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Lessons from the future YTD March 2014


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Our Strategic Forum is based on the principle of creating a memory of the future. We believe that the recognition of early signs of change begin with anecdote and is only sometime thereafter confirmed …

Our Strategic Forum is based on the principle of creating a memory of the future. We believe that the recognition of early signs of change begin with anecdote and is only sometime thereafter confirmed by hard data. These anecdotes are visible in the daily conversations (reports in the newspapers) where various stakeholders articulate their views of the current reality, the future, their plans, visions and strategic intents. By monitoring these conversations, reported as daily events, and interpreting them in a scenario context, the emergence of underlying themes or patterns of change can be identified. These are the lessons from the future that provide the early signs of change, long before they are confirmed in the data. Scenario learning is an on-going process - not an individual event. As stated by Charles M. Perrotet (Learning from the future: 2000) “. . . if you use scenarios, you will never read the newspaper the same way again."

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  • 1. Lessons from the future: YTD 2014 (March) P a g e | 1 BMI-BRSCU LESSONS FROM THE FUTURE: MAY 2014 (YTD MARCH) 1. PREAMBLE This is our first Newsletter on “Lessons of the Future”. In future we will analyse this on a monthly basis. We don’t want to miss important early signs of change. For example, we are reminded that in our first Strategic Forum in 2004 we reported: The International Monetary Fund (IMF) urged the Bank of England to raise interest rates to avert the possibility of a crash in house prices. It also warned about the risks posed by high levels of household debt, saying, 'the main risk to the outlook is the possibility of an abrupt correction in the housing market'.(The Telegraph, London, 25 April 2004) In hindsight we can now see that this was an early warning and weak signal of change. However, to our knowledge it was not heeded. If it had been, the World may have avoided the global financial crisis and South African businesses would have received confirmation in 2008 when the NCA was introduced. If due concern was shown it would have resulted in a flurry of “what if” scenario planning to cope with the downturn that followed. IT WAS A KNOWN UNKNOWN which was described by Donald Rumsfeld as gaps in our knowledge, but they are gaps that we know exist. We share the passion of Management Guru Peter Drucker (1909-2005) “. . . to look at the future that is already present, at the trends that are going to shape society that are already evident in the bud.” Our Strategic Forum is based on this principle. We believe that the recognition of early signs of change begin with anecdote and is only sometime thereafter confirmed by hard data. These anecdotes are visible in the daily conversations (reports in the newspapers) where various stakeholders articulate their views of the current reality, the future, their plans, visions and strategic intents. By monitoring these conversations, reported as daily events, and interpreting them in a scenario context, the emergence of underlying themes or patterns of change can be identified. These are the lessons from the future that provide the early signs of change, long before they are confirmed in the data. Scenario learning is an on-going process - not an individual event. As stated by Charles M. Perrotet (Learning from the future: 2000) “. . . if you use scenarios, you will never read the newspaper the same way again." 2. EARLY WARNINGS OF A PROPERTY BUBBLE Are we again on the cusp of change? Consider the following report: Bank of England (BoE) governor Mark Carney has given his strongest warning to date about the risks of a housing bubble and said policymakers were looking at new measures to control mortgage lending. The British housing market had “deep, deep” structural problems, among them insufficient construction of new homes, Carney said yesterday. “When we look at domestic risk, the biggest risks to financial stability and therefore to the durability of the expansion, centre on the housing market and that’s why we are focused on that,” he said.(Reuters, 19 May 2014)
  • 2. Lessons from the future: YTD 2014 (March) P a g e | 2 Are we again going to stand passively by and wait for the future to unfold? Or are we going to respond by taking a scenario approach and asking the “what if” questions? 2.1 WHAT IF THE BoE IS CORRECT ? We are given a clue as to what the response of the Banks will be. The Bank of England (BoE) noted that British house prices rose about 10 percent in the 12 months to April but Carney has previously stressed that the BoE would seek to take measures to exert more control over mortgage lending before it resorted to raising interest rates, which could hurt the economic recovery. Carney said the bank would check lending procedures “so people can get mortgages if they can afford them but they won’t if they can’t”. He said the bank was looking at the possibility of recommending that banks do more to limit the size of mortgages based on the incomes of borrowers, a potentially controversial move by the BoE that could be felt by many would-be homeowners. “The level of higher loan-to-income mortgages, ones above four-and-a-half, five times loan-to- income, potentially could store up bigger problems for the future and we need to be careful,” he said. “We need to be calibrated, we need to be proportionate, if we were to suggest some adjustments to the amount of these types of mortgages that banks should underwrite.” (Reuters, 19 May 2014) No doubt Banks world-wide, including South Africa, would have taken note of the BoE actions and would be ready to follow suit if necessary. An interesting Homeowner response was reported from Sweden. Most Swedes with a home mortgage are doomed to die before repaying their debt, according to a study by Sweden’s central bank.With help from the borrowers, the central bank compared the incomes and loan repayments of almost 4-million people — or 52% of Sweden’s adult population — between 2010 and last year. The study revealed that the debt of 25% of them grows every year, while for 15%, their debt stays the same year after year. The remaining 60% pay back their mortgages at a very slow pace. 