Not swinging for the fences
Abrief online search of South African economic data is a useful way to get a helicopter view of the present situation. One of the top results on my feed was the release of the Absa purchasing managers’ index data for May, which showed its fourth consecutive month of declines. The Reuters article I found noted that expected business conditions have reached their lowest level since early 2020, which means local managers see loadshedding as on a par with lockdowns.
The Reserve Bank is in a situation where it only has a hammer, so every problem looks like a nail. The inflation problem isn’t a nail, so higher interest rates aren’t going to do much about the costs of fuel and alternative energy sources, thanks to Eskom.
The Bank’s latest hike wasn’t exactly received with fanfare by the market. There is much debate about cause and effect in the rand, with some arguing it responded negatively to the hike and others referencing the sobering commentary in the Bank’s update as a driver of further weakness in the currency. I tend towards the latter, while believing that ongoing hikes aren’t doing our economy any favours.
Instead of helping with inflation, these rate hikes are just shifting more value from equity providers to debt providers, something investors should consider carefully when determining the split of growth-focused and yieldfocused investments in a portfolio.
Broken stories
I recently rebalanced quite heavily away from equities towards yield. You need to think carefully about how the operational profit pie gets split in every company. The lenders get the first piece, and the size varies based on interest rates. If rates are high enough and the quantum of debt is too high, equity investors can be left with little more than crumbs.
This is why high interest rate environments generally aren’t good for broad equity exposure. If you split out the huge rand hedges from the local index to isolate the performance of local equities in 2023, you’ll see why prioritising yield can be a winning choice. A quick way to see the difference is to chart the top 40 index (heavily influenced by the likes of Richemont) against the FTSE/JSE dividend plus index (a far more “South African” index). The former is up 6% year to date, and the latter is down more than 16% over the same period.
The certainty of yield adds a muchneeded underpin to a portfolio at a time of big economic challenges. The trouble with economic volatility is that sentiment among corporate management teams is sticky. People tend to be both bullish and bearish for longer than they should, as it takes a while to change their minds when presented with new information. In the current environment, this means the broken trust between private and public sector will take a while to heal, even if a miracle is found at Eskom.
The impact this has on capital allocation decisions by corporate management teams is significant. When results come in and a management team has a pile of cash profits available, decisions need to be made about the optimal use for that cash. In a booming economy, reinvestment in the business is a likely outcome and jobs are created along the way, adding further momentum to GDP. In a shrinking economy, management teams have a defensive rather than a growth mindset and this contributes to the problem. They pay off debt and do share buybacks rather than reinvest.
This is why I’m not swinging for the fences by taking outsized bets on some of the broken stories on the JSE at the moment. Stock-picking opportunities are always there, with Hosken Consolidated Investments an excellent recent example. They require deep research and an understanding of the underlying drivers of returns, with businesses such as Spar and Tiger Brands facing economic conditions I can’t see improving soon. I wouldn’t buy those dips.
The decision to add some yield to your life can be as simple as working through fixed deposit opportunities at the various banks, and figuring out how to optimise your yield. This is achieved by spending time on your likely cash requirements and leaving a decent buffer, while putting the rest of your money to work.
There’s no shame in being cautious in this environment.