Desperately seeking alpha
MODERATE INFLATION CHANGES INVESTMENT EXPECTATIONS What a difference six months can make in the investment world. Declining inflation expectations, a stronger rand and spluttering quantitative easing programmes have changed our fortunes.
Six months is a long time in economics. In January, South Africans were being warned about the rising interest rate cycle, driven by higher inflation expectations – the weak rand, drought and rising food prices being the chief culprits.
Fast forward to August and the situation is quite different. The rand has strengthened, inflation rate expectations have decelerated. While economic growth remains muted, the stable oil price and lack of demand-led pressure have reduced inflation forecasts. For investors this may influence their asset allocation decisions.
Lesiba Ledwaba, a fund manager at Ashburton Investments, does not anticipate much change in the next 12 to 18 months.
“Local rates are also impacted by global trends and global monetary policy is increasingly dovish,” he says.
“Expectations are that the US Federal Reserve would hike interest rates gradually over the next 12 to 18 months,” says Ledwaba.
In the UK, EU and Japan, fears that economic growth could slow have raised the prospect of interest rate cuts.
However, all that the monetary policy environment of low or negative interest rates has achieved so far is to drive the carry trade back to emerging markets, strengthening these currencies in the process.
As a result, emerging market bonds, more specifically SA government bonds, were a significant beneficiary as the local bond market saw about R61 billion of inflows so far this year.
The All Bond Index (ALBI) has outperformed other asset classes this year, returning 16%.
For investors who are not currently invested in bonds, Ledwaba does not advise getting into the market at this point. “Global yields are artificially low and there is very little likelihood of them reducing much further from current levels,” he says.
The low interest rate environment may, however, create opportunities in equities, particularly in interest rate sensitive stocks – like clothing and furniture retailers and banks.
“Anything that consumers save in debt repayments, they are likely to spend with retailers,” he says.
There are, of course, risks to the current inflation outlook, says Ledwaba.
“If the US economy proves to be resilient and we start to see inflation sooner than expected, then it is likely that US Fed will increase rates and this could reverse the flows.” Portfolio inflows to South Africa (and other emerging markets) are notoriously volatile, driven by market sentiment and so cannot be relied on necessarily for further rand strength.
On the other hand, European and Japanese economies have been slow to respond to quantitative easing, and uncertainty around the impact of Brexit on the UK economy is likely to persist. This should drive the central bankers to keep monetary policy very accommodative.