March / April 2016

Weak Rand eliminates option of offshore diversification for investment managers
After the financial crisis, when the United States Federal Reserve introduced its large scale asset purchase programme and reduced its repo to 0.25%, when commodities and the oil price were running hot, things were not extremely well with many resource driven emerging economies and with oil producing countries. Their interest rates were low, their currencies and bourses appreciated substantially driven by foreign investors looking for yield. Those were the days when many of these countries started to think about how to break the shackles of the global hegemony. There were moves to trade crude in currencies other than the US Dollar in an effort to break the US Dollar monopoly. We read about the BRICS countries having resolved to establish a BRICS Bank in order to break the shackles of the IMF and World Bank.
A number of oil exporting countries that became more outspoken on their anti US sentiments experienced civil uprisings, some experienced regime changes and with the dramatic fall of the oil price, those regimes that survived are at last also experiencing severe economic problems. If we look at the BRICS countries, Brazil, Russia, India, China and South Africa it seems too much of a coincidence that all of them, barring perhaps India, are also now suddenly facing serious economic difficulties. Their currencies have depreciated severely while the windfall from high commodity prices was blown away.
It seems that all plans to break the shackles had to be abandoned. We have not heard of BRICS Bank as the BRICS countries are under extreme pressure to salvage their economies. So it seems the oil price and the Fed interest rate levers have certainly strengthened the position of the US by weakening the ability of those rogue countries that attempted to challenge the US. These countries are down – but they are not out yet and are still a threat to the US. Will they be able to survive to overcome the hegemony or will they buckle down eventually? And we are really only talking about China and Russia here that have the potential to pose a serious challenge and only if they establish a strong alliance. Russia is in a much weaker position and if a regime change can be achieved there the challenge posed by China can then be tackled in earnest.
If these global strategic goals are behind the dramatic decline of the oil price, one should expect this to continue until we have ‘mission accomplished’ in Russia, i.e. Mr Putin and his party are removed from power. Not seeing a strong alliance between Russia and China, this is the most likely scenario at this stage.
What is worse is that we may see the economic measures being complemented with military measures which may then start looking very ugly also for bourses around the globe.
As far as South Africa is concerned, the dream of a BRICS Bank is probably off the table and that challenge to US dominance has died. Our commodity prices will move in sympathy with the oil price which we do not expect to recover substantially anytime soon. Our currency may well recover as it was totally oversold but it will remain under pressure for quite some time as the result of likely further Fed repo rate increases. This will at the same time maintain pressure on local interest rates and with that also on the local consumer for quite some time to come.
Conclusion
We do not expect an improvement in the global economy soon. Equity markets will continue to drift sideways while interest bearing assets, including property, will face headwinds with anticipated increases in interest rates. Investing in the right asset classes and in the right assets within each class is a skill that should still produce acceptable investment returns.
We therefore like prudential balance pension portfolios in the current scenario where the manager can move between asset classes. This has proven a successful recipe over many years and has delivered returns well above inflation, the ultimate enemy of anyone who is concerned about retiring in dignity.
Our view is unchanged. We believe the commodity sector may offer selective buying opportunities but it may require patience to realise gains.
The consumer facing increasing pains, and the fact that Consumer Goods and Consumer Services had a terrific run since the beginning of 2006, it is hard to see this sector continuing on its trajectory. The financial sector too is likely to suffer in sympathy with the consumer.
The excessively depreciated Rand indicates that it should recover along with an increasing oil price and other commodities. The weak Rand at this point eliminates the option of offshore diversification although offshore should otherwise always be part of an investor’s strategy of diversifying risk. This leaves the Industrial sector as a sector we believe to also offers prospects, in light of the weak Rand and low commodity prices.
In terms of diversification between different asset classes locally, the likelihood of further repo rate increases suggests that interest bearing investments do not hold good prospects at this stage. However the prospect of accelerating inflation favours inflation linked bonds.