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A shocker

28 July 2006 Angelo Coppola

The producer price index (PPI) data for June was a shocker as was the case with the consumer inflation data (CPI) released the day before. Do investors have options?

According to the Efficient Group the PPI recorded an increase of 7.5% compared to June 2005 the highest increase seen figures since January 2003.

Similar to the previous months data, the domestic produced goods provided most upwards pressure; however the 6.8% y:y increase in imported goods are also a worrying figure.

Meanwhile Old Mutual Asset Managers chief economist Rian le Roux says that an economic cycle of higher inflation and interest rates has arrived in SA, and its severity will depend on global activity.

"A local cycle has arrived but we expect it to be muted," he says. "We do not foresee a major slump in the rand, provided our global view is correct. The local rate cycle could therefore be muted.

"Inflation risks from oil, a softer rand and food prices do argue for further tightening. But we think the cycle will be limited to possibly two more 50-basis point hikes." The risk of a bigger rate cycle is essentially dependent on the global environment, he adds.

On the other hand Steve Mills from SIM says that interest rates drive future growth and definitely effect current valuations and the bond rates are directly impacted by any movements.

Yields on fixed income investments are at historically low levels despite the recent 50 basis points hike in interest rates. Conservative investors can, however, enhance their after-tax returns without undue exposure to the risk of further interest rate increases, says Tamas Kulcsar from SP Advisory Services.

In a low interest rate environment, cash returns are unattractive and yield-enhancing investments such as income funds are vulnerable to interest rate hikes, says Kulcsar. Interest rate increases, which are positive for an income stream, would, however, reduce the capital value of an investment.

By combining low risk absolute return unit trusts, dividend-income funds and flexible fixed interest funds one can construct a portfolio that meets the above criteria, he suggests.

On the other hand there is however lots of negative sentiment around in the short term, and the listed property sector has just undergone a serious correction, and liquidity remains an issue, although the fundamentals remain positive.

Economic growth is still solid, says Mills, with inflation differentials still supportive of the rand, while any interest rate adjustments are an adjustment only.

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