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The tide is turning

Undoubtedly the two subjects that currently feature most prominently in financial circles, is the rapid depreciation of the Rand and the dramatic decline in the price of oil. For the investor, these are important indicators and the question begs to be answered whether we will see a reversal of these developments or whether these represent new norms.

Over this period from October 2000 to the end of July the Rand depreciated by 67% against the US Dollar, by 80% against the British Pound and by 117% against the Euro.
The depreciation of the Rand occurred despite continued foreign investment capital inflows, specifically into equities. Foreigners still seem to find value investing in local equities, having invested close to R 20 billion over the past 12 months of which R 10 billion was invested in July alone.
So why have foreigners kept on investing despite the severe depreciation of the Rand?
Despite the recent decline of the ALSI, expressed in foreign currency, as the result of the depreciation of the Rand, the ALSI still delivered a return of 9.5% per annum in US Dollar terms, 9% per annum in British Pound terms and 7.6% in Euro terms over this period of close to 15 years. To this return can still be added the dividend yield of close to 3% per annum. Comparing this to the Dow Jones’ 3.4% per annum over the same period, the British FTSE’s 0.3% and the DAX’s 3.2%, it should become self evident why foreigners still keep investing in local equities.
Foreign interest rates are at, or around zero percent in the US and other developed economies, and in cases even negative when inflation is brought into the equation. Investors can thus borrow cheaply and invest in our local bourses for a decent yield they will not find at home.
For foreign investors the question is whether the Rand will continue to weaken to the extent is has of late or whether it will actually move in the opposite direction. The exchange rate should be 10.25 rather than the rate of 12.67 at the end of July, let alone the more recent 13.14 which represents an under valuation of close to 30%.
Considering the fundamentals, there is no reason why the Rand should have weakened so rapidly. Foreigners remain net investors in local financial markets while the SA trade balance has also been positive of the past 2 months in a row. The only conclusion is that this is driven by currency speculation that will not persist. Our expectation is thus that the Rand should strengthen in time although it is impossible to foresee when this will happen.
For the local investor this means that investing offshore now is not the right time in the light of the likelihood of the Rand strengthening again.
Other key economic variables the local investor should bear in mind are the oil price and interest rates. The oil price is important because oil is a core commodity in many commodity hedge funds and therefore also drives the price of other commodities. In the light of the shale gas ‘revolution’, shale gas can in many cases be produced profitably at today’s oil prices, while technology is improving rapidly and its market share of global energy production is growing steadily.
It is therefore likely that the oil price will remain at its current levels with little prospect of any significant increase but rather a long-term declining trend. At the same time the expectation would then be that commodities in general will remain at low levels for some time to come. This in turn will impact negatively on the SA and Namibian economies that are commodity driven.
Turning to interest rates, it is likely that the US Fed will start raising the repo rate in the foreseeable future. However this will probably be done in very small steps and over a protracted period.
We believe this expectation has already been discounted by financial markets and an announcement of an increase is therefore unlikely to impact financial markets. As things stand with the US Dollar, any significant rate increase would further strengthen the Dollar and would harm the US economy.

Monetary policy in a number of developed economies has driven capital out of interest bearing investments into equity. As the result global price levels of equities and interest bearing investments are artificially inflated while global interest rates are artificially deflated. This imbalance between interest rates and asset prices is due to reverse as the US starts lifting interest rates and as other countries will do the same. As pointed out, this will happen over a protracted period of time during which investors are likely to experience pedestrian investment returns. Double digit returns over extended periods, as we have seen in the past are a matter of the past. The investor’s benchmark should thus move from high absolute returns to only out performing inflation by between 3% and 6%. With inflation running at just over 3%, the investor should be comfortable with investment returns of between 6% and 9%. We believe that under these conditions, equities are still the preferred asset class offering the best prospect of sustainably yielding these returns in the long term. As pointed out before, it will be very important to pick the right stocks.

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