SMU Political-Economic Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION - What Rising Yields Mean for Bond and Stockholders - The Final Nail in the Coffin - South Africa: On its knees?
The Fortnight In Brief (2nd September to 15th September) US: The most exciting FOMC meeting yet The FOMC meets Sep 17-18 where m arket expectations point toward the announcement to pare back monthly asset purchases from $85 billion to $75 billion. Retail sales out Friday rose b elow expectations by only 0.2%, the smallest gain in four m onths. W eaker consumer confidence again raised speculations of a less aggressive tightening of monetary policy. President Obamas nomination for Fed Chairman can also be expected as early as late next week. Lawrence Summers, who is widely expected to edge out incumbent Vice Chair Janet Yellen for the job, could spark a tough confirmation fight as more Senate members speak out against the former treasury secretarys nomination. Asia: Stocks advance as China sees encouraging data Asian stocks saw its largest two-week advance since January 2012 with the MSCI Asia-Pacific Index rising 5.3%. The advance comes on the back of positive economic news from China, with exports rising 7.2% versus a 5.5% median estimate and retail sales climbing 13.4%. Meanwhile, the Topix Index in Japan experienced a 3.3% advance after Tokyo was chosen as the prime choice to host the 2020 Olympics. The news comes as Japans Economy Minister Akira Amari announced that Japan is considering a corporate tax cut designed to cushion the blow from the 3% consumption tax hike. EU: Spain's debt raises flags, Germanys election looms

ISSUE 45 16 September 2013

IN COLLABORATION WITH

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Trouble continues for Spain as public debt edged above the Prime Minister Rajoys year-end 91.4% target to 92.2%. Spains compliance with deficit targets hinges on the broader recovery of the tax base which is expected in the second half of 2013 after eight consecutive quarters of contraction. The EU has urged Spain to stay the course of economic reform. W ith German election looming, Chancellor Merkel has doubled down against raising taxes amidst calls from the opposition to up the top rates to 49%, citing a troubled Eurozone economic climate. Efforts to establish the Single Resolution Mechanism (SRM) as part of banking union in the area are also expected to pick up after election day.

1710 1690 1670 1650 1630

S&P 500

316 312 308 304 300

STOXX Europe 600

545 535 525 515 505

MSCI AC Asia Ex. Japan

What Rising Yields Mean for Bond and Stockholders

By Lin Liye, Singapore Management University
Interest rate movements over the past few months and the impact on Asian markets. On 22 May 2013, the Fed signaled that it might begin to taper its quantitative easing (QE) measures. Ben Bernankes comments shook expectations that treasury yields would remain low for the next 6 to 12 months, and both the equity and bond markets were hit. Investors in Asia ex Japan equities have lost over 6% of their investments in June alone before markets rebounded from the trough. For an Asian bond investor that began investing on 22 May, the portfolio will still be down by over 9%. For most investors facing such a huge loss in such short a time, the psychological pressure to cut losses and sell off all investments is great. Though this would hugely reduce the investors wealth, had leverage been used, the investors entire net wealth could essentially be wiped out in a month. How do treasury yield movements impact bonds and equities? Individual Bonds vs. Bond Funds There are 2 common types of investments in bonds; either in single bonds or in bond funds. Single bonds are individual bonds issued by companies, and tend to have a fixed maturity date. Bond funds provide a simple alternative to investing in single bonds directly. These funds work like mutual funds, where investors investing in incremental amounts of $1,000 to pool together a sizeable sum. The fund manager then constructs a portfolio with securities which could outperform the stated benchmark. Bond funds hence provide a way for retail investors to participate in bond markets with adequate diversification at an affordable price. Interest Rates and Bonds What happens when bond yields go up? Simply put, prices go down. The cardinal rule is that bond yields and prices move in opposite directions. When prices go down and the bond is sold before maturity, a capital loss is incurred. Single bondholders will not be affected by the capital loss if they are willing to hold the bond to maturity. However, in a high interest rate environment, it means locking in a low interest rate in their investments while new bond investors enjoy higher yields. In comparison, bond funds do not have maturity dates, which mean the bond funds will be affected by capital losses when interest rates go up. Stockholders are generally affected negatively in rising interest rate environments. A rising interest rate signals a tightening of monetary policy by the Fed, which means lower liquidity in the market. Rising interest rates also raise the cost of capital for firms and individuals, reducing consumption and investments in the economy. The economy slows down and grows at a lower pace as a result. Companies are no longer expected to grow as fast, and this is generally reflected in lower share prices in the broader market. 2 Copyright 2013 SMU Economics Intelligence Club

