Pinpointing Demoralising Pivotals

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Pinpointing Demoralising Pivotals

By Cees Bruggemans, Chief Economist FNB
11 August 2008

We are in an unbelievable sorry state, really, and getting worse in stages.

One approach to finding our bearings and understanding our condition better is to identify remarkable happenings. I came across two only last week.

Apparently some estate agents now favour an end to house sellers dropping their price. Instead, they allegedly try to talk them into upping their price.

For as long as house prices keep falling, buyers remain coy on the sidelines, expecting house prices to fall even further.

This is not good for business. Deals don’t get done, at least not on a sufficient scale. So the downward price spiral needs to be stopped.

A macro economist will take the view that an end to uncertainty, specifically the first cut in interest rates heralding the new down cycle, might be central to achieving this. But in its absence one might as well at micro level try to beat back the angry waves.

It reminds vividly of the desperate US housing market, where in a major city-sample prices are now down nominally by -20%, and the bottom is projected sometime in 2010 at -30% peak-through-trough. This in a country that hasn’t seen nominal house price declines since the Depression and where it was no longer thought possible.

But this catching-a-falling-knife-business is very real, and until demand and supply of housing units stabilize at lower prices, the turn cannot really come and is sometime off, a reflection of the exuberance and excesses that went before and which need to be worked off.

Another anecdote concerns the motor industry. One well-known motor industry analyst has tried to model the current passenger car sales decline and finds that his well-tested historic model cannot replicate the actual declines of the past two years. The model simply refuses to generate as drastic a decline as observed in reality.

He has had to force the model with dummy variables, mainly non-price (emotional) ones, in order to get to current rates of decline.

Such can be the enormous distortion of the replacement cycle, once it starts going down vigorously after equally monstrous distortions earlier on the way up.

A brick manufacturer has reportedly seen orders fall by 30%. A quantity surveyor was on a 40% growth curve and suddenly saw this flatten out. Both occurrences trace back to between late 2007 and Easter this year.

Other businesses will have their own tales to tell of rather extraordinary happenings.

There will be the happy tales, such as farmers experiencing agricultural commodity prices exploding higher, and 50% bigger harvests. Construction companies being overwhelmed by a flood of very large infrastructure projects. Public sector entities putting projects out to tender and getting no replies! Mining companies finding their output down, but their earnings are strongly up due to stratospheric commodity prices.

But there are probably many more demoralizing tales. Not least those encountered by these selfsame farmers, mining companies and engineering contractors in terms of input costs, massive jumps in certain materials and equipment prices eating up large parts of any income windfall.

Many households can probably break their own experiences down into three stages.

The first, and early harbinger of bad times, was the turn in the interest rate cycle from mid-2006. Instead of remaining limited to only two or three rate hikes, prime rising from 10.5% to 12%, further instalments kept coming like clockwork, until prime today is 15.5%.

This has taken 6% out of disposable income over a period of three years, a major squeeze.

The second hit dates from the past twelve months, when oil and food prices suddenly started to do strange things, eroding consumer purchasing power.

Car owners and taxi users encountered an unsettling surge in transport costs. And especially the poor encountered a major erosion of real income at the supermarket.

Having been hit serially by these two buses over the past two years, in particular hitting many new middle class households with few asset buffers to fall back on, and the newly minted National Credit Act to enforce yet more discipline, a third bus is coming into view in 2H2008.

For high skilled and protected employment, the wage increase this year may be adequate to cover inflation, if just. But that covers only half of formal employment and only a quarter of the labour force. In addition, flexible remuneration components such as commissions, bonuses, overtime and part-time earnings, and informally earned incomes are being trimmed or are in jeopardy. In some instances this year and next employment itself may be lost (possibly 1% of the active work force).

It is bad enough when these things happen to a particular individual. But observation creates unease in watching bystanders about what still awaits them. Thus the effect multiplies greatly throughout the labour force.

The effect on morale and the willingness to spend can be imagined. No wonder many businesses experienced a sudden change in sales conditions sometime this past year. This Christmas season is unlikely to be a cheery one.

Yet another way of approaching this subject is trying to identify pivotal moments, like a loud crack in the ice or a warning rumble announcing the earthquake that something fundamentally is shifting.

