The volatility of indicators calls for circumspection

European confidence in the economic outlook improved to its best level in more than two years, according to the European Commission (EC) in Brussels; but unease and concern among investors that a double-dip recession may still be awaiting the world economy remains firmly in place as share markets still seem to be stuck in the sideways trajectory that has been around since October last year after an initial upward trend during the preceding six months.

The EC announced recently that an index of executive and consumer sentiment in the 16 euro-zone countries increased to 101.3 during July, compared to 99 in June. It represents the highest level since March 2008.

After the shock to economic outlook confidence by the Greece-led budget deficit crisis, Europe’s economic prospects seem to be improving, as companies – from major banks to luxury goods manufacturers – have surprised with the profits they were able to post.

Growth in services and general manufacturing also accelerated during July, and some European analysts claimed they are detecting clear signs of stabilisation and recovery of the global economy.

There may, however, be an element of ‘talking the market up’ present. Not all have been convinced after the thoroughness of last month’s stress tests on European banks; and casting a wider eye beyond Europe reveals there are still some real risks.

Other analysts point out that while markets initially moved up strongly since March last year on the back of stimulus packages deployed by governments in particularly the developed world, they started running out of steam by October last year and went into sideways movement. As the stimulus measures slowly started tapering off, the economic activities they were driving also began slowing down and the picture is not as rosy as it seemed a few months ago.

Uncertainty and volatility have become the order of the day, which investors have to try to navigate.

The Morgan Stanley Capital International world stock market index, based on some 1 500 international stocks, remained largely unchanged since October last year as the fear of a double-dip recession remains strong among investors.

These fears are fuelled by, among others:

• Concerns that the sovereign debt crisis in Europe could trip up growth in the global economy;

• A slowdown in the growth of the Chinese economy;

• A slower than expected rebound by the American economy, where consumer confidence last month dropped to its lowest level in a year; and

• Uncertainty whether the corrections that have taken place in the global financial markets and property markets, in particularly the US but also elsewhere, have run their full course yet.

Alwyn van der Merwe, investment director at Sanlam Private Clients, was quoted by Sake24.com at the beginning of August as saying that even some of the best research houses in the world are unsure where markets are heading.

Europe

Further indicative of this is the fact that the euro showed little change in response to the EC report of an improved economic outlook.

Bloomberg pointed out in a report in early August that banks in Europe’s most indebted nations need to re-finance bonds to the tune of $122 billion this year, and are likely to pay high interest costs even after the clean bill of health they received from regulators.

“There is still a strong cloud of pessimism hanging over the markets. Getting that funding done will be as good a test as the stress tests were,” Crédit Agricole Corporate and Investment Banking strategist Peter Chatwell was quoted from London.

The austerity measures being deployed by European countries and in the United Kingdom in the face of the sovereign debt crisis may turn out to be not only much greater and painful than is generally anticipated – it could also turn out to be a stress test of its own for stability and the social order in Europe.

James Petras, in a recent column published on the website of the Information Clearing House, wrote that “structural changes are reversing decades of social welfare and subjecting labour, natural resources and the wealth of nations to raw exploitation, pillage and plunder, driving living standards downwards and provoking unprecedented levels of discontent.”

Early in August, the UK’s Guardian newspaper reported that Greek security forces have warned of a wave of violence reminiscent of the terror that stalked Italy in the 1970s after urban guerillas threatened to turn that country into a war zone.

“Greece has entered a new phase of political violence by anarchist-oriented organisations that are more murderous, dangerous, capable and nihilistic than ever before,” said Athanasios Drougos, a defence and counterterrorism analyst in Athens.

Anyone old enough to remember the days of the so-called student revolution that set Europe alight in the late 1960s will know that to accept peace and social stability in Europe as a given may be a serious miscalculation.

Wider international scene

At the same time, there were increasing reports of an escalating risk of conflict breaking out in the Middle East – something that could easily and quickly become a large-scale war that will suck in not only the rest of the region, but will resonate throughout the world.

Accompanying such a conflict will be large-scale disruptions of oil supply in particular, and markets in general.

Outside Europe credit markets, the additional yield that investors demand to win corporate bonds rather than government debt narrowed in July by the most since December last year. The cost of protecting US company debt from default fell during July following a quarter of increases, while prices of high-yield loans gained for the first month since April, Bloomberg reported.

Early in August, chairperson of the US Federal Reserve Ben Bernanke warned that the US economy has yet to recover fully, with high employment and a weak housing market leaving consumers unsettled. This called for an accommodative monetary policy until the economic recovery was on a sustainable path and job creation picked up.

On the domestic front

In South Africa, data released by the Reserve Bank indicated that the economic recovery remained vulnerable. The Bank’s composite leading indicator, which signals growth some months ahead, dipped from 131.3 in May to 130.6 in July. It was the first contraction since July last year.

Also down were the coinciding and lagging indictors, confirming fears that the revival in economic activity could be losing momentum.

In mid-July, a MasterCard survey found that consumers were expected to spend less on nonessentials during the second half of 2010 as they struggle to service their debt. The lacklustre consumption was expected to dampen the country’s recovery, as consumer spending is the economy’s main growth engine.

At the same time, South African authorities are battling to come to grips with an ever strengthening rand that is hampering export expansion.

In early August, it came to light that the governing ANC in September would discuss options of forcing the unit down.This could include tax on short-term inflow of capital.

The initial reaction was a degree of volatility, before the currency at that stage resumed its upward trend.

Most economists were unconvinced to negative about these plans, in general claiming it would come back to bite us, as it would lead to distortions in the economy.

On the other hand, there is a strong correlation between export performance and job creation.

With the South African economy having shed a further 61 000 jobs during the second quarter of the year, it is understandable that the Confederation of South African Trade Unions (Cosatu) would be pressing for a weaker rand.

With Cosatu being a key member of the governing Alliance, it may be naïve to expect the government to follow a laissez-faire approach on this front.

What should not be discounted in this debate is the fact that not all the capital coming to the country at this point is development capital – not by a long shot.

Much of it is speculative, going into listed shares and bond markets. It could easily leave again overnight, depending on what occurs elsewhere in the world markets.

For now, caution seems to remain the wisest approach on the investment front.