However, rising interest rates also signify the confidence that the Fed has in the US economy. The unemployment rate has decreased to 7.3% as compared to 10% back in 2010. The Case- Shiller Home Price indices have also shown rising home prices over the trailing twelve months, reflecting a recovery in the real estate market. The S&P500 has also hit record levels in recent months as companies report earnings levels not seen since the Great Recession. It is good news that the US economy is appearing to be regaining lost ground. As the US is the most important market for many of the largest Asian corporations, its recovery will mean stronger consumer spending power, which translates to growing revenues and larger profits globally. So in a rising interest rate environment, both bondholders and stockholders get the short end of the stick. Rising interest rates hurt shareholders in the short run as markets historically dip with tightening monetary policy, which is particularly evident in the upcoming tapering of QE. However, in the longer term, the recovering US economy will benefit corporations as it improves general business confidence and boosts the purchasing power of US consumers. Shareholders gain from the broader economic recovery through the higher profits earned by companies, which is passed on through higher share prices and dividends. Sources: 1. Bloomberg: http://www.bloomberg.com/news/2013-08-20/rupee-drops-to-record-on- concern-fed-tapering-to-spur-outflows.html) 2. Yahoo Finance: http://finance.yahoo.com/echarts?s=AXJL+Interactive#symbol=axjl;range=6m;compare=;i ndicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=undefine d; (WisdomTree AxJ ETF) 3. Google Finance: https://www.google.com/finance?q=MUTF%3AAEEAX&ei=42MZUtjiG8nvkQX6VQ (using Aberdeen Asia Bond Fund) 4. S&P Indices: http://asia.spindices.com/index-family/real-estate/sp-case-shiller

3 Copyright 2012 SMU Economics Intelligence Club

The Final Nail in the Coffin

By Edison Yong, Singapore Management University
Augusts less than stellar nonfarm payrolls, out Friday, might still be the final nail in the QE Infinity coffin. While everyone is asking when?, a handful of economists are instead asking why? Talks of taper have, for months, saturated every news source, and any financier with an opinion has, by now, added to a growing chorus against Bernanke, The Blower of Bubbles (title courtesy of Paul Krugman). Amidst the cacophony of voices, some inflationistas still cling tightly to miscalculated predictions of runaway inflation that did not come to pass, with a fringe few insinuating a broader federal deception conspiracy. Equity markets have gained considerable ground since it bottomed out in 2009. It has come to a point where concerns over resource misallocations, bubbles and negative spillover effects on international markets leave many financiers calling for an end to easy money. While investors have been delighted by the markets long bull run, the real economy continues to creep along at a petty pace. Economists, mainly those of the New Keynesian variety, have been vocal advocates for the Federal Reserves continued support for the weak recovery through its asset purchases. Why? rather than When? As Adam Posen, President of the Peterson Institute, points out, there has been a penchant among policy makers to dismiss measures before theyve been given a chance to take effect. Posen speaks of the eagerness of policymakers to declare Americas unemployment problem structural, and therefore withdraw stimulus. Only a year ago, at the annual Jackson Hole conference, a paper that would validate QE3 asserted that much of U.S. unemployment was cyclical, and was thus fixable with stimulus without risk to inflation. This eagerness to trash policies before their chance at life is nothing new to the Obama administration. The Recovery Act of 2009 was one of the earliest instances of such defeatism. The package, which many argued should have been at least $1 trillion for any discernable results, was ultimately watered down to $800 billion because Congress had no political appetite for the T word. The inability of the watered-down bill to be the silver bullet quickly became a convenient cudgel against the efficacy of the stimulus itself. Unfortunately, much of the success of this administrations policy, both in its Recovery Act and monetary easing, rests in the proving of the counterfactual but for our actions, things would have been even worse. Talks of paring back stimulus in the face of broader data pointing to the contrary, continue to confound the Keynesians. Meanwhile, markets continue to conflate QE with forward guidance, which only serves to complicate matters. Too soon August jobs numbers have cast labor participation back into the spotlight. The chart-of-the- month (image below); employment population ratio, still indicates numbers are well below pre-crisis levels. The depressing figures have led many to question the prudence of the Feds policy path. Given the low inflation and the lack of fiscal space, some economists, whose ranks include the IMFs Olivier Blanchard, have suggested that a 4% inflation target would be 4 Copyright 2013 SMU Economics Intelligence Club

