MAMOKETE LIJANE: Bond outperformance could continue for a while yet

As they say, calling the markets is a mug’s game. One is as likely as not to end up with egg on one’s face. However, every so often one has what we call in the trade a “high conviction call”, when the ego will not allow us to leave our predictions unspoken. My high conviction call for the coming year is that bonds will continue to outperform cash for an extended period, and equities for some time.

Of the three major listed asset classes — equities, bonds and cash — equities top the list in terms of risk, followed by bonds and then cash. The cardinal rule of investments is that investors should get more money for more risk, which implies that over time equities should give the best returns, followed by bonds and then cash.

However, over the past decade the JSE all share index returned 123%, about the same as the all bond index. In contrast, in the prior decade the all share returned 452%, which is 3.6 times what you would have received if you had invested in bonds.

The difference between the past 10 years and those before is growth. SA’s average GDP growth dropped since about 2013 from 2.5% after the financial crisis to a load-shedding 1%, and the equity market was decimated. Equities feed on growth.

But bonds have also not consistently outperformed cash, as should have been expected given the risk across the asset classes. Between 2012 and 2019 investors were as well off saving in bonds as in cash products. This was likely a fiscal deterioration and debt increase story. The devaluation of SA debt as more and more was issued has done the asset class no favours.

Add to this the demise of inflation, a function of both the global environment and policy credibility, and opportunities to get returns from switching between bonds and cash assets were scarce. Like equities feed off growth, bonds feed off disinflation in the short to medium term, and fiscal discipline in the long term.

There is another interesting phenomenon supporting bond returns in the SA context, and this is very high interest rates. The steepness of the bond curve is much discussed, and that the level of interest rates make debt unsustainable is well understood. However, the other side of high rates is the elevated returns bond investors earn.

We are at the top of the rate hiking cycle and the prevailing repo rate, at 8.25%, is the maximum you can earn in money market investments in the medium term. A 10-year bond will yield more than three percentage points more, compensating you handsomely for the added fiscal risk.

In a world where the dividend yield on the JSE is 4.5% and the growth outlook does not promise to unlock value in the equity sector, the only asset that makes sense is bonds.

Which brings me to my prediction. Though bonds had a good year in 2023, performing better than both equities and cash, that relative outperformance could still have some way to go. Cash returns will be battered by the SA Reserve Bank when easing starts. Meanwhile, a credible growth narrative that can support higher equity valuations is yet to emerge.

Bad news on the fiscal front could still upset the bond market, but those come in batches and we had a batch before the medium-term budget policy statement in October. For now, I would stick with bonds until further notice.

• Lijane is global markets strategist at Standard Bank CIB.