We have had ten such moments these past two years when the SARB each time raised interest rates by 0.5%.

Each one of these announcements was like a bullet entering the body at great velocity and doing untold damage to the living tissue it encountered along the way.

The analogy isn’t mine, but originally belongs to a long departed central bank governor who knew exactly what he was doing every time he increased interest rates, not unlike generals when they send divisions on doomed missions, or employers when they have to fire someone. But these things sometimes need to be done, and someone needs to do them.

In an even greater context, however, loud cracks of the ice sounded globally and locally, although we didn’t always recognize the symptoms.

In mid-2005, President Mbeki fired his deputy-president. That’s where the real political revolt began, and deep trepidation amongst others arose.

Sometime in early 2006 the US housing market peaked and went into screaming decline. Anyone over here noticed?

Women’s Day 2007 was for South Africans a happy day off, except for working stiffs making inspirational speeches to women audiences about our wonderful economy, though not realizing that in Europe that day the ECB was about to inject $140bn of liquidity to smooth increasingly unsettled money markets.

The Great Global Credit Deleveraging had begun.

This ultimately didn’t affect us much, even though it increased the borrowing costs of our banks and apparently made our macro policymakers cautious.

Unfolding global housing and credit contractions did affect global economic performance, also reversing some of the windfall conditions favouring us for some years, especially uncritical foreign capital inflows.

Polokwane in mid-December 2007 formalised a formenting democratic revolt with a swing away from the political status quo. Only coming years will show what political surprises and policy changes this ultimately could yield.

These deep stirrings, however, unsettled large swathes of critically skilled labour. The perception that the good times could be ending, and more importantly that permanent relegation from premier to second league, in Clem Sunter’s words, was perhaps on the cards, was the final straw for many.

As if confirmation was needed, Eskom then proceeded to switch off the lights for a while, with 24 January 2008 the pivotal moment as even large parts of the mining industry unexpectedly shut down.

If the gradual interest rate tightening, political stirrings, judicial farce, spreading crime and rentier mentality of preceding years hadn’t quite done it yet, this offered the realization that things were breaking down all around us.

This at a time when things next door in Zim were steadily coming to a head in a far more spectacular fashion, all the while pushing out people, like a comet steadily loosing mass on its journey into the sun.

Emigration of skills has been a reality for many years, just as immigration of no skills. Both underwent tsunamis this past year, a revolving door that is changing our city appearances daily.

Just how fundamentally became clear in May when Xenophobia suddenly and unexpectedly flared, as some poverty-stricken township dwellers across the country struck out at even poorer foreigners in their midst.

This led to yet more anecdotes, and not only about African nationals leaving the country in fear and disgust, and local communities after some introspection desperately trying to woe them back for they could not do without their useful services.

Also in the richest suburbs, I am told, far removed from any violence being perpetuated, some foreigners abruptly sold out, declaring that this was the end and the country wouldn’t see them again.

At about that time, too, or shortly thereafter, petrol broke through R10/l and diesel through R12/l. To fill up your favourite 4×4 bakkie now costs over R1000 per filling. Brother, can you spare me a dime?

These are demoralising pivotals from hell, concentrated in a very short period of time. Like the bulkheads of the Titanic loudly giving way.

Try taking time off some time, and tell yourself this is just a minor cyclical dip searching for a bottom some time in 2009, after which the new economic revival will be upon us.

The logic of the interest rate cycle, coupled to the replacement cycle, inventory cycle, credit cycle, trade cycle and investment accelerator tells us just that.

But believing it and living it is another matter.

For that we need the right perceptions, psychology even. That just might be missing in action at present. Something to mull over, especially north of the Jukskei.

Cees Bruggemans is Chief Economist of First National Bank. Register for his free e-mail articles on

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About FIAC

Mr. Gavin Bruce Ferrier Dip. Prod, CEA, GA, CIPS, TRC, is the founder of FIAC, with over thirty years of general management and investigation experience and has worked throughout Southern Africa during this period in the Commercial and Industrial sectors. I have conducted and managed various successful businesses and projects on behalf of clients across the business spectrum. I understand the importance of relationships, and how to use my gifts and passion to positively influence those I have come into contact with.

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