FERNANDO DURRELL: SA offers investors chance for growth as world heads for slowdown

In a global landscape in which inflation surged and in which we don’t know if the landing will be hard or soft, SA emerges as a beacon of opportunity. While the world navigates high interest rates and the threat of economic downturns, SA presents a compelling case for investors seeking value and returns. 

Historically, central banks in developed markets such as the Federal Reserve have targeted a 2% inflation rate. This figure is not arbitrary; it is a balance intended to avoid the perils of deflation while keeping inflationary pressures in check.

Deflation, a decrease in the general prices of goods and services, can lead to a vicious economic spiral. Consumers delay spending in anticipation of lower prices, leading to decreased demand, reduced production and job losses, further depressing spending and economic activity. Thus, a modest level of inflation is seen as a safeguard against such a scenario. 

Now, however, inflation rates in developed markets remain stubbornly above this target. Despite efforts to rein in prices, the journey from high inflation to the desired 2% level is fraught with difficulty. Our research shows that over the past 30 years in the US, each time soaring inflation seemed to come down close to the 2% mark it surged again. It happened in the 1970s, ’80s and ’90s. In the ’90s it took almost four years to come back down to 2%.

The question is whether this pattern is likely to repeat in the current climate. Historically, the Fed has had to retain high interest rates to bring inflation back down.

Costs aren’t coming down either. Our research shows that though the rate of inflation is slowing, prices continue to rise even after the inflationary surge from 2020 to 2022. Consumers and corporates are likely to continue to face higher costs and interest rates, stifling purchasing power and economic growth. 

The recent resilience of the US economy, buoyed in part by substantial pandemic-related stimulus measures, is likely to have played a notable role in delaying the onset of a hard landing. With these excess savings having run out or expected to soon, the underlying consumer vulnerabilities are becoming more apparent.

Recession follows

The purchasing managers’ index shows the US economy’s manufacturing sector is contracting; the economic surprise index has similarly been trending down, showing actual economic data falls short of forecasts. These factors suggest a slowing US economy. With the US growth rate coming in lower over the past two quarters, the risk is that it is trending towards a landing, with a sharper decline potentially leading to a recession.

Sanlam Investments active manager research shows that a recession in the US frequently follows a significant increase in interest rates. This proved not to be the case only once, in the ’90s, with no follow-up recession. Speculative-grade default rates in the US and EU have been rising to levels similar to the global financial crisis in 2008, usually the first indicator before things start slowing down significantly.

The New York Fed has said the probability of a recession remains elevated, with its indicator historically a good predictor of a recessionary period. A recession has historically had big implications for global markets. It has consistently been one of the main causes of the MSCI’s worst levels of equity performance — recessions are equity return killers, not least because they are usually unforecastable. Right now the markets seem to be performing well, with growth still holding up. But recessions come “unexpectedly and painfully”.

In this time of turmoil, SA is providing fantastic return prospects, with favourable compensation from our cash and bond yields. It is an exceptional time in our country from an investment perspective; SA’s 10-year bond yield, adjusted for inflation, has reached these favourable levels only four times in the past 25 years.

It is the exception and not the rule that real yields are this attractive. When adjusted for inflation, the yields on SA bonds are among the most attractive globally. This is not just a matter of high nominal yields; it’s about the real returns investors can achieve, particularly in an inflationary environment. 

Reasonably priced

One can earn about 6% interest in a standard savings or cheque account. A one-year fixed deposit is yielding 8.5%, guaranteed over the next 12 months. Retail savings bonds may offer up to 11% over the next five years. Given the excellent inflation-adjusted returns from interest-bearing assets, these will be our primary focus in our clients’ portfolios before delving into equities and property. 

The SA equity market, bolstered by attractive valuations and relatively stable inflation, also presents a unique opportunity. While developed markets are plagued by overvalued equities, SA stocks remain reasonably priced. This valuation gap is a key driver of our preference for SA equities over their developed market counterparts. 

Emerging markets, including SA, have been more proactive in managing inflation. While inflation rates in these regions can be more volatile, many emerging-market central banks have been vigilant, maintaining policies to tackle inflation — as seen by the high real yields in these economies.

SA also benefits from a diversified economy with strong sectors that can weather global economic storms. The exchange rate dynamics play a potentially favourable role. The rand, while volatile, has lately shown signs of strength towards its estimated fair value. This potential for currency appreciation adds another layer of attractiveness to SA investments. Offshore investors not only gain from the higher yields and attractive valuations, but also from potential currency translation gains.

The US is still dealing with the full impact of one of the swiftest interest rate hiking cycles since the ’80s, keeping the risk of a hard landing elevated. Against this backdrop SA is a gem of opportunity, in at least its fixed-income market. With our long-term pragmatic approach we look to take full advantage of this. 

• Durrell is head of absolute return at Sanlam Investments.