Market Solutions – September 2017

By Alexander Forbes Investments on Oct 11, 2017 in Market and Economic Commentary The news


Forcing investors down the risk continuum

South African consumers have been jolted by the recent jump in domestic petrol prices, which will eat into household disposable incomes. The petrol price shock combined with rand weakness vs. the US dollar at the end of September and early October has created worry among financial market participants that the falling CPI inflation cycle might be over. The year-on-year (y/y) percentage change in CPI fell from a peak of 6.7% y/y in December 2016 to 4.6% y/y July 2017 and ticked up to 4.8% y/y in August 2017, spurring this fear further still. However in-house analysis of the underlying inflation trends suggests that much lower CPI growth is in store over the coming months. Forecasts of CPI inflation to the precise decimal point are not particularly valuable, but the trend suggests CPI growth as low as 2% or 3% is possible, which has strong implications for asset class performance.

Money market funds have performed remarkably well over the past two years after the South African Reserve Bank’s (SARB’s) interest rate increasing cycle. Y/Y money market returns hit north of 7.5% in mid2017. Bear in mind that there is very little chance of capital loss on these instruments, which is in contrast to equities and bonds. Real inflation-adjusted returns on cash instruments will remain positive over the coming months as CPI inflation drops but nominal returns will dwindle as the SARB attempts to stimulate economic activity with lower interest rates. Whether this monetary policy is prudent, or likely to be successful, is another question altogether, but as cash rates fall asset allocators will be forced to think of alternative destinations for capital.

Understanding interest rate dynamics from this angle provides good insight into one of the reasons for strong domestic equity performance. Low-interest rates force investors to assume risk to eke out investment returns for clients. The All Share Index (ALSI), along with numerous other global equity indices, hit a new record high in early October 2017. Does this imply the global economy is firing on all cylinders? No. Does this imply the local economy is firing on all cylinders? Certainly not. Could it imply attractive investment alternatives are difficult to find? Perhaps.

Strong equity market returns are heartening for clients because the majority of portfolios remain invested in these long-term growth assets. However, the further indices run higher, without commensurate improvements in real activity and earnings, the larger the degree of risk inherent in those indices. At present, there is no clear sign of global financial market stress to cause a turnaround in the upside equity momentum. However expensive valuations generate fragility within the financial system, where reactions to negative news can become severe. We continue to monitor potential market stressors, and attempt to manage these risks in advance rather than become purely fixed on the attractive short-term returns.

Alexander Forbes Investments

Alexander Forbes Investments

Alexander Forbes Investments was established in 1997. We are a forward-thinking and trusted global investment provider, with roots in Africa. In pursuit of certainty we set out to understand our retail and institutional clients’ circumstances and risk tolerance to set clear goals. Our adaptive investment approach, called Living*Investing allows us to maximise opportunity and minimise risk at every stage of the investment cycle.

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