Economics vs your shares

Watch these economic variables as they exert a big influence on your shares.

Share prices are sensitive things, reacting to news from far-flung places.

Think for example, about how political developments in oil-rich Iran work wonders on Sasol's share price, and how the same news sends shudders down the spines of MTN investors (as MTN is rolling out a network in Iran, which needs to be ready by August).
A company's value, return and share price reflects the perception of its earnings and profit flow. If any news is perceived to affect a company's future profits adversely, its share price falls. Remember how Sasol's share price took a knock on Budget day (February 15) this year, when Finance Minister Trevor Manuel said government was considering levying a tax on the company's windfall profits? In the space of an afternoon, millions were wiped of Sasol's market cap as investors hurried to offload their shares for fear that profits may be affected.

An important component of the constant flow of information that can influence share prices is the change in economic variables both in South Africa and the world's biggest economy, the USA.

We examine interest rates, inflation, exchange rates, inflation and an economy's growth below.

Interest rates and inflation

Inflation is basically how quickly or slowly the price of goods and services goes up or down over a period (usually a year). In South Africa, the rate of change in prices is measured every month by Statistics South Africa, and the change is expressed as a percentage. SA's inflation rate is currently 4%, which means we pay 4% more for an average basket of goods and services now than what we did last year.

One of the reasons that people invest in the share market is to try and beat inflation. With annual inflation at around 4%, and the average fixed deposit yielding around 5% a year, inflation eats away most of that growth, leaving you with a real return of only 1%.

Shares don't like inflation: inflation pushes up costs for companies quicker than it can pass them on to customers, adversely affecting profits.

Historically, low inflation has had a strong inverse correlation with valuations (low inflation drives high multiples, and high inflation drives low multiples). Deflation, on the other hand, is generally bad for shares because it signifies a loss in pricing power for companies.

How is inflation prevented from spiraling out of control? The answer lies in interest rates.

Central banks - in South Africa's case, the SA Reserve Bank, headed by Tito Mboweni - monitor inflation carefully; if prices are rising too quickly, rates are increased, thus increasing the costs of loaning money from a bank and driving down profits. On the other hand, growth is boosted (with people and companies spending more) when interest rates are cut, as the cost of borrowing money is lowered.

A rise in interest rates increases the attractiveness of fixed-interest investments relative to shares. However, because people and companies need to fork out extra to service their debt, purchasing power decreases, which does not bodes well for companies.

Exchange rates

With businesses constantly importing and exporting goods, much of this trade is done in other currencies. The most important of these currency crosses is the rate of the rand to the American dollar. A high rand in relation to the dollar can be good for certain sectors of the South African economy, making both our exports and local import-replacement industries more competitive. It's particularly good for local miners who sell their commodities in USA, but take their profits and report their earnings in rands.

Exchange rate depreciation (if you need for rands to buy a dollar, for example) has adverse effects on industries that depend on imported raw materials, as their costs will rise. For example, assume you own a factory producing jeans. You import the raw materials (fabric) from the USA to make the jeans. If the rand depreciates against the dollar (ie, goes from R6 to R7 to the dollar), it costs you more money to import the raw materials. On the other hand, exporters benefit since they receive more money. For example, if you are in a business that sells jeans to the USA, if the rand depreciates, ie, from R6 to R7, you get more money.

Economic growth - GDP

The gross domestic product (GDP) of a country is the value of all goods and services produced in the economy. When GDP decreases, the economy contracts and companies' earnings fall. The reverse applies for when the economy is growing.

Big brother USA

The most important economic news affecting the South African share market is that concerning the health of the American economy, the biggest on the globe. In the short term, when bad economic news causes a fall in the US share market, the South African market comes under pressure the following day even though it's US economic data, not South African.

Economic Activity (num1)

A person is economically active if they are either employed or unemployed in a particular period - usually the survey reference week. Economically active people supply, or want to supply, their labour to produce goods and services within the production boundary, defined by the UN System of National Accounts. Therefore, economic activity is on the supply side of the labour market framework. Some countries refer to 'participation' to mean precisely the same as economic activity.
The Office for National Statistics (ONS) produces estimates of economic activity based upon the International Labour Organization definition. The data are based upon the Labour Force Survey . Respondents are asked about different aspects of their labour market behaviour, and from these they are classified as employed, unemployed or economically inactive. The economically inactive are those people who are not in employment, but do not fulfil all the criteria to be classified as unemployed.
ONS regards the economic activity rate (the economically active as a percentage of the population) as the headline measure. It allows comparison between different groups of people, different areas, and between different countries. It also allows unemployment to be interpreted in the context of overall changes in the population.
Economic activity figures are published every month in the labour market statistics First Release, Labour Market Trends and on Nomis . They are also published quarterly as part of the Labour Force Survey Historical Quarterly Supplement.