Expect the worst on economic front is the clear message

By Ryk de Klerk Time of article published Mar 23, 2020

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JOHANNESBURG - Global central bankers, including the South African Reserve Bank, had no other choice than to deepen their quantitative easing to free up liquidity locally and worldwide to prevent a total collapse.

The massive dump of equities by global investors since the last week of February saw equity markets in developed countries, as measured by the MSCI World Index in terms of US dollars, slump by more than 20percent.

The behaviour of an equity market in a specific country is generally a good indication of what is happening in the country's underlying economy. So too is the behaviour of global equity market indices a good indicator of the health of the global economy. There are, however, leads and lags as investor sentiment tends to be more volatile than the underlying economy but, most importantly, it is the major turning points that count.

I use my own proprietary formula to calculate the weekly smoothed annualised growth rate of stock indices to get an indication of what the stock market is anticipating about the economy.

It is evident that the weekly smoothed annualised growth rate of the MSCI World Index correctly anticipated the OECD GDP growth rate through the major cycles. The depth of the stock market contraction during the global financial crisis in 2008/09 correctly anticipated the depth of the recession at the time, followed by the strong recovery afterwards.

Currently, the weekly smoothed annualised growth rate of the MSCI World Index is sitting at -8percent and is pointing to benign or even zero GDP growth in the world in the first quarter of 2020.

Even if global equity prices recover by 1percent per week over the next 5 months, the MSCI World’s weekly smoothed annualised growth rate is set to bottom by the end of April or the beginning of May this year. What it means is that the OECD GDP could contract by up to 2percent in the second quarter of this year and will only expand again in the third quarter.

If, however, the bear market in global equities continues over the next five months and the MSCI World Index falls by 1percent per week, OECD GDP is likely to contract by more than 3percent in the second and third quarters of this year.

Yes, a similar contraction to the 2008/09 crisis could play out. That is the very reason why the drastic measures to contain the spread of Covid-19 are implemented to save lives and why the central banks are throwing all they can at the market through quantitative easing to restore confidence.

The situation on the SA front is even more severe than in developed economies. Equity prices in SA as measured by the FTSEJSE All Share Index points to a further contraction in the economy in the first quarter of this year. Furthermore, the economy is facing a severe contraction of two percent and more in the second quarter even if the All Share Index bottoms and increase by 1percent per week over the next few months. Although the situation may improve somewhat, the prospects for the third quarter are not that promising either. The outlook is dire if markets keep on falling. The SA economy could contract by an annualised 4percent or more per quarter over the next two quarters.

SA’s finances are under huge strain already and we find ourselves in a very precarious situation as the debt-ridden state-owned enterprises will continue to need further bailouts to avoid defaults. On top of it all, the likelihood of a credit downgrade by specifically Moody’s is increasing by the day.

The SA bond market is already telling us this as the SA 10-year government bond yield sits at 200 basis points higher than the BRICS curve given the corresponding sovereign credit ratings. The JSE Assa All Bond Index’s yield to maturity last week surpassed the highs during the 2008/09 crisis and the Zuma debacle in December 2015 where we had three ministers of finance in a space of 3 days.

Furthermore, the steepening of the BRICS yield curve since the end of January indicates that emerging market bonds and especially those with junk bond status (SA and Brazil) are bearing the brunt of risk aversion in the global bond market with yields jumping by 250 basis points.

The markets’ message to central bankers and governments is clear. Expect the worst on the economic front! To quote from Steinhoff’s Covid-19 update on Friday: “The situation (impacts of the virus on supply and demand) remains fast-moving and uncertain.” The markets will tell when global economic activity picks up again.

Do not give away your savings at bargain prices as some of us did in 2008! Stick to your original investment plan, this fire-storm will also pass. Panic also creates opportunities. Regular investors in funds and equities get more units or shares for every rand invested.

Ryk de Klerk is analyst-at-large. Contact [email protected] His views are his own. He has no direct interest in any company if mentioned in the article. You should consult your broker and/or investment adviser for advice.


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