Capital markets experienced a sell-off in September due to factors including inflation fears, China corporate bond payment defaults, higher US bond yields and a developed market energy crisis.
Global inflation remains elevated with signs of a slowdown in the US, China and Japan. The marginal easing is due to lower food, medical care, used-car, tobacco and services inflation in August. As a result of lowering inflationary pressures and a continued focus on economic stimulation, we expect most developed markets to keep rates low and postpone hikes further into the future. This seems less likely for emerging markets as some countries have already started hiking rates, and South Africa is looking at a hike as early as November 2021. We do, however, think that the inflation debate is not as straight forward as “transitory vs structural”. We’ve got so many moving parts here, it’s oversimplistic to suggest that it’s fully structural or fully transitory. The fact of the matter is that a lot of the things that are pushing inflation numbers around are a mixture of both. So, the conclusion from all of this is that, yes, you are going to see higher inflation with a structural element to that. But that doesn’t mean that you are going to have a run-away inflation rate, the truth is probably somewhere in between.
The combination of worries about China corporate bond payments, higher energy prices, potential tapering of bond buying in the US have all led to higher US bond yields. This, combined with more foreign selling of SA Bonds impacted the direction of the R186 and R2030 yield curves negatively. We are keeping a close eye on these yields to see if they break through March 2021 highs, which could signal immense pressure in our bond market.
We are aware of the potential negative consequences of ‘higher for longer’ energy/gas prices but believe these are part of the imbalances created by the events of the past 20 months. We are of the opinion that OPEC and shale gas operators will get production going again.
The risk-off forex environment (i.e US Dollar strength) is playing through into Rand weakness versus all other currencies. We feel that the Rand is probably close to fair value now but could range between 14.30 and 15.40 to the Dollar in the medium term. We are, however, cognizant that a break through the 15.40 resistance level could cause increased weakness for the Rand.
Investors must be mindful of the facts that will support global economic growth and will support equities as an asset class. Developed market interest rates remain low and are negative after fees and inflation. US equity valuations are now less demanding – S&P 500 trading below 20 X 2022 forward estimate earnings. Vaccination success in developed economies is making it possible for economic activity to normalise despite supply imbalances caused by Covid-19 disruptions (eg. the global semiconductor shortage). Earnings growth (8-10% p.a in developed markets) is being supported by pent-up consumer demand. Another positive is the need to rebuild inventories and supply chain stretching out the demand cycle from here. There is $2.5 trillion of excess savings in US household balance sheets. A lot of pent-up demand!
From a JSE perspective, these factors continue to bode well for selected Resource counters. The cyclical nature of these resource counters does increase volatility in our portfolios. We also find value in SA Banks as better than expected earnings growth and improved balance sheet risks make the sector more attractive as we can expect small interest rate hikes in November and into 2022.
Roeloff Horne
Director and Head of Portfolio Management
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