'If the borrowers who have reduced their debts over this period continue to reduce these debts at the same rate, on average they will be free of debt in about 100 years,' according to the calculations of central bank economists Jakob Windstrand and Dilan Oelcer. (Bus. Day, 8 May 2014) 3. THE WORLD-WIDE ISSUE OF INEQUALITY A narrative that is trending is the whole issue of inequality and of course the impact on Fiscal Policy and social cohesion. It was a major theme of the most recent World Economic Forum in Davos, as well as regular research papers by the World Bank and the IMF. South Africa is one of the most unequal countries in the world. We are not, as is often claimed, the most unequal. There are a few countries with higher measures of income inequality and several others that don’t measure their
  • 3. Lessons from the future: YTD 2014 (March) P a g e | 3 income inequality out of embarrassment for what this would reveal. Nonetheless, our level of inequality is unusually great. Economists are increasingly focusing on the links between rising inequality and the fragility of growth. Narratives include the relationship between inequality, leverage and the financial cycle, which sowed the seeds for crisis; and the role of political-economy factors (especially the influence of the rich) in allowing financial excess to balloon ahead of the crisis. (Redistribution, Inequality, and Growth: Prepared by Jonathan D. Ostry, Andrew Berg, Charalambos G. Tsangarides: International Monetary Fund: April 2014) In America, as average house prices fell more than a third between the second quarter of 2006 and the end of 2011, a large proportion of Americans – those with large mortgages – saw their wealth essentially wiped out. At the top, CEO’s were remarkably successful in maintaining their high pay; after a slight dip in 2008, the ratio of CEO annual compensation to that of the typical worker by 2010 was back to what it had been before the crisis, to 243:1; The top 1 percent get in one week 40 percent more than the bottom fifth received in a year;the top 0,1 percent received in a day and a half about what the bottom 90 percent received in a year; and the richest 20 percent of income earners earn in total after tax more than the bottom 80 percent combined. (Joseph Stiglitz: The price of Inequality: 2012) It is probably the cause of growing unrest and frustration in Countries world-wide. The occupation of Wall Street by the one percenters was indicative of this growing frustration; as would the unrest world- wide, leading in many instances to the over-throw of Governments. In South Africa, our own Marikana tragedy and the ongoing labour dispute, with AMCU insisting on a minimum wage of R12 500 pm whilst pointing to the obscene wage gap with the pay of the Senior Executives in the Group. This has led to PPC CEO, Ketso Gordhan to taking the lead so that when the next round of PPC salary adjustments takes effect in October, he would earn only 40 times more than his lowest- paid worker. When Mr Gordhan took over as CEO in January last year, he was earning 120 times more than his lowest-paid worker. The company’s drive to reduce the earnings differential had reduced this to a 48- times multiple. Mr Gordhan said he would not take a pay increase this October and PPC’s other executives would be awarded increases of about 4.5% to 5% — less than the usual 6.5%. This would allow the minimum total pay package at PPC to be hiked to nearly R11,000. Mr Gordhan said the 40-times multiple was seen by many as 'a justifiable spread'. This was based on similar initiatives by US-based grocery giant Whole Foods, which has since extended this to cap executive pay at 19 times the average employee’s salary. (Bus. Day, 22 May 2014) It will be interesting to see whether other CEO’s in South Africa will follow Mr Gordhan’s example. In the current climate, failure to do so could have unintended consequences. 4. THE COMMITMENT TO THE NDP The issue of inequality has ramifications in Fiscal and Monetary Policy. This comes amid a global debate about whether countries should be more concerned about addressing economic growth or closing the inequality gap through wealth redistribution. President Zuma must have been particularly alarmed by Minister Gordhan’s recent warning that without better growth, the government might find itself defaulting on its social welfare payments, which sustain about 16-million people who are the backbone of the ANC’s solid rural support. It is particularly pertinent to South Africa as it has one of the highest rate of inequality in the world and a stubbornly high unemployment rate of about 25%. Sluggish economic growtjh over the past five years has not helped. Business has called for a focus on economic growth, while Government has said it wants “inclusive growth” to promote jobs.
