurate was our prediction that Morgan Stanley, Goldman Sachs and Barclays could follow Bear Stearns or Lehman Brothers into forced sales or bankruptcies during 2009. All three companies have prospered during the year, avoiding or repaying government aid, making record profits (in the case of Goldman) or bold deals (in the case of Barclays).
Closer to home we were correct in predicting that there would be no major collapse of a SA-based financial institution. However we did flag the potential exposures these institutions had as a result of funding BEE deals and acting as clearing members in the Single Stock Futures market.
We also accurately forecast 450 bps of interest cuts in 2009 and a recovery from recession in the second half of the year.
Our political predictions were less impressive. A merger between the DA and COPE is now highly unlikely as the latter party disintegrated into chaos during 2009. Our pick of “Terror” Lekota over Helen Zille as the merged party’s leader was less than inspired if you consider the growing reputation of the latter and the virtual disappearance of the former.
The less said about our hunch that Kgalema Motlanthe would stay on as President after the general election, the better.
However our call that H2 2009 would see the return of a bull market, something not so easy to imagine in the dark days of January 2009, should be enough to convince readers to spend a few moments reviewing our 2010 predictions. We noted that at a PE of 8.0x the JSE was cheaper than it was in April 2003 (8.7x), immediately prior to a four year bull market. We forecast that the smartest and bravest investors would make a lot of money from long positions in 2009, and they did. The S&P 500 ended the year up 25% while the JSE racked up a 29% gain for the year.
Following our almost complete lack of success in political forecasts last year (we did manage to predict that the ANC would win the elections) readers will be relieved that this article is focussed on the global economy and financial markets as a result of the merciful lack of major political events in 2010.
A Tough Year Ahead for the West
Since April 2009, when stock markets begun to recover, there has been talk of the “green shoots” of recovery in the real economy. As actual economic data begun to improve (Britain was the only large economy still in recession at the end of 2009) this optimism has appeared justified. The swift intervention of Western governments and the emergence of China and India as independent engines of growth seem to have been enough to rescue the global economy from a protracted downturn.
Will these same engines continue to power recovery in 2010? In the case of government intervention it is unlikely. The fiscal and monetary stimuli extended at the height of the crisis will be withdrawn in 2010, at least in the West. The Fed has already indicated that it will end its programme of asset purchases as it faces pressure from Congress over its market interventions and from creditors of the US government over the inflationary consequences of its actions. The ECB has also indicated that it will follow suit and withdraw the bulk of the “crisis liquidity” programmes that were in place during 2009. While interest rates are likely to remain low in both regions, there is no scope for further cuts.
There is also no room for rich country governments to extend their fiscal stimuli. Public debt as a proportion of GDP has reached the level of 200% in Japan. The gross public debt of the ten richest countries of the G20 club of big economies will reach 106% of GDP in 2010, up from 78% in 2007. Ratings agencies and bond investors have already expressed their displeasure at the fiscal positions of countries such as Greece and Spain. Rumours have begun to circulate about the AAA credit ratings of the US and Britain. Taking heed of this, the Irish government has announced a tough austerity budget. It is more likely that we will see this replicated by other rich countries in 2010 than that we will see further fiscal expansions.
The Rise of China
The story is brighter in the emerging world. The collapse of the European and US economies flattened China’s exports but the government produced the mother of all stimulus packages in combination with a state-directed lending expansion. In contrast with the Western economies, the Chinese can afford to do it again in 2010 if necessary. They should have no problem delivering 8-10% growth once more.
Plenty of other economies will benefit from China’s success. Its infrastructure projects are boosting demand for the exports of other Asian countries, while commodity producers such as Australia, Brazil and South Africa will continue to be dragged along. India should also do well, assuming a better harvest than 2009 (agriculture still contributes 17% to the Indian GDP).
In addition to the strong markets for our commodity exports, SA will continue to benefit from our own fiscal stimulus and from the positive impact of the World Cup. In the three-year period to 2012 the planned public sector investment programme will amount to $100 billion, or around 30% of GDP. The completion of this programme will however be dependent on a recovery in tax revenues and a credible government plan to reduce its debt burden following the investment programme. Some projects have already been cancelled due to a lack of access to funding and more will be in 2010.
We expect another 100-150bps of interest rate cuts in the first half of 2010. Whether this is justified within the existing monetary policy framework of inflation targeting or within a revamped and expanded framework will be interesting to see. Our money is on a revision of the monetary policy framework to include the twin goals of balanced economic growth and price stability. The former goal will allow the SARB to target an optimal level for the Rand and also to factor unemployment into its decision-making processes.
We expect SA to register GDP growth of at least 3% in 2010, although this could rise to 5% if the government decides to overhaul monetary policy to allow SARB to pursue more development-orientated strategies.
