A contracting PMI and possible recession, all due to strike action? Is mechanisation all that’s left?

The seasonally adjusted Kagiso Purchasing Manager’s Index fell to 44.3 index points in May from 47.4 in April. The PMI is made up of a number of indices, these indices refer to business activity, employment, new sales orders, prices and expected business activity. When the PMI is above 50 it indicates a healthy, expanding manufacturing industry and when it is below 50 it indicates an industry in contraction. While there were marginal improvements in a few of the indices, the trackers for business activity and employment dipped significantly. The business activity index fell from 48.5 index points in April to 42.5 in May, thereby signalling a likely contraction in factory output. In line with the slowdown in activity, the employment index fell sharply to 37.2 index points – the lowest level in five years. This drop places the index in contractionary territory and suggests that the activity index of the PMI could see another contraction in factory output in Q2. Abdul Davids, Head of Research at Kagiso Asset Management discusses the contraction and what this could signal for the South African economy. Is it time for mines to mechanise? -LF

ALEC HOGG:  The seasonally adjusted Kagiso PMI – that’s the Purchasing Managers Index – fell to 44.3 points.  The index fell to that in May from 47.4 in April. It’s a monthly index.  Abdul Davids, who’s Head of Research at Kagiso Asset Management, joins us from our Cape Town studios on a day, I suppose Abdul, where we just have to scratch our heads.  If you took the platinum strike out of the picture, would we have had a similar result?

ABDUL DAVIDS:  That’s a very difficult one.  Clearly, what we would have seen is some of the spin-off effects of the platinum strike on the manufacturing sector as a whole.  However, I think one should probably be guided by what’s happening globally.  We’ve seen the European and the Chinese PMI strengthening and obviously, ticking up so we could have potentially seen an uptick in our PMI in the absence of the significant platinum strike – yes.

ALEC HOGG:  Well, we’ll need to because it’s gone down so far…it was almost like a freefall in the past month, when I’m looking at the graph of the index here in front of me.  Abdul, is there bounce that’s likely to happen because of international factors?  If the strike continues – and I’ve been talking to business leaders who are saying they think we’re all underestimating the impact of that…

ABDUL DAVIDS:  Well, we could see the impact on the GDP numbers and that was quite material already.  If one unpacks the GDP numbers further, we would have seen that manufacturing also contracted in terms of its contribution as well.  Clearly…anecdotally speaking, with companies such as ACI for example.  They are seeing impact in terms of them servicing the mining sector, the drop-off of activity, and the impact that’s had on their businesses as well.

ALEC HOGG:  What are the chances of us going back to the kind of levels we saw in 2009?

ABDUL DAVIDS:  In terms of ‘post the recession’, or ‘during the recession’?

ALEC HOGG:  Well, going back…  We are in a recession, aren’t we?

ABDUL DAVIDS:  Well, I think one probably needs another negative contraction in GDP for the second quarter to come through.  Technically, it feels like a recession already.  If one looks at the significant drop-off in activity levels, that is one the big contributors to the decline in the PMI that we say and if one takes the Employment Index for example, that’s at a five-year low of around 37.  It definitely feels like it’s a recession in terms of manufacturing in South Africa. 

ALEC HOGG:  And yet, our JSE powers on.

ABDUL DAVIDS:  Yes.  Over the years, we’ve seen a diminishing contribution from manufacturing towards the South African economy.  Moreover, we’ve seen South African companies globalising as well.  As we know, companies like Naspers, SAB, and BAT, largely have the bulk of their operations outside of South Africa.  You can’t necessarily draw that link between South African companies, the South African economy, and the stock market at this stage.

ALEC HOGG:  What’s the best index?  Is there one on the JSE that we can follow that gives you a reflection of how South Africa Inc. is performing?  Clearly, the way you’ve put it we have Richemont, SABMiller, BAT, and Glencore…many of these global companies that dominate the JSE All Share Index.  Is there one that we should be following?

ABDUL DAVIDS:  It’s a difficult one.  I’d have to wrack my brain for that one.  Retail is probably the one sector that is 80 to 90 percent South African-focused.  Obviously, we know Woolworths is now making an acquisition in Australia, so that will change the dynamics a bit.  The industrial sector in terms of the transport sector is probably a good indicator as well, I would think.

ALEC HOGG:  So it’s not really bad news for South African investors (what’s happening in the economy), certainly, in the short term because we’re benefitting or the Retirement Funds are benefitting from this globalisation of South Africa Inc.  When you look longer term, we need to be a little bit concerned, surely.

