A LARGE DEFICIT on the current account of the balance of payments in the past always worried me as an investor in listed shares. There was too close a correlation between the direction of the deficit and the price: earnings multiple at which the shares were trading.
Even just the turnaround of a surplus on the current account to a deficit in the past caused a fall in the p:e at which shares were trading. Of course, the fall of a p:e means that share prices fall.
South Africa not only has a large deficit on the current account of its balance of payments but in the fourth quarter of 2006 the country also had a huge, unhealthy, structurally dangerous, unprecedented - and call it other names if you like - deficit of an annualised R143bn, or 7.8% of SA's gross domestic product.
The student who wonders why there's a correlation between the current account deficit and share prices would be well advised to take a look at the latest SA Reserve Bank Quarterly Bulletin. The table on page S 124, which deals with the financing of gross capital formation, shows that SA's gross capital formation was R350bn last year. However, the country's gross savings were only R239bn.
Investment therefore exceeded savings by R111bn - exactly equal to our balance of payments current account deficit for that full year. In 2006, that deficit was comfortably covered by the inflow of all kinds of capital.
My longstanding fear of a current account deficit and its effect on share prices rests on the simple supply-and-demand principle. Investment can't exceed savings forever, especially not at 7.8% of GDP.
Savings - specifically, personal savings - just have to increase from the current negative levels. That can only happen if personal spending is lowered. And for that drastic measures are required, such as a significant increase in interest rates.
Trader Vic asked Mboweni as far back as April of last year for a two-percentage point increase in the repo rate. So far, we've had two little steps of 0.5 percentage points each.
The time has come for a full percentage point increase in the cost of credit. It's now necessary for the new class of consumer who has only recently discovered the wonderful pleasure of plentiful credit - and also the rest of the interest cycle - to learn about the pain of rising interest rates.
full story from Fin24 here
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