On a global level, 2010 will see the acceleration of a long-term trend as economic activity increasingly moves to the developing world, in particular China. The flip side of this is a decline in the relative importance of the US and Europe. In 2010 China will overtake Japan to become the world’s second largest economy and its exports will reach 10% of world trade. Its GDP as a % of US GDP will still only be 38% (versus 34% for Japan) but its rise from 7% of US GDP in 1985 (versus 32% for Japan) has been sensational. Even assuming a slowdown in the pace of expansion (from an average of 10% to perhaps 7%), most economists now expect China to overtake the US as the world’s largest economy within 20 years. We expect the reality of the Chinese awakening to dominate all aspects of global economics throughout 2010.
Markets
As the global economy re-sets the world of finance will inevitably change along with it. New York and London will continue to be important centers but will have to increasingly share the stage with Singapore, Hong Kong and Shanghai. The late 2009 listing of RUSAL, the Russian aluminium producer, in Hong Kong will be the start of a new trend. London was previously the destination of choice for similar listings. We also expect the major currency pairs that we are used to tracking to gradually be supplemented by new crosses. SGD/ZAR (Singapore Dollar) may become as familiar to us as USD/ZAR during 2010.
Stock markets in the emerging world, China and the commodity producers (including SA) in particular, will be driven by positive macro factors. These factors will favour resources counters and those sectors exposed to infrastructure spending. Manufacturing will continue to struggle due to the weaknesses in the major export markets in Europe and the US. As China takes steps to rebalance its economy away from exports and government-led spending towards domestic consumption, expect all sectors that stand to benefit to perform well as investors grasp the magnitude of the opportunity for these firms. However we do not expect the significant rallies seen during 2009 but rather a period of consolidation as economic reality catches up with market valuations.
The breathtaking rally in Western stock markets — the S.& P. 500 index has surged 66 percent since March 2009 — look to have made stocks too expensive. The 10-year price-to-earnings ratio of the S&P 500 was more than 20.3x in late December 2009, up from 13.3x in March. The average for the last 130 years is 16.4x. With fiscal and monetary stimulus likely to be withdrawn during the course of 2010, and with no replacement drivers on the horizon, we expect a correction in these markets during the course of the year. When the correction comes we would look for opportunities in corporate debt. Governments have shown that they are willing to allow shareholders to take losses on a large corporate failure (e.g. at AIG), but not creditors. During the crisis this backstop was not reflected in the valuations of corporate debt and there may again be opportunities to buy high quality corporate paper that yields +10% in USD or GBP during the course of 2010.
On the JSE, the large cap stocks have rallied hard but there remain opportunities. Anglo-American looks the best value amongst the miners on both a PE and EV/EBITDA basis. It also has a lower level of net gearing than its peers. Amongst the banks we like Standard Bank due to its strong African franchise, its strategic relationship with ICBC and its growing international profile amongst those looking to do business in Africa. Certain small and mid-capitalisation shares also offer good value. Many of them did not participate in the rally in the second half of 2009 as most investors remain unwilling to assume liquidity risk following the trauma of the credit crisis. Recent meltdowns at Blue Financial, African Dawn and Alliance Mining have reinforced risk perceptions of this sector. However, as was true in 2009, money will be made by those investors willing to take calculated risks ahead of the broader market.
Conclusions
In summary, we predict that 2010 will be an extremely tough year for the West. Weak conditions in the real economy will be combined with a stock market correction and the reality of a reduced role in the world. For the emerging world the future looks brighter, although China in particular will need to assume some of the costs and burdens of leadership as its economy continues to grow in relative importance. The G20 has already replaced the G8 as the pre-eminent decision-making body and we expect greater emerging market involvement, or leadership, in all global initiatives in 2010.
Our position on the S&P 500 would be short for the year but we would keep a close eye open for value in specific sectors when the market corrects. On the JSE we are broadly neutral although we expect some positive growth from all sectors exposed to China and other high growth emerging markets. We would caveat this forecast in that we expect any change in the monetary policy framework to be extremely positive for SA’s growth prospects and for export-orientated industries in particular. Certain under researched sectors of our market look to be offering good value and investors should expect to be rewarded for assuming liquidity risk.
Right or wrong, the opinions expressed in this article offer a flavour of the year ahead. After two years of drama – economic collapse, rollercoaster markets, the Polokwane conference – it may turn out that 2010 is slightly boring. We wouldn’t bet on it though.
References:
1. Bajaj, Vikas, Heart-Stopping Fall, Breathtaking Rally, the New York Times. December 30, 2009.
2. Reuters, Big run for SA stocks in 2009. December 31, 2009.
3. The Economist, the World in 2010, London. Various.
4. Thomas, Landon, With Greece Teetering, the Worst May Not Be Over for Europe, The New York Times. December 30, 2009.
5. Ng, Colin, Asian Shares End Year Up, the Wall Street Journal. December 31, 2009.