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A shift’s taking place in financial markets and local assets are likely to offer better prospects than global assets over the medium-term

04 August 2022 Adriaan Pask, Chief Investment Officer at PSG Wealth
Adriaan Pask, Chief Investment Officer at PSG Wealth

Adriaan Pask, Chief Investment Officer at PSG Wealth

A shift is taking place in financial markets. A low-interest-rate and high-growth environment have been the general experience for most investors over the past decade.

Now the environment looks decidedly unsettled, with the risks of higher inflation and interest-rate pressure adding to uncertainties of the war in Ukraine and threats to oil and wheat supplies. With inflation surpassing all-time highs throughout the world, the main concern now is how market players will keep their portfolios balanced.

Global investment markets are reaching an inflection point. Historically, offshore bonds have offered protection to investors in times of market turmoil, however, this asset class has in the recent past become increasingly correlated to equity markets. This is primarily because of the fact we are at the end of a 40-year bond bull market, where interest rates can simply not go any lower.

Rising rates also have a well-documented impact on the equity markets where investors are far less comfortable with expanding valuations in a rising interest rate environment. As interest rates rise input costs go up, volume growth slows, and margins come under pressure. This impacts sentiment and ultimately valuations.

This scenario is currently playing out for high-growth technology stocks where valuation multiples have reached levels that is simply not sustainable. As rates increase reality is sinking in, recession fears are starting to come into play and investors are starting to question the sustainability of volume growth and in particular margin growth.

Against this backdrop, South African assets have started outperforming global assets after years of underperformance, and potentially offers better prospects than global assets.

Our data shows that real yields on SA bonds remain attractive – and that's despite significant improvements on the fiscal side. It wasn't too long ago that we saw some forecasts indicating debt-to-GDP ratios exploding over 100%. However, this ratio has actually moved lower (now under 70%), largely on the back of support from higher commodity prices. Our debt-to-GDP ratio is lower than the OECD (Organisation for Economic Co-operation and Development) country average. So, South African investments are actually in decent shape, yet our bond yields seem to indicate that there's significant default risks.

We should also remember the key global fear currently is really about inflation and which companies are able to protect their margins and pass on input costs and inflationary pressures to consumers. However, South Africa has a commodity-centric market, and there's an inherent hedge against inflation from higher commodity prices. This is reflected by the fact that US and European inflation rates have surpassed South Africa’s inflation rate.

The other sector that tends to benefit from rising rates are the banks. As rates tend to move higher, banks become more profitable because they can actually afford to borrow on the short end and then earn better income on the long end of the curve.

So, from a valuation perspective, South African equity and bond valuations have a margin of safety already built in, unlike global assets.

In our view, the US bond market is not accurately reflecting the current risks in that environment. US debt-to-GDP has ballooned by a multiple of four times since GFC [the global financial crisis], and yet yields have only gone lower and lower. This suggests that the US debt situation is improving, but it hasn't. It has deteriorated quite significantly.

Investors need to prepare themselves for offshore returns that are far more muted than what we've experienced since the GFC. Investors who have overallocated to offshore assets would do well to reconsider valuations and make sure their portfolios are positioned properly.

Turbulent times often hit retail investors’ pockets and confidence. The point of departure for retail investors, in the current environment, is to try and save, continue with their contributions and not deviate from investment plans. Importantly retail investors should not try and time their entry and exit from markets.

Thinking long term has a much better success rate than thinking shorter term, so don't shorten your investment horizon on the back of this volatility. Most financial planners have designed plans to take into account multiple recessions over your 40-, 50- even 60-year investment horizon. So, if that was done properly, don't make sweeping changes to your portfolio.

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