We have had 8 years of record low interest rates, and there is some sort of fragile economic recovery through-out the US, Europe and Asia. But the main beneficiaries have been investors who invested in the stock markets in 2009. As it is obvious by the mood in the political landscape, the broad population has not necessary benefited the same as those investors. They still feel poor, and are fed up with 8 years of austerity imposed by their governments. Instead of taking advantage of the record low rates, governments have not taken on more debt and haven’t spent it on building better infrastructure, new schools and hospitals. They have done their best to cut down on spending. They have not bought back their “expensive debt” (bonds at a higher yield), issued years ago when the interest rates were much higher and replaced it with debt at current levels, something any property company would have done. The investors have benefited so much, not because the companies are selling more than they have ever before, but mainly because debt is so cheap that it makes business sense to buy back their own shares and thereby increasing their earnings per share. They have also taken this time to rationalize as much as possible, which is a good thing because it makes them leaner in the next up-cycle. But 8 years down the line, any reasonable manger has used the opportunity to move things around to be as competitive as possible. Lowering interest rates even further or even starting such ridiculous plans as “helicopter money” won’t make the companies more competitive.

Private individuals with mortgages have also have had enough time to refinance their loans at more favorable rates. The property markets have recovered and over indebted investors must have had enough opportunities to off-load some of their assets at reasonable prices.

The reaction of governments around the world (particularly Europe and USA) to the financial crisis has been to implement stringent austerity plans instead of pushing through more infrastructure spending, the benefits of which can often only be seen years down the line. Now we see the adverse effect of a narrow recovery (ie the broad dissatisfaction), for example with the vote to leave the European Union by Britain and the nomination of Trump as presidential nominee (which would be comical if it wouldn’t be so sad). You would have been described as a lunatic a few years ago, if you would have predicted this, but there is probably more to come. As I said in a previous article, we will remember this time as a time when central bankers did too much and politicians too little.

So trying to reduce the effective interest rate even further will have almost no positive effect. Most of the benefits are in the system already, and I think that the benefits of increasing interest now to reasonable levels would be far greater than any reduction in lending rate. For a start, pensioners can finally look forward to more reasonable pensions. As most of their money is invested in “safe” assets that provide a steady stream of income, such as bonds, they would benefit from higher rates (especially the ones about to retire). Savers in general would get a higher reward for doing so. Also, low interest rates makes the whole business of banking very tricky, because the margins are so thin that it becomes almost impossible to attract much money to lend out. Insurance companies would also have less hassle to provide enough liquidity for payouts, while generating returns on the investments. And finally, the hurdle rate for a good investment is so low at the moment (all you need is a single digit return to make it worthwhile) that the decisions are not going through enough scrutiny and thus a lot of capital might be invested in projects that under real circumstances would never be able to survive.

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The problem with the South African stock exchange is that it is dominated by a few really big companies. If you add up the market capitalization (ie the value of all the companies), you get to a figure just slightly higher than R10 trillion. If you then divide the market cap into 3, the top third of companies is made up of only 3 companies, the next third of 14 companies and the bottom third of 153 companies.  Thus our market is very concentrated, and share price moves of a few big companies have a far greater impact on the index than the performance of many smaller companies. So which are the top 3 companies? The biggest weight is British American Tabaco (BAT), closely followed by SAB and then Naspers. The performance of these three shares have got as great of an impact as the performance of 153 smaller companies.

The problem at the moment is that the top 3 companies are all trading at a P/E more than one standard deviation above their long term mean. Even though the historical P/E is not a precise determination of value, it is a fairly good indicator. SAB’s P/E is above 34 now, and Naspers above 100. This is astronomical stuff, and you would have to expect massive earnings growth to justify such high P/E’s. As a fund manager, you would have to have really strong conviction to buy such highly priced shares. Surely there are better opportunities that offer better risk-reward returns. However, an index tracker fund does not do such decisions. 1/3 of your money would be spent on buying such expensive shares. I am not sure if that is such a good idea. I am therefore of the opinion that this environment will definitely favor good active fund managers with an established track record.

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In this article I write about a buzzword that has been making headlines courtesy of the German government over the last few years: Austerity. In the very basic format, austerity is when the government tries to save any unnecessary costs and cuts down on their spending. In general this is seen as a good thing, and thus should be endorsed. Germany is the most prominent country advocator of it. They have managed to present a balanced budget, thus they would not need to incur any new borrowings. Thus they have been trying to force everybody else to follow suite, with mixed results. The Greeks for one, can’t stand the word and are trying to get away with less. Brazil ended up in a recession, partly due to the government’s austerity drive.

