*Falling inflation is not an instant economic cure

*Which sectors are worth considering

From Gareth Stokes, MoneyWeek editor, SA

Dear MoneyMorning reader

It’s official. South Africa’s spiralling inflation has finally turned – reacting to cooling prices on the back of lower oil and softer international growth prospects. On Wednesday, Statistics SA reported December CPI at 10.3%, while CPIX (inflation with the effects of mortgage interest stripped out) fell to 9.5%. This decline clears the way for the Reserve Bank’s Monetary Policy Committee to lower interest rates when they next meet on the 4th and 5th February. Economists say a half percent cut is a given – with many suggesting 1% is on the cards.

What does this mean for you....

Benefits will be slow to filter through

The immediate benefit is obvious. Lower interest rates will lead to an immediate decrease in your monthly repayments on mortgages and other hire purchase agreements. And that means the average South African will have slightly more disposable income from February this year. But lower inflation and interest rates don’t translate immediately to a healthier economy.

Turning an economy is a bit like stopping the Titanic. You can throw the engine room into full reverse and still wait ages for the ships forward momentum to subside. In other words – the good news on inflation isn’t going to filter through to South Africa Inc tomorrow. So you’ll have to wait for the impact of the coming interest rate cuts to filter through the economy before celebrating.

How long will it take?

It’s very difficult to measure the impact of improving lending rates on an economy. You will appreciate that the damage caused by the previous rising interest rate cycle is still playing out in South Africa today. Many sectors of the economy are in serious trouble following a long period of consumer difficulty – motor vehicle retailers, furniture retails and residential housing construction companies to name a few. And unfortunately these sectors need much more than a rate cut for a full recovery.

The reason we say this is that the average consumer is going to use any extra disposable income to ‘catch up’ with existing expenditure rather than rushing out to buy a car or new appliance. With so many bond holders and vehicle owners in arrears it’s going to take months before they even contemplate using their extra cash for anything else. There are also serious concerns that the overall benefit from declining interest rates will be rendered void by the massive surge in job losses. At a recent StanLib presentation economist Kevin Lings said retrenchments could go as high as 200 000 by year end. So don’t go rushing in to the stock market just because interest rates have come down. You have to think through your strategy carefully!

What sectors to consider

What MoneyMorning likes to do is consider appropriate sectors to invest in given the general economic news flow. So we spent some time thinking about what shares would benefit from the factors discussed today. Banks usually get a boost when interest rates fall because of improvements to their impairment outlook. But banks remain under tremendous pressure at the moment and we think they’ll need more time to recover (Make sure you read our coverstory in Moneyweek out tomorrow – Not a subscriber, don’t worry start your 3 week free trial now). So we’ll stick with the relatively defensive food retailers. You might already know that companies like Shoprite (JSE: SHP), Pick ‘n Pay (JSE: PIK) and The Spar Group (JSE: SPP) have proved resilient through 2008. They’re not going to provide massive capital growth over the next 12-months; but we’re certain that each of the above counters will outperform the JSE All Share index for the full year.

Turning to the markets

The JSE all share index gained 1.87% yesterday. The gold mining index shed a massive 5.57%. Resources closed up 1.66%. Banks and financials rose 4.6% and 3.26% respectively. Industrials climbed 1.49% and the platinum mining index added 0.86%.

London’s FTSE100 closed up 2.40%. The Dow Jones gained 2.46% and the Nasdaq increased 3.55%.

Tokyo’s Nikkei surged 0.61 %. Hong Kong’s Hang Seng rose 5.47%.

Brent crude is currently trading at $44.25 per barrel.

Spot gold’s trading at $883.51 and platinum was last quoted at $946.50.     

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