consistent with the Feds dual charter. But there remains a schism between some Committee members in the dove-hawk continuum; while notable doves have expressed possible support for the other side if convinced, some previously hawkish ones dont seem to be drinking the taper kool-aid. St. Louis Feds Bullard dissented from Junes Committee statements, calling for a stronger signal of the Feds resolve to defend inflation targets, and more recently, that there was no rush to step away. Minneapoliss Kocherlakota (non-voting) remarked on Sep 4 that the Committees own inflation forecast implies that they are failing to provide sufficient stimulus to the economy. Figure 1: Civilian Employment-Population Ratio

Source: St Louis Federal Reserve A Different Telos Perhaps it is futile for anyone but the Committee to debate its motivations. However, in the interest of policy discourse (to the extent that voters elect the President who then nominates the Fed Chair), Bradford DeLong, Economist at UC Berkeley, proffers an interesting view of to whom the central bank is in service of; the Banking Camp or the Macroeconomic Camp. Under the Banking Camp, the central bank functions to ensure the prosperity of the banking sector, and in so doing, their bottom line. The Macroeconomic Camp on the other hand, views the institution as central to preserving the broader economy; balancing demand, unemployment, inflation etc. DeLong and others hold the opinion that reducing stimulus (and bringing on a rising interest rate environment) while recovery is still weak, suggests an institution that tends to the Banking side of the continuum which allow financiers to coast a steepening yield curve for profits. Identification with the other camp would instead lead the Fed to call for the 2-4% inflation required to bring real GDP closer to the Congressional Budget Offices estimates of potential. Where is the Fiscal policy? This fixation with central banks is born of the lack of fiscal space in the developed world (see Europe and Japan). But to ignore the specular breakdown of fiscal action in the recovery (i.e. sequestration which, remember, was intended to be so unacceptable, that neither party would 5 Copyright 2012 SMU Economics Intelligence Club

let it happen), too easily lets policymakers off the hook. Even the IMF has changed its initial stance, conceding that fiscal multipliers in prevailing conditions are larger than they once presumed, and called the sequestration excessively rapid and ill-designed. With the House GOP preoccupied with planning another debt ceiling debate, and probably repealing Obamacare for the 41th time, there is clearly no action at the fiscal front on the horizon. As a result, all eyes are now on the FOMC meeting ending 18 Sep. Sources: 1. 2. 3. 4. 5. 6. The Financial Times The New York Times Project Syndicate Federal Reserve Bank of St. Louis Federal Reserve Bank of Minneapolis International Monetary Fund, Research Department

6 Copyright 2013 SMU Economics Intelligence Club

South Africa: On its knees?

