Low interest rates, slow growth driving financial market trends

Ultra-low interest rates and slow economic growth are the two main factors currently driving global financial market trends – trends which also inform the South African asset allocation landscape and are integral to both investor behaviour and investment manager decisions.

According to Alwyn van der Merwe, director of investments at Sanlam Private Wealth, the world of investment can be compared to that of fashion: “When an item of clothing is in fashion the so-called fashionistas clamour for it and drive prices higher. The pattern repeats in financial markets where the desire to benefit from ‘fashionable’ investment trends results in investor’s exhibiting herd behaviour, which in turn sends prices soaring and creates potential value bubbles.” 

The interest rate cycle – one of the factors informing current investment fashions – has desynchronised worldwide, and the rates mantra can be reworded to read: “Rates will remain lower for longer for just a bit longer”. Low interest rates have a massive impact on investment decisions as they reduce the attractiveness of cash and ‘inflate’ the valuation of other asset classes (lower discount rates result in declining present value of future cash flows).

The ‘lower for longer’ interest rate outlook supports the case for equities and to some degree listed property, though the latter asset class is relatively expensive today. This in turn means that investment managers will have to keep a close eye out for the inevitable trend shift in the interest rate cycles.

“Predicting this trend change is more difficult than you might imagine and despite many leading indicators both locally and abroad having pointed to a rates hike for quite some time, nothing has happened,” he says. Central banks are cautious about raising rates for fear of scuppering fragile economic growth after the global financial crisis. 

To date, savers and pensioners have borne the brunt of the low interest rate cycle. By way of example, the income generated by R1 million in a domestic money market account has more than halved over the past six years, from R124 300 in January 2009 to just R61 400 per year in January this year.

“Low interest rates are devastating for older people who often have a large allocation to cash in their portfolios, and explain why people have been searching for alternative investment opportunities with better yields,” says Van der Merwe. 

Slow economic growth remains a concern to businesses with the International Monetary Fund predicting 3% in global GDP growth for 2015, with Europe’s mediocre outlook somewhat offset by China, which is still growing strongly albeit at a slower pace than before. 

Choosing shares in a slow growth environment is tricky because there are always concerns about firms’ profit generating abilities. “South Africa-based investment managers, for example, are extremely concerned about earnings in the construction sector and have voted with their feet – something that reflects in Top 40 JSE-listed share price performances going back to 2009,” says Van der Merwe. Six year performances show a massive outperformance of consumer-based versus cyclical counters. 

How do you construct a winning share portfolio against the backdrop of low interest rates and slow growth? Van der Merwe says Sanlam Private Wealth interrogates every potential position against a seven-part checklist that reflects on price, value, corporate earnings, real interest rates (low or not), commodity prices and the risk of permanent capital loss to investors. 

“Our indicators are rather bearish on prospects for equities at present, but you should not discard your tried-and-tested wardrobe just because the fashionistas suggest that your clothes are out of style,” he says. 

“It is premature to panic about equity markets because yields from equities still exceed the yield on government bonds and equities remain the best risk to return option available – as long as interest rates remain low, the equity bull market will continue to climb the wall of worry.” 

According to Van der Merwe, what separates Sanlam Private Wealth from the herd is that it is not afraid to make contrarian decisions with regards its portfolio holdings. This requires ignoring the market ‘chatter’ and shrugging off criticism from analysts and investors alike.

 “Following the ‘fashion’ is not a long term solution. We find ourselves in a unique environment where the current trend has been in place for quite some time – the best an investment manager can do is to remain overweight in shares and take a bit of money off the table when the opportunity presents,” he concludes.