The trouble with low interest rates
The trouble with low interest rates is the return generated from conservative asset classes swiftly dissipates. As we near the end of the rate cutting cycle – with prime pegged at just 9% – those of us relying on cash and near-cash deposits to cover our post-retirement salaries are feeling the pinch. Last year cash (as measured by the Steffi Composite Index) returned a mere 6.93%. And that’s no great shakes given Statistics SA reports average annual consumer price inflation (CPI) at 4.3% for 2010. Inflation came in at 7.9% in the preceding year.
I’ve always argued the inflation number is a bit of a misnomer, because each subset of South African society experiences inflation differently. A retired couple won’t experience the same inflationary pressures as a young middle-income family with two children. Likewise the inflation number for a low-income family living in an informal settlement in Diepsloot or Thembisa won’t be the same as for someone living in an expensive flat in the glitzy Northern suburbs. But the return on cash savings will look just as gloomy regardless of your socio-economic position.
Anywhere but cash!
A summary of 2010 asset class returns confirms cash as one of the worst places for an individual to invest through early retirement. Last year listed property topped South Africa’s total return performance tables with an impressive 29.62%; equity investments – which still come out tops over the long-term – delivered 18.98% (16.1% before dividends); and bonds weighed in with a reasonable 14.96%. Even prime-linked preference shares returned 13.6%. And that means nominal returns from cash were less than half the next best asset class last year!
Returns from cash will remain stunted through 2011. Craig Pheiffer, general manager of Investments at Absa Asset Management Private Clients, reveals just how poorly the asset class is likely to perform in his Review of 2010 And Preview of 2011 newsletter. He observes: With the repo rate forecast to remain unchanged at historically low levels for the duration of the year, cash will return nominal yields barely ahead of inflation.” A wealthy person paying tax at the top marginal rate of 40% could even lose money in real terms, after tax. To find out how long we’ll remain in this “cash is trash” environment we need to get a feel for where we are in the interest rate cycle.
Pheiffer believes we’re at the bottom. “Domestic interest rates are not expected to rise soon, but it should be borne in mind that we are at the bottom of the interest rate cycle in this country and the next big move in bond yields could be higher!” he writes. In other words we shouldn’t expect another cut in interest rates. How long will we wait before we see an upward move? After the January 2011 Monetary Policy Committee meeting the South African Reserve Bank said “barring significant surprises” interest rates would remain stable for quite some time.
How long is a piece of string?
FNB economist Cees Bruggemans says there’s no guarantee “they will stay low for long!” But like most of us he can only guess at when the next change will occur. One of the problems economists are wrestling with is the varying per sector extent of economic improvement attributable to low interest rates. Some areas of the economy are firing on all cylinders – others are not. According to Bruggemans the major benefactors of low-cost credit have been:
- The motor industry experienced a 25% surge in new vehicle sales last year, and look set for another 10% to 15% through 2011.
- Household furniture, appliance and equipment merchants emerged “top of class” in the retail sector last year, with 20% year-on-year growth and likely to extend these gains through 2011.
On the flip side of the coin: “Credit growth overall remains remarkably anaemic, barely 5% in 2010, with home mortgage growth at best doing 6 to 7% as compared four times that in boom times!” Prime has almost halved since its previous peak (until December 2008, 15.5%) BUT the property market remains bombed out!
Bruggemans concludes: “Unlike previous economic upswings, this one is not being led by an aggressive upturn in credit use… even so the anaemic credit performance won’t prevent the economy from growing, with consumer incomes rising and consumption spending leading the recovery.”
Editor’s thoughts: The low expected return from cash will require careful structuring of client portfolios through 2011. The challenges financial planners face is to protect the conservative portion of clients’ capital from the ravages of inflation without succumbing to the temptation of “fly by night” schemes which offer high returns with seriously misrepresented risk profiles. Does cash still form an important part of your overall asset allocation strategy – and could you explain why? Add your comment below, or send it to [email protected]