By Nompikazi Majola, Richmond University in London
The South African economy has suffered significant drawbacks from the 2008 financial crisis. Prior to The Great Recession, the economy saw an average growth of about 4.2% from 2000 to 2008. However, since experiencing a -2.7% growth in 2009, the economy has struggled to recover to pre-crisis levels. Economic performance is not the only challenge impeding the South African economy. After almost 20 years of democracy, poverty, unemployment and unequal income distribution continue to be major challenges for the developing nation. The recent bout of social unrest has significantly impacted the mining industry, contributing to the weakening of the South African Rand. Figure 1: South Africa GDP Annual Growth Rate

Source: Trading Economics Ambitious targets According to Wolassa Kumo from the African Development Bank: The government launched the Accelerated and Shared Growth Initiative for South Africa (ASGISA) in 2006. The initiative envisages rapid reduction in poverty, unemployment and improvement in economic growth enabling the country to achieve major development goals of halving poverty and unemployment by 2014 and raising economic growth to an average of 6% between 2010 an 2014. The government hoped to achieve these goals through accelerated infrastructure development and investments. Unfortunately, since 2009, the unemployment rate has continued to hover around 25%, a large portion of which are unemployed youths. The Economist reported: Joblessness is a particular problem for the young. The unemployment rate for those under 25 is 53%. Many are ill-prepared for work. Only 60% pass matric, the high school graduation certificate. One legacy of apartheid is that many blacks live far from where the jobs are. Even travelling to a job interview is costly because of poor public transport. Last year saw annual GDP growth of 2.5%, down from 3.1% in 2011 and growth for 2013 is proving to be weaker than expected. The South African government reports that growth rates 7 Copyright 2012 SMU Economics Intelligence Club

of approximately 7% would be necessary to alleviate poverty and unemployment. However, in the current state, it would be difficult for South Africa to even reach its 2013 growth target of 2.4%. The first quarter of 2013 saw a weaker than expected 0.9% growth rate, and according to the South African Reserve Bank, the last 3 quarters will need annualised rates of more than 3% to achieve its 2.4% target. Adding on to the pessimism, the World Bank and the International Monetary Fund has lowered South Africas 2013 economic growth to just 2%. Lower than expected growth can be attributed to the ongoing Eurozone crisis as Europe, South Africas biggest export market (approximately 25% of all exports), which still remains in recession. Although South Africa has better developed infrastructure such as roads, educational institutions and health facilities [...] investments in key economic infrastructure such as energy have lagged far behind the domestic demand. With the economy underperforming the way it has, its highly unlikely that South Africa will reach any of its primary growth initiative targets by 2014. Government fails to deliver Adding to unemployment and income inequality is an education system which, despite improvements in its institutions, continues to fail the black population. The lack of provision for vocational training has resulted in a mismatch of skills for many black South Africans seeking to apply to the available jobs. This failure of policymakers to deliver on many fronts, especially to the impoverished municipalities, has sparked a number of strikes this year alone and shaken confidence in the governments ability to deliver. Labour relation challenges Following the Lonmin mine incident in Marikana last year, where several armed mineworkers on strike were killed by police officers as a clash between rival unions boiled over, the mining industry continues to be plagued by frequent strikes over demand for higher wages and compensation for families affected in the Marikana incident. Labour unrest has significantly undermined confidence in South Africas mining sector, and the slowdown in investment [is] likely to further dent prospects for economic growth. Since the Lonmin incident, disgruntled miners have left the National Union of Mineworkers (NUM) for the Association of Mineworkers and Construction Union (AMCU). AMCU, which now represents the majority of miners in that region are looking replace NUM at the Lonmin offices. The series of mine related strikes, along with the Eurozone crisis, has dented South Africas exports and continued to deter foreign investors. Further wage disputes are expected. Political parties With South Africas 2014 elections fast approaching, political parties have focused on garnering support. The ruling party, the African National Congress (ANC), looking to restore voter confidence, is selling a strategy aimed at restoring and stabilising the economy. The main opposition, on the other hand, the Democratic Alliance (DA), seeks to capture support from Gauteng (one of South Africas big metropolitan areas), where the ANC has a strong foothold, while hoping to maintain its numbers in the Western Cape (another big metropolitan area). All eyes are on the 2014 elections as political parties vie for votes in key provinces and tackle as many service delivery issues, such as the provision of basic utility, sanitation, education, healthcare and the like beforehand, in an attempt to shore up support for election day. 8 Copyright 2013 SMU Economics Intelligence Club

