Help! The Rand is in decline and the markets are “tanking”.
Where to from here?
The past few weeks have seen tremendous volatility in South African and World markets on the back of a number of global events. Most investment managers have been expecting this for many months and so have positioned their portfolios defensively in anticipation of the one big event which would trigger the sell- off.
Despite the best efforts of the Greeks and their Syriza party’s radical economic policies to be the catalyst, markets largely shrugged that off. Then came talk of the certainty of raising of interest rates in the US only for that speculation to fizzle out somewhat. Ultimately, the big trigger event was the recent extreme decline in the Chinese Stock market and the resultant reactive decision by their authorities to devalue the Yuan against the US$. Since then, all the talk has been around China and the ability of its economy to maintain a reasonable growth rate, thereby continuing to fuel World economic stability. Every investment presentation I have attended or investment report I have read over the past month has significant commentary on China and its economy. As is always the case with economic speculation, it is just that, speculation, and no one really knows what the outcome will be.
The following 7 graphs (courtesy of Investec Asset Management) and my commentary on them will hopefully give some perspective on South African and Global markets.
- SA Asset class returns over the past 12 months. The star performer has been Listed property with all other asset classes disappointing somewhat. In our view, now is when the true skills of Investment managers will shine through and those with above average stock assessment/picking abilities and portfolio construction capabilities will outperform indices and will provide the best risk adjusted returns into the future.
- SA Equities (ALSI) Price Earnings ratio. This graph shows that the average price of the shares making up the ALSI is in historically expensive territory at 18x at the end of July. Anything above the solid line is above average and you will note that since late 2012, the ALSI has been in relatively expensive territory. Again, the superior stock picking ability of some managers will produce desired types of returns.
- Foreign buying and selling of SA shares and Bonds. Foreigner investors make up a significant element of the South African markets. The following 2 slides illustrate that Foreigners were nett buyers of SA Equities but were nett sellers of SA Bonds in July. The so-called “carry –trade” which is represented by foreign inflows and outflows into our financial markets is an important balancing figure in our balance of payments and the resulting level of the Rand relative to world currencies.
Foreigners were nett buyers of SA equities in July
Foreigners were nett sellers of SA bonds in July
- SA Equities are expected to lag Global Equities for the foreseeable future. South Africa and virtually all Emerging Economies are experiencing severe headwinds as a result of US$ strength and the Chinese slowdown. Accordingly, most investment managers have positioned their portfolios to take maximum advantage of those companies which earn significant portions of their income in foreign markets and currencies. Similarly, multi-asset class portfolios have historically high foreign asset exposures. This positioning will sustain until the balance of events in World economies and currencies changes.
- The Rand’s weakness against major currencies since 2012. The Rand’s weakness is largely a function of US$ strength, Emerging Market aversion, the weakness of resources demand and prices and weakness in the SA economy and Balance of Payments. At current levels, the Rand is possibly too weak and might well recover in the medium term, but the reality is that it will weaken at around 3-6% annually based upon inflation differentials and emerging market risks.
- SA Inflation and Interest rates. In line with interest rates across the Globe, interest rates are near historical lows and yet the South African economy continues to struggle. Despite this, the SARB increased interest rates by 0.25% in July, largely as a measure to counter concerns around inflationary pressures as a result of Rand weakness and imported price inflation. The current inflation rate is within the target range of 3% to 6% but is forecast to trend upwards in future. Accordingly, we expect nominally higher rates of interest and inflation for the foreseeable future.
- And the good news is, the US $ Oil price. The Oil price fell below $50 per barrel in July and is maintaining a level around the $50 mark. This is extremely good news for both the SA consumer and the Rand as a weak Rand with materially higher oil prices could be catastrophic for SA and it’s consumers. Commentators are predicting continued low Oil prices with a long term forecast of no more than $75 per barrel 3 to 5 years out. Let’s hope they are right!
So what does this mean for us as South African investors and what should we be doing about it?
- Avoid reacting to sensational news and commentary. Focus on factual information and recognise that none of us have any influence ove
r world events. There have been countless “crises” during our lifetimes and there will be more in future. Economies and markets are amazingly resilient and investments which focus on fundamental realities will endure volatility and will prevail.
- Make sure you have a financial plan and whilst it is important to revisit that plan periodically, only make material adjustments if your personal circumstances have changed materially. Do not react to market “noise”.
- As was illustrated in the graph on Asset class performances, different markets are largely uncorrelated and will perform at different levels. Similarly, different managers will have different perspectives on the same subjects and so diversity between asset classes, geographies and investment styles is critical.
- Regardless of whether you are a lower risk or higher risk investor, employ an appropriately conservative level of risk, particularly with the core of your investment portfolios. More aggressive investments can be employed as “satellite” strategies, but ultimately, make sure you have a good understanding of the fundamentals and characteristics of any investment you make.
Author: Jeremy Squier, 08-09-2015.