ABDUL DAVIDS:  Definitely.  Clearly, not only from an investor destination sentiment toward South Africa point of view – and we’ve seen the new Cabinet obviously, and the reshuffle that has taken place on that side.  Already, we’ve diminished in terms of our standings, relative to other African countries, but we really need to be re-established in South Africa as the premier investment destination on a global basis as well as in an African context.  I think it’s quite important.

ALEC HOGG:  So how is that going to happen?

ABDUL DAVIDS:  Well, I suppose that’s a question for government and there’s a host of stakeholders that obviously need to be part of that process.  At a current level, what we’ve seen in the platinum sector for example, with the labour disruptions etcetera…  Clearly, the legislation that allows this to happen needs to be re-looked at: the fact that we can have strikes as long as this, being protracted and obviously, the impact it has on the economy, without the necessary checks and balances in place to prevent this from recurring in future.

ALEC HOGG:  What are those checks and balances?

ABDUL DAVIDS:  It’s very difficult for me to comment.  Clearly, I’m not a labour expert, but I would think that once you pass a month in terms of a strike, there should be a meaningful effort and government should really get involved in terms of resolving the strike, especially to as significant a sector as the mining sector is in South Africa.  We know it’s a significant contributor and earner of foreign exchange so clearly, for significant sectors – especially given this duration – there should have been intervention a long time ago – yes.

ALEC HOGG:  But it is the biggest earner, isn’t it – platinum – of foreign exchange into South Africa.  Yet, there’s been a silence from the Labour Minister Mildred Oliphant, apart from the fact that she was reappointed, I guess that’s the last time we saw her in the headlines.

ABDUL DAVIDS:  Yes.  Obviously, the Labour Court tried to get involved.  Given where the parties are obviously, it seems to be quite rigid positions in terms of for example, the R12500.00.  I think you need serious intervention to obviously overcome that rigidity in terms of their positions.

ALEC HOGG:  Our poor country.  Abdul, is there any upside?  I look at the platinum strike and it seems to be at an impasse.  If you look at the PMI that you released today, that’s in freefall.  I talk to business leaders.  They tell me they feel very proud of themselves, having invested outside of South Africa’s borders, which of course, doesn’t help us a whole lot here within the country.  Where’s the upside in all of this?

ABDUL DAVIDS:  At the moment, it’s very difficult to see.  Clearly, we have seen a slight weakness in the currency post the GDP numbers being released, and I suppose the only small silver lining we see is that at the margin with the weaker currency, hopefully it will improve our competitiveness on a global basis.

ALEC HOGG:  So that’s about it.  We’re relying on the weak Rand.

ABDUL DAVIDS:  Unfortunately, at the moment that’s all we have going for us.  From labour competitiveness, from the issues we spoke about previously, the excess capacity that we have in the labour market…it’s very difficult to see a significant turnaround in the short term.

ALEC HOGG:  Abdul, just from a broader perspective, if we look at where this is all going to end up, because at some point in time the pain is intense enough for radical action to be taken…  We heard from government: the radical action proposed is greater State intervention in the economy, which is I suppose, one path toward solving the issues.  Is there any other option and is there any other perhaps, ‘rock bottom’ that will finally get people sobering up here?

ABDUL DAVIDS:  Again, I think if one looks at what the consequences will be of this very prolonged strike, we’ll probably see significant job losses in the mining sector.  If you look at Amplats’ Rustenburg operations, clearly it will never be viable again.  It was already marginal in terms of the previous labour negotiations.  With significant job losses, I think there will be a realisation that actually, we need to step in and we need to make an environment, which is not only conducive to future employment levels, but also to allow companies to make a decent return.  In that way, obviously, have them employ more people into the future as well.  That realisation will come only when we see the significant job losses that will come as a consequence of this strike.

ALEC HOGG:  Yes, I guess the other side of the coin is that as the industry finds itself more and more constrained by labour issues, it might just mechanise more and then that hope for increase in employment won’t come through anyway.

ABDUL DAVIDS:  That’s right.  In the past, these mining companies have always tried to link wage increases to productivity levels.  Clearly, if you have a  machine, that machine can work 24/7 and the productivity there would be significantly higher compared to a labourer for example, or a rock drill operator.  From that point of view, I think at least linking wage increases to productivity gains and productivity levels, at the very least, will get a benchmark in terms of what productivity levels are for labourers versus mechanisation.  Already, if one looks at the stats that have come through in terms of mechanised mines in South Africa, they are significantly more productive compared to labour-intensive mines.