So is austerity really the medicine the country’s  need to get their economy’s on a track for growth? The basic idea is right, however, the timing if and when to do it is almost more important though. It is good to save some costs while the economy is on a sustainable recovery and the private sector is beginning to boom again. It can have the opposite effect however, if the economy is in tough times. Just imagine yourself running a business and, just as trading slows down you become more reliant on existing customers., This tells you that they you are focusing on saving money as  they will not buy as much anymore. Governments are usually a country’s biggest customer as they  contribute between 25% and 35% to the local economy.. John Keynes already said that governments should run counter-cyclical budgets, i.e. save in the good time and spend in the bad times.

But what should countries like South Africa, Greece and Brazil do, whilst they are in a situation where it is almost impossible to spend more (because of debt restraints)? Should they spend their way out of their situation or are they better advised to embark on austerity? Well certainly most of the countries facing such difficult economic times have a third option – make the private sector as attractive as possible to investors. That means reduced tariffs, get rid of restrictive policies and red tape, show that the rights of investors are upheld in courts and focus on reducing corruption. Without much fiscal spend,  governments would be able to make their economies more competitive, thus more lucrative to investors who would be more willing to take a risk and invest in the hope of benefiting through the up-cycle.

The post How to run a government: Economic cycles and austerity appeared first on Crystal Water Investment Management.

In the last financial year where we have seen the capacity utilisation drop, meaning that of the installed capacity to produce electricity, less was available to actually produce electricity because power stations were offline for repairs. This lead to forced load-shedding, impacting most of the economy. What Eskom seems to forget is that electricity is a vital ingredient to the functioning of an economy, much like water is a vital ingredient to life. Without it, much of the economy simply doesn’t exist. Thus manufacturing plants had to lay idle for a few hours a day, shopping centers had to close early and restaurants were not able to serve food. Stopping the flow of electricity has a multiplying effect that is far greater than the actual cost of the electricity. When you produce a R3.6bl profit, surely more could have been done to reduce the amount of load-shedding. I remember that one of the reasons given at the time was that they did not have enough money to spend on diesel to keep the expensive gas generators running. Well, seeing that they did report a profit, that must have been a false statement.

Another concern is why they tried hard to lobby for steeper increases in electricity prices if they managed to produce a profit in the financial year. Seeing that electricity is a forced input cost, it should be in everybody’s interest to keep it as low as possible. The low electricity prices used to be a big competitive advantage to producing in South Africa, but that is now truly in the distant past. The current electricity supply is a detractor to the attractiveness of manufacturing in South Africa.

I however have a suspicion that reducing the maintenance capex derived the profit. The maintenance capex is the money spent on maintaining the capital. Like anybody would know who wants a house, it requires regular upkeep to prevent it from falling into disrepair. Transmitting cables, transformers, power stations and their general infrastructure have a given lifespan. Even though they still work, they would need to be replaced before they break, to prevent the system from collapsing. The bigger the infrastructure is, the bigger your maintenance capex should be. So, by just reducing it a bit gives you a massive boost to your cash flow and to your bottom line. It can make the company look good, even though they have just kicked the can down the road, and more problems will emerge further down the line. In the meantime, management can pad themselves on the back, and pay out handsome bonuses.

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By Laura du Preez

Read the full article here.

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I think that all we have done is to kick the can down the road once more, because the systematic flaws of the European Monetary Union has not been addressed. Sure there is a lot more that Greece can do to make their economy competitive. They could relax their  labour laws, get rid of cartels, make sure that everyone pay their fair share in taxed  and reduce the size of their overcrowded, corrupt and inefficient  public sector and government. They could also raise the age of retirement  and try and get rid of many  tax loopholes by implementing a flat Tax rate system.  They they should get rid of the attitude that they are the victims, because nobody forced them into this mess but their democratically elected government.  Other  European countries should also realize that they have benefited from a larger Union, partially because the exchange rate is  one within the  Union (obviously) but also because the exchange rate reflects the competitiveness of all economies put together.