  • 4. Lessons from the future: YTD 2014 (March) P a g e | 4 As far as Monetary Policy is concerned, Nobel Laureate Dr Joseph Stiglitz mentions in his book (The Price of Inequality: 2012) and at the recent Discovery Leadership Summit in Sandton, that it makes no sense to increase interest rates in order to quel rises in inflation. He argued that inflation is caused primarily by increases in oil and other prices and raising the interest rate has no impact on that. It only impacts the cost of living in general and home ownership in particular and by implication the Building Industry. He also referred to inflation targetting as a useless policy and argued that employment creation should be the major objective of Governments world-wide. It is interesting that Trevor Manuel, the former Minister of Finance riposted at the Leadership Summit that he could take issue with this argument. In taking sides in this argument I cannot help to believe the Economics Nobel Laureate rather than our highly regarded former Minister. It would appear that the new Government is strongly committed to the NDP, which is of course premised on economc growth and employment creation. The National Planning Commission and Performance Monitoring and Evaluation portfolio will remain in the Presidency but have been combined into a powerful Ministry under former Justice Minister Jeff Radebe. This is aimed at “harmonising” both functions likely to drive the NDP. Investec CEO Stephen Koseff has called for a growth agenda rather than wealth redistribution. He argued that the Private Sector need to grow and to grow it needs a business-enabling environment and business-friendly policies. Trust between Government ad Business needs to be restored because Mr Zuma’s first five years in Government have been characterised by incrasing distrust between the State and Business. Prof Ben Turok, Editor, New Agenda, SA Journal of Social and Economic Policy, took issue with the views expressed by Stephen Koseff that South Africa needs a 'growth agenda' rather than wealth redistribution (SA 'needs business-friendly ministers', May 23). Koseff also seeks the appointment of 'business-friendly ministers'. In an open letter to the Business Day of 26 May 2014, Turok argues that no serious person wants business-hostile ministers. Indeed, he writes, given the frequent comments that government- business relations are at an all-time low, we certainly require a far more pro-active stance by the government to business so that we put our mixed economy on a sound footing with the correct allocation of roles to the private sector and government. Turok refers to the recent article by Ricardo Hausmann that the free market system also requires rules and regulations. The challenge is rather to ensure that those regulations do not increase bureaucratisation and stifle the economy. It is accepted that decision-making about those rules needs wide participation to ensure they serve the national rather than sectional interests. However, Prof Turok’s main quarrel with Mr Koseff’s comments relate to the reported simplistic contrasting of growth with redistribution. There is, he says, a worldwide debate about inequality sponsored by the International Monetary Fund (IMF) and many similar institutions. Writing in the respected Financial Times on April 22, Martin Wolf, its leading expert, says: 'Inequality damages the economy and efforts to remedy it are, on the whole, not harmful.' He supports the recent paper by the IMF, titled Redistribution, Inequality and Growth, and argues 'less inequality is likely to make economies work better by increasing the ability of the entire population to participate, on more equal terms'. Turok argues that this is the crux of the matter. Not only does less inequality increase demand for goods and services, and is therefore good for business, but it also improves the participation rate in the economy, where South Africa is one of the worst in the world. (Bus. Day, 26 May 2014)
  • 5. Lessons from the future: YTD 2014 (March) P a g e | 5 The implications of the foregoing trends are that Business should carefully study the NDP and the ANC Manifesto in the context about the world-wide debate on the the negative impact on the economy and strategise accordingly to be ready to collaborate with Government in driving the growth Agenda. 5. THE ROLE OF THE FINANCIAL INSTITUTIONS IN MORTGAGE FINANCING AND UNSECURED LOANS The trends in lending patterns in the banking industry is damaging the transformation of the South African economy, particularly when it comes to home-ownership, says Stuart Theobald in the Business Day of 26 May 2014. He argues that since 2008, when banks were hit by bad debt, home loans have become more expensive and are provided at lower loan-to-value ratios. So whereas pre-2008 home buyers could obtain 110% loans at 2% below prime, now borrowers tend to be granted loans priced at a premium to prime and at loan-to-value ratios of 80%. This trend is evident from the following graphic. The following Chart shows the Mortgage Advances (MA), Buildings Completed (BC) and Net Mortgages in the Pipeline (NMIP) in the Residential Sector as well as the relationship between Mortgage Advances and Buildings Completed (MA/BC and BC/MA) in each of the periods between trend-breaks. It is evident that in the period 1993 to 2006 Mortgage Advances exceeded Buildings Completed. This was followed by a flattening off of this trend and from approximately 2009 to date Buildings Completed have exceeded Mortgage Advances. Clearly this means that Home building was not reliant solely on Mortgage Advances but also on unsecured credit. 