Module 2 : Evaluating the Market –
The Domestic Economy
A brief overview of those indicators that regularly
influence the JSE.
Analysing economic indicators can help investors to evaluate the general equity market trend
better as well as to identify the best sectors to invest in. Here are some of the most important
indicators we see regularly and the likely market reaction they provoke:
Indicator and Description
Consumer Price Index (CPI)
The CPI index measures the prices a
basket of goods and services bought by
a typical household in South Africa. The
weightings were compiled in 2000 after
a survey of 30 000 households and are:
Food – 28% (Meat 7%, Grain 6%)
Transport – 14,5% (Petrol 4,7%)
Housing – 10,5% (Rent 4,4%)
Medical care – 7%
Household operation – 5%
Clothing & footwear – 4%
CPIX (CPI excluding interest) is used by
the Reserve Bank to decide on interest
rates.
Announced – 3rd week of every month
Producer Price Index:
The PPI reflects price movements of a
basket of goods in production or
manufacturing level as opposed to
consumer level.
Announced – 4th week of month
Prime Interest Rate:
The interest rate banks charge their best
clients. The Reserve Bank with the
object of keeping inflation low and the
Rand exchange rate stable influence
interest rates.
Announced – When the Reserve
Bank change the Repo Rate
Money Supply (M3):
The money supply is the total currency
(notes and coins) in circulation plus all
short, medium and long term deposits. It
is usually expressed only as a
percentage increase or decrease.
Announced – End of month
Gross Domestic Product (GDP):
GDP is the sum, in money terms
(Rand), of all the final goods and
services produced in the South African
Likely Equity Market Reaction
Increase = Negative
Because of past experience with high inflation,
increases in the CPI index have a major influence on
interest rates. When the monetary authority (Reserve
Bank) sees an increase in the general price level,
they will quickly increase interest rates to raise the
cost of borrowing and therefore inhibit spending.
(See “Prime Interest Rate”).
Core CPI = CPI excluding volatile items such as
fresh and frozen meat and vegetables, fresh fruit and
nuts, interest rates on mortgage bonds and
overdrafts/loans, changes in VAT and assessment
rates.
CPIX = CPI excluding only interest rates on mortgage
bonds. Government has committed itself to maintain
CPIX between 3% and 6% from 2002.
Increase = Negative
PPI is normally a leading indicator of consumer
prices (CPI). Changes in the oil price will have a
much bigger direct influence on the production side
(PPI) of the economy than on the consumer side
(CPI). Big increases in PPI can lead to higher
inflation (CPI) and as a result the Reserve Bank will
increase interest rates.
Increase = Negative
Firstly, higher interest rates increase a company’s
costs (interest on debt) and therefore reduce profits.
It also reduces the spending power of consumers,
resulting in lower sales. Thirdly, it makes bank
deposits more attractive as an investment relative to
shares, resulting in investors selling shares.
Increase = Negative
There is a close correlation between M3 and inflation.
Big increases in M3 will lead to higher inflation and
therefore to higher interest rates which are negative
for share prices.
Increase = Positive
An increase in GDP shows an increase in economic
growth in S A. Higher growth will increase sales and
therefore profits, making shares attractive buys.
 economy in a certain period (quarter or
year). It includes goods and services
produced for export, but excludes
imported goods and services. It also
includes the Government sector.
Announced – Every quarter
Reserves:
The most important figure is the gross
reserves announced at the beginning of
every month. Included in gross reserves
are foreign currency and gold. Gross
reserves reflect the country’s ability to
meet its short-term foreign currency
commitments. It is like the cash in your
pocket, it does not reflect your debt
level. Most of our foreign exchange
reserves are held by the Reserve Bank.
Net reserves include loans.
Announced – 2nd workday of month.
Some sectors, like retail, lead an economic upswing
while sectors like construction usually lag behind. If
GDP growth is too robust, interest rates will be
increased to discourage spending and that can lead
to a negative reaction on the share market.
Increase = Positive
An increase in reserves is usually positive because it
puts the Reserve Bank in a better position to stabilize
the Rand and to meet the need for a sudden flight out
of the Rand to foreign currency. A stable Rand (even
if it gradually looses some value) is positive for
inflation and therefore for interest rates. A solid
reserve position, equal to at least 3 month’s imports,
will also affect foreign investors positively. Foreign
investors will feel more confident to invest on the JSE
knowing that they will be able to convert back to a
foreign currency in times of a crisis.

Trade Balance: Increase = Positive

The trade balance is the difference If exports exceed imports, the country’s gross
between the value of exports and reserves will increase and that will have a positive
imports of goods. effect on interest rates and the share market (see:
Announced – Last week of month Reserves).
On a more advanced level: A negative trade balance
(imports exceed exports) usually indicates high
economic growth. Developing countries like S A must
import a lot (especially technology) to sustain high
economic growth rates. Do not be too alarmed if the
trade balance runs into negative territory as long as
we are importing mostly technology and not
consumer goods. It will improve the economy’s
potential to grow.

Evaluating the economy:

The easiest way to evaluate economic indicators is to ascertain the impact on interest rates. If
an indicator puts upward pressure on interest rates, the stock market will in general react
negatively. There are two main reasons for this. Firstly the higher interest rates increase
borrowing costs for the company and thereby reduces its profits. Secondly, interest-bearing
deposits provide a risk free alternative to stock market investments. Higher interest rates
mean that deposits are more attractive to investors and many will switch out of the stock
market to deposits. Both these factors tend to impact negatively on the stock market.

Economic analysis is more of an art than a science. Many factors influence the stock market
and expectations are very important. Even objectively good economic figures can sometimes
lead to a decline in the equity market if they are not as good as subjectively expected.

Gerhard Lampen.
Head – Sanlam iTrade.