Just imagine what would happen if the Germans  exit the Union and adopt their Deutsch Mark (DM) again? The DM would soar (at least vs the Euro), slowing the export driven economy substantially. This would hurt the German economy. So the Germans have benefitted by not having the DM, while the Greeks have had to realize that they have to restructure their economy to be able to compete with the European peers. You generally find a very similar situation within countries. In Germany for example, most of the car manufacturing is in the south, thus they have a bigger  tax base than counties like Bremen. In the USA, you have states like Alabama, where the GDP per capita is much lower than that of New York. But because many of the taxes are collected on a Federal system, the governments of the US and Germany can implement transfer pricing, where some “underachievers” are being supported by “overachievers”. Thus some counties or states get more tax income per GDP allocated than others, thereby helping them achieve their goals.

The Euro Monetary  area doesn’t have this, because each country wants to preserve their federal independence. But that is like wanting the best of both worlds. This is clearly not achievable, and even though everybody is better off if they stay together, nobody wants to share their part of their success.

The post What we have learned from Greece appeared first on Crystal Water Investment Management.

In simple economic terms, it would make sense. But such decision would be short sighted and naïve. In fact, the fallout could be so severe for the Greek population, that they could have mistaken it with Zeus, the god of thunder, returning. The Drachma would immediately devalue against all other major currencies, since the exchange rate always acts as the pressure release valve in an inefficient economy. Any company, who has taken out debt in Europe will see their debt burden skyrocket, and probably make it unsustainable. Banks would only be able to survive with the support of the Greek central bank, because in accounting terms they would be bankrupt. You would probably see high inflation coming through, wiping out any value of cash savings by pensioners, and the venerable parts of society would be thrown into poverty with little help or hope. That’s because the Greek government has still not sorted out one of their main problems: Tax collection. Going back to the drachma would not enable the Greek government to collect more Taxes, which they need to help to support the faulting economy.

Once the massive devaluation has taken place, the Greek economy will start to gain traction again, but from a much lower level. If the GDP falls by another 25% in real terms, after the Grexit, and the economy then grows by between 3 and 4%, they will need 20 -30 years to arrive at the level they have been at in 2008. That is a big price to pay.

All these doomsday scenarios would certainly advocate a “yes” vote this weekend, yes to stay in the Euro area and yes to reforms. But there is a much more fundamental reason why Greece should stay in the Euro area. As mentioned earlier, the currency exchange is a pressure-release valve to uncompetitive and in-efficient economies. In the global village, countries compete more and more head on against each other. Thus, over the long run, countries that produce the most efficient will benefit (in constant currency terms), while countries, that are marked by restrictive practices (such as ineffective and corrupt governments, high licensing fees, tight labor laws, etc), will perform badly. Either the economy will do badly, or, if they have their own currency, the currency should depreciate each year to make up for the inefficiencies (often coupled with inflation).

Greece is doing badly because they are not as competitive as their European counterparts. Their government employs more people in questionable and unproductive positions, the labor laws are more restrictive, the Tax collection not as efficient and they protect more industries resulting in companies being less efficient because high local barriers to entry which are restrictive. In a fast changing world dominated by disrupters like the Taxi service Uber, you can’t try and protect your own Taxi industry by restricting it and charging high license fees. At the end of the day, the main people who suffer from such bad policies are the Greeks.

To end this ongoing crisis, the Greek people have a chance to vote “yes” this weekend and give a clear signal: Yes, they want to be part of Europe; Yes, they want reforms to make Greece, including their government more competitive; and yes, they want they want to be proud to be a Greek again, a nation that rises up to the challenge a conquer it, rather than blaming others for their own faults.

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None of the politicians, listening to their top commander (Zuma) giving the State of the Nation Address (SONA), really inspires confidence. Most look like they are there just because there is a big banquet after the SONA, that they don’t mind nor do care the message Zuma gives. Zuma’s ideas on how to get this economy up on its feet again are more about how much more the state can control and interfere in the free market system. Members of Parliament enthusiastically applauded when he said that foreigners are not allowed to own land. Have they forgotten that if it were not for the help of foreigners that it otherwise would have been very difficult to overthrow the apartheid regime? Instead of freeing up the electricity market, he burdened Eskom (a state owned company that by any accounting standard is bankrupt) with another future nuclear plant. Have we not had enough proof that the monopolized control doesn’t work? Most of the jobs that were created were in the public sector, while the private sector is still struggling with too ridged labor laws, red tape and skills shortage. None of the fundamental bottlenecks have been addressed. Instead Zuma celebrated an agreement with China that allows us to export Maize and Apples there, but there won’t be any Maize or Apples to export if his farm reforms go through.