0 500 1 000 1 500 2 000 2 500 3 000 3 500 4 000 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 RMillions(CurrentValue) Gross new mortgage loans and re-advances for construction of new buildings vs Residential BC: By Month: 1993- 2013 (Dec) (Source: SARB, BMI-BRSCU Workings) Gross new mortgage loans and re-advances for construction of buildings Residential BC 12 per. Mov. Avg. (Gross new mortgage loans and re-advances for construction of buildings ) 12 per. Mov. Avg. (Residential BC) Trend Break BC/MA (%) NMIP=(MA-BC)/BC (%) RES Descr RES RES RES Descr MA 191 555 191 555 37 550 NMIP BC 154 005 154 005 BC Ratio 124.38% 80.40% 24.38% NMIP Ratio MA 66 443 66 443 -69 198 NMIP BC 135 641 135 641 BC Ratio 48.98% 204.15% -51.02% NMIP Ratio MA 97 655 97 655 -1 401 NMIP BC 99 056 99 056 BC Ratio 98.59% 101.43% -1.41% NMIP Ratio R*MILLION MORTGAGE ADVANCES (MA), BUILDINGS COMPLETED (BC) AND NET MORTGAGES IN THE PIPELINE (NMIP) IN THE RESIDENTIAL (RES) SECTOR Trend-break Period Mid 2009- End 2014 MA/BC (%) 1993-End 2006 2007- Mid 2009
  • 6. Lessons from the future: YTD 2014 (March) P a g e | 6 To find the extra cash to fund the value of their purchase, plus the transaction costs, borrowers are taking large unsecured loans. The actual cost of credit for the post-2008 home buyer has increased substantially, at least until the unsecured portion has been paid off, by more than double. While not all unsecured credit goes into home ownership, the statistics clearly show how the type of credit has shifted. In mid-2008, of the total loan books in SA, 63% was mortgage finance and 4% was unsecured credit. At the end of last year that had shifted to 54% mortgage finance and 11% unsecured credit. The National Credit Regulator’s statistics show that for the last quarter of last year, mortgages of less than R350,000 comprised 7% of the total amount of new home loan lending. For the second quarter of 2008, this proportion was 16%. So mortgage finance has become much scarcer for cheaper housing; presumably buyers are relying on unsecured lending. The effect is that fewer South Africans can afford to buy a home, and those that can afford to buy are forced to buy lower valued ones using unsecured credit. This is compounded by the fact that lenders have simultaneously tightened up on credit criteria, so fewer people can access home loans. Why give this a racial spin? At the same time as this trend in lending has occurred, the race of home buyers has shifted. Black South Africans now make up more than half of the middle class, according to a study by the Unilever Institute at the University of Cape Town. However, the absolute number masks the fact that a far higher proportion of the newly middle class are black, and it is the newly middle class who are likely to make up the bulk of home purchasers. Homes are an important product for the middle class, alongside cars and other consumer goods. This is speculative — the proper numbers for recent trends are not yet available to confirm what should be happening in the market. However, when lending trends are overlaid on demographic trends, it is clear that older middle classes benefited from cheaper access to home finance than the newer middle classes do. The result is anti-transformative — it protects the old white-dominated pattern of home ownership. Home ownership is not yet the political issue here that it is in developed economies. President Jacob Zuma’s inauguration speech spoke of land restitution as a priority to drive black economic empowerment, but had nothing to say about urban home ownership. This rural bias in thinking about property ownership reflects the African National Congress’s performance at the polls, with rural support stronger than urban. However, the political impetus is sure to shift over the next few decades, if not sooner. SA reflects the experience of many developing countries with strong population shifts into the cities. Also, as the country develops, the middle class grows within urban areas. That will translate into increased pressure to make urban home ownership more affordable. The trend in the lending industry has gone the opposite way, which will accelerate political demands. Those with the greatest barrier to entry are the excluded middle, between those qualifying for social housing and those who are able to obtain formal home credit. These are, roughly, households earning between R3,000 and R10,000 a month. This no-man’s-land has partly been filled by unsecured lenders, but also through some innovative products. (Bus. Day, 26 May 2014) For the Building Industry the implications are clear. Property is an Engine for growth and wealth creation and without mortgages the pipeline dries up as the earlier graphic shows. The question is – what can the Building Industry do about this? From 1993-2006 the Net Mortgages in the Pipeline (NMIP) = + 24,38%; From 2006-2009 NMIP worsened to = - 51,02% and from 2009-2014 it improved to - 1,41% . This means that not all BC are funded by Mortgages and unsecured loans are used to make up the shortfall.