South Africa still has a long way to go in ensuring favourable living and working conditions for all its citizens. Service delivery and education will need drastic improvements to build public confidence in government institutions, and labour relations must be repaired in order to restore investor confidence, which will ensure the stability of key industries. Despite all its challenges, South Africa arguably remains one of the least risky investment opportunities in the African continent. It just needs more time to get back on its feet. Sources: 1. Alessi, C. (2013). South Africas Economic Fault Lines. Council on Foreign Relations. [Online]. Available at: http://www.cfr.org/south-africa/south-africas-economic-fault- lines/p30727 2. Economist. (2013). Muddle through will no longer do. The Economist. [Online]. Available at: http://www.economist.com/news/middle-east-and-africa/21578692-slow-growth-and- sliding-currency-are-alarming-symptoms- deeper?zid=304&ah=e5690753dc78ce91909083042ad12e30 [accessed 31 August 2013] 3. Kumo, W. (2012). Infrastructure Investment and Economic Growth in South Africa: A Granger Causality Analysis. Africa Development Bank Group: Tunisia, Working Paper Sieries no. 160 November 2012. [Internet]. Available at: http://www.afdb.org/fileadmin/uploads/afdb/Documents/Publications/Working%20Paper %20160%20- %20Infrastructure%20Investment%20and%20Economic%20Growth%20in%20South%20Af rica%20A%20Granger%20Causality%20Analysis.pdf [accessed 24 August 2013] 4. Maswanganyi, N. (2013). SA needs to play catch-up to achieve growth of 2.4%. Business Day Live. [Online]. Available at: http://www.bdlive.co.za/economy/2013/07/23/sa- needs-to-play-catch-up-to-achieve-growth-of-2.4 [accessed 23 August 2013] 5. Pickworth, E. (2013). Survey of Executives shows sharp drop in confidence. Business Day Live. [Online]. Available at: http://www.bdlive.co.za/business/management/2013/07/23/survey-of-executives-shows- sharp-drop-in-confidence [accessed 24 August 2013] 6. Ruch, F. (2013). The Impact of International Spillovers on the South African Economy. South African Reserve Bank. [Internet]. Available at: http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/5705/WP130 2.pdf [accessed 24 August 2013] 7. Staff writer, (2013). Rand weakens back above R10/$. Business day live. [Internet]. Available at: http://www.bdlive.co.za/markets/2013/06/10/rand-weakens-back-above-r10 [Accessed 06 September 2013] 8. Trading economics. (2013). South Africa GDP annual growth rate. Tradingeconomics.com. [Internet]. Available at: http://www.tradingeconomics.com/south- africa/gdp-growth-annual [accessed 06 September 2013]

9 Copyright 2012 SMU Economics Intelligence Club

The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents : Vera Soh (Vice President, Publication) vera.soh.2011@economics.smu.edu.sg Singapore Management University Singapore Samuel Ong (Publications Director/ Editor) samuel.ong.2010@business.smu.edu.sg Singapore Management University Singapore Ng Yongxiang (Marketing Director) yx.ng.2011@accountancy.smu.edu.sg Singapore Management University Singapore Lin Liye (Writer) Undergraduate School of Economics Singapore Management University liye.lin.2011@economics.smu.edu.sg Edison Yong Undergraduate Lee Kong Chian School of Business Singapore Management University edison.yong.2010@business.smu.edu.sg

Ng Jia Wei (Vice President, Operations) jiawei.ng.2012@economics.smu.edu.sg Singapore Management University Singapore Yingyu Zeng (Liaison Officer) yingyu.zeng.2010@economics.smu.edu.sg Singapore Management University Singapore Darren Goh Xian Yong (Editor) darren.goh.2010@business.smu.edu.sg Singapore Management University Singapore Nompikazi Majola (Writer) Undergraduate Business administration: International Business Richmond, the American International University in London nompikazi@gmail.com

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