Zuma was at a juncture, go left and turn to communism or right to follow market friendly approach. Given the pressure that the ANC is under from the left (the other members of the triparty alliance), it would have taken a strong leader, somebody with a plan and a vision, to implement more reforms to make South Africa more market friendly. Zuma turned left.

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It is very difficult to draw blanket comparisons between nations. South Africa, for example has got a large self-subsistence farming community. They live according to their own traditions. It is very hard to quantify their wealth, which clearly can’t be zero. Since they are only marginally active in the real economy their output is very hard to count, and thus their wealth is normally understated. But I am not sure that they would necessary live a better life if they all learned a trade, become factory workers and live in big cities. South Africa is also unique in the way that we have very complex industrial sectors that easily compete with the best of the developed world. We have a financial sector that seems often a lot more robust and advanced than the European and American peers, since we have very developed and liquid financial markets. We have some of the best engineers and doctors in the world.

Thus while we have a massive wealth gap, we also have a massive skills gap. We have some of the most talented people, while the majority of our population (mainly the young ones) had to endure a very poor educational system. The education system was focused more on providing education for everybody, instead of keeping high educational standards while expanding the system to include everybody. So while most school leavers have not had mathematics (one of the core subjects) and only had to get every third answer right in order to pass their matric, some kids were lucky enough to be in private schools or model C schools,. Those lucky ones probably passed their matric with flying colors and then went on to further their education in Universities and Colleges. Their skills are sought after by established businesses and because they are so scarce they are highly paid. This trend will continue until our quality of education to everybody increases.

So while we are topping the list of most unequal societies, it should not be seen as how to make to wealthier poorer (by increasing Taxes or other social burdens), instead it should be seen as how to give the poor masses the opportunity to earn more money. Clearly a better quality of education will have a major impact.

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Some of the reasons given by the Reserve Bank were that the weakening Rand leads to imports being a lot more expensive, and that food costs are going up. I don’t think that a hike in the rates would achieve any of the desired effects. When it comes to food costs, South Africa is in a very unique position, different than America, Europe and Asia. Theoretically we produce largely enough for our own consumption, however if we fail to do that we need to rely on imports to make up for the shortfall. But in contrast to let say Germany, we can’t rely on our neighboring countries to supply our shortfall. Firstly, they are not big producers of crops themselves, and often have to import to make up for their own shortfall. Secondly, if our crop harvest is down by 10% it is the equivalent of the consumption of the whole of Namibia and Botswana combined. So if we do have a shortfall, we will have to import, and given the geographical position of South Africa, the transport costs will be high. This means that as soon as South Africa doesn’t produce enough crop, we will experience inflation as all crops are then sold at import parity pricing.

So would a rate hike curb food inflation in SA? As long as the inflation is supply driven, I doubt it. In fact it might even make it worse. There are many ways to increase the yield of crops, thus making sure that South Africa has the required food security. But these rely on economies of scale, and using modern technology to optimize the planting and harvesting process. These require big capital outlays which are often partly financed by banks. Increasing interest rates make such investments less feasible. The Governments latest comments about farm ownership (see previous article) also deters any such investments.

One of the other reasons given was the weak Rand, which would cause imports to be more expensive. Unfortunately the Rand was too strong after the world financial crisis, as investors around the world were searching for yield, since they got nothing at home. Thus a big demand for Rand came from investors, not from sustainable trade requirements. At that point, the SARB should have lowered the interest rate substantially to make the short term investments in South Africa less attractive.

In the subsequent years, consumption was one of the main drivers of the economy, as imports became cheaper and South Africans splashed out on new cloths, TV’s, cars, etc. Without any support of the producing side of the economy, the growth was only driven by the stronger Rand (which had nothing to do with the underlying economic factors) and thus unsustainable. Basically we helped countries like South Korea, Vietnam, Mexico, Thailand but also Spain and Italy among others achieve sustainable growth by buying all the products they produced.

Yet again, the government could do a lot more to foster growth. One of our natural big economic advantages are resources. We have a wealth of natural resources and in theory that should be one of the main drivers of economic growth and thus prosperity. Added to that we had just experienced the biggest commodities bull market since the sixties, but South Africa has not been able to increase production and thus benefit from these extraordinary times. In fact, due to the fast rising labor costs, poor electricity supply and a lack of infrastructure many of the small mines had to close down. Many of the big mines had to turn to their parent company or their shareholders for additional cash injections, just to survive.

A hike in interest rate will not make South Africa suddenly more attractive to international investors. A change in politics will though. Thus I am not sure that we are on the right course, however only history will determine the correct outcome.

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