  • 7. Lessons from the future: YTD 2014 (March) P a g e | 7 The boom years of financial market trading, when banks made unprecedented profits from bonds, currencies and commodities, may be over for good as financial firms realise there will be no cyclical upswing on their dealing desks. 6. HIGH-RISES TO REPLACE HOUSES ? The development of flats and townhouses is the relative sweet spot in the residential building market at the moment. Absa Home Loans property analyst, Jacques du Toit, believes the focus in the future, particularly in metropolitan areas, will shift to high-rise residential space because of issues such as service delivery and land availability. “South Africa will move in the direction of the major cities of the world with high-rise residential property development. South Africans are not keen on it but they will have little choice.” Du Toit conceded that high-rise living was already a feature in some city centres, with office blocks being converted into apartments for the lower end of the market. However, he stressed there were only so many office blocks that could be converted before new developments needed to be built. “We’ve seen it in Sandton for the upper end market. But it will filter down.” (The Star, 14 May 2014). Although I agree with the sentiment expressed by Du Toit, the numbers don’t bear this out, as shown in the graphic. The BC of Dwellings > 80 m2 exceeds that of Flats and Townhouses by some 2X and it would take decades to reverse this trend. I agree with Du Toit’s viewpoint that there was only likely to be a revival in the residential building market once the price gap between new and existing houses narrowed to at least the mid-20 percent level. However this is not the only, or the most important consideration. Firstly the Banks have to increase their lending with Net Mortgages in the Pipeline (NMIP) increasing from the current -1,41% of BC to pre-crisis levels of + 24,5% as mentioned earlier and the Net Building in the Pipeline (NBIP) for Residential must increase from the current + 53,37% of BC to the pre-crisis level of + 84,31% X BC. For the Building Industry the question remains whether these trends confirm the emergence of the “New Normal” and what, if anything, can strategically be done about it ? 0 40 000 80 000 120 000 160 000 200 000 240 000 280 000 320 000 360 000 400 000 440 000 480 000 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 SquareMetres BPP & BC Residential Flats and Townhouses: 1993-2014 by month: m2 (Source: StatsSA; BMI-BRSCU: BC Total RSA by Month and Type of Building: F&TH M2) BC Flats and Townhouses BC Dwellings < 80 m2 BC Dwellings > 80 m2 12 per. Mov. Avg. (BC Flats and Townhouses) 12 per. Mov. Avg. (BC Dwellings < 80 m2) 12 per. Mov. Avg. (BC Dwellings > 80 m2) The m2 of BC Flats and Townhouses has decreased by some 70% since 2009. The decline has been arrested and trend is increasing. The m2 built of BC Dwellings < 80 m2 has decreased by some 50% since 1999 with signs of flattening off and moving sideways. The m2 of BC Dwellings > 80 m2 has decreased by some 50% since 2008. The decline has been arrested and trend is sideways.
  • 8. Lessons from the future: YTD 2014 (March) P a g e | 8 The transition to the new normal is a sea change for the global economy. The full impact will take years, if not decades, to become clear. In the meantime, the world will face much greater uncertainty, as conflicting views of the world play out on a day-to-day basis. As a result, companies need to plan for a VUCA environment during the transition that is now underway. Volatility, Uncertainty, Complexity and Ambiguity will be the order of the day and this will present challenges to the Building Industry. Dr.Llewellyn B Lewis, Principal Consultant, BMI Building Research Strategy Consulting Unit cc, 9 Adrienne Street, Strathavon, Sandton, PO Box 784133, Sandton 2146. Tel: (011) 884 2075 Cell 082 884 0063 Fax 086 6472 494 DENIAL Companies - carry on past “tip” Policy makers – stimulus spending (or austerity, or both) ANGER Implications of change becomes more obvious Need to BLAME someone for the disaster BARGAINING Companies – Asset sales, closures Individuals – Stop borrowing, start saving DEPRESSION Reality begins to be confronted Growing awareness of what has been lost ACCEPTANCE Finally people accept what has happened New opportunities emerge out of extreme pessimism THE NEW NORMAL The paradigm of loss model: Elizabeth Kuler-Ross: Source International eChem THE TIPPING POINT THE VUCA ENVIRONMENT 2008 2013 2020 ?