FERNANDO DURRELL: Navigating uncertainty amid recession fears

A tight labour market and the potential impact of tariffs under US President Donald Trump’s second administration will contribute to US inflation, forcing the Federal Reserve to keep rates higher for longer and influencing rate-cutting decisions at central banks worldwide. 

The “higher for longer” interest rate outlook is affecting consumers and businesses who have less spare cash available to spend and invest. We cannot rule out a hard landing (or recession) for the world’s leading economy just yet — because the increasingly stressed consumer accounts for roughly 70% of the US economy. 

The Trump administration lists its objectives as seeking to lower interest rates to boost growth and stabilise the country’s debt ratio; to curb immigration; to use import tariffs and dollar depreciation to bring jobs back to the US’s manufacturing sector; and to extend 2017 tax cuts and potentially enact further cuts. Sensible or not, these policies will fuel inflation, forcing the Fed to hold or increase interest rates, which could cause significant market corrections globally. 

The threat of market corrections and recession aside, high interest rates are good news for fixed-income assets. We welcome the elevated yields and margin of safety on offer from both offshore and domestic cash and bonds as bonds are less risky than equities through the cycle, allowing us to improve risk-adjusted returns — the higher your starting yield, the greater your margin of safety. 

Uncertainty and volatility will dominate tactical asset allocation decisions over the near term. The Trump 2.0 playbook of threatening high tariffs, waiting for affected countries to beg for restraint and offer concessions, negotiating a postponement and bragging to constituents about each “win” will result in excess volatility in global markets. And this volatility will make it difficult for the US to reach the Fed’s 2% inflation target. 

If Trump’s inflationary tariffs do materialise, then we can expect real rates, longer-term rates and discount rates to remain higher for longer, resulting in lower justified multiples for equities. Asset managers in the absolute return, fixed-income and generally multi-asset disciplines can then bank on bonds and enhanced cash to do the heavy lifting over the short to medium term. 

Capital loss

Absolute return funds seek to achieve an inflation-plus target while minimising the probability of capital loss over the short term, making it an imperative for portfolio managers to blend asset classes appropriately. Tactical asset allocation is key in how one manages a multi-asset fund, and an absolute return fund in particular. 

We are, however, upbeat over return prospects from SA’s enhanced cash segment, because it gives portfolio managers a solid base from which to achieve clients’ real return targets in a risk-efficient manner. We are in a relative sweet spot when it comes to the real returns on offer from local interest-bearing assets. 

Entering 2025, savvy asset managers could at present lock in inflation plus five from enhanced cash investments, using bonds to limit volatility and smooth returns over time. The more consistent we can make the return profile of our funds, the more it mitigates entry-point risk and the more our clients can plan for the future without having to worry about timing their entry or buying into the fund at the wrong time. 

Outlook for equities  

Exposure to offshore equities bolstered local portfolio returns over three and five years, driven by a tech-fuelled surge that pushed US markets to record highs. However, as momentum faded in the second half of 2024, local investors found themselves relying more on currency depreciation to sustain offshore equity performances. 

Equity markets have really come under pressure of late, factoring in rates being high for longer and the expected tariff wars that were signalled by the incoming Trump administration. For equity market exposure, we favour SA equities over emerging markets (EM) and developed markets entering 2025. We must be cautious though, because both domestic and EM equities are highly correlated with developed market equities during severe market corrections. 

Why should equity investors care about a recession threat? Recessions are really an equity return killer. Should a US recession occur, SA equity investors will be somewhat insulated due to the lower relative valuations of local shares compared with those in developed markets and some of its EM peers. Overall, the JSE all share index is nowhere near as expensive as the S&P500 and offers relatively better value than Indian equities.  

Market data supports that US valuations are close to record highs compared with SA valuations, which are near the middle of their long-term distribution. And though portfolio managers cannot depend on history repeating itself, the weight of historical data points to poorer returns from US equities from today’s extreme valuations. Based on history, the starting valuation level of SA equities offers more comfort than that of the S&P500 on both a one- and three-year view.   

The Republican sweep in the US has had market implications which we expect to continue over the short to medium term and, potentially, over the entire four years of Trump’s term. Investors face a bumpy ride as global policymakers figure out how to get inflation in check, including the possibility of a renewed rate hiking cycle out of the world’s leading economy.

Our tactical asset allocation decisions aim to achieve clients’ return targets with the least amount of risk possible. We like the current real yields from local cash and bonds and will switch out of these classes into SA and selected offshore equities as the outlook changes through the cycle.

• Durrell is head: absolute return at Sanlam Investments’ Active Manager.