The graph below depicts a few interesting trend lines. Firstly, the blue line depicts one year rolling foreign investment flows into equities. Do these flows actually impact the JSE Allshare Index? Tracking the red line which depicts a ‘blown up’ movement of the JSE Allshare Index relative to the blue line, a close correlation between these two trend lines becomes very evident.
Tracking the black line which depicts the one year rolling total of net foreign equity flows, net foreign fixed interest flows and the SA trade balance against the green line that depicts a ‘blown up’ movement of the Rand: US Dollar index one can also see a correlation between these two trend lines.
A negative black trendline lifts the green trend line, meaning that an outflow of capital weakens the Rand relative to the US Dollar. We can also see a decline of these capital flows since the end of the financial crisis and a virtual collapse since October 2013.
This negative trend has been caused for one by a decline in world commodity market but most likely also by a decline in SA’s competitiveness as the result of the strong Rand. The decline in commodity markets was clearly impacted by the financial crisis and since then by reduced demand for commodities from China as the result of it restructuring its economy. The Rand of course has been weakening steadily over the past 4 years.
Can there be any expectation of this to improve? We would expect the sudden collapse in the trade balance to reverse and to it recovering to more normal levels. It is unlikely though that the trade balance will move into positive territory soon. It is also unlikely that global commodity markets will be what they have been before the financial crisis, as the result of the revolution we are currently witnessing in the energy sector.
Our conclusion from this analysis is that the Rand will remain under pressure for some time to come, however we would expect it to recover some lost ground in the short term if the trade balance improves as we would expect it to do. We would expect it to return to around 10 to the US Dollar but to trend weaker with little support from foreign investors.
Any upward movement of interest rates in the US will expedite the demise of the Rand if this is not matched by a significant increase in local interest rates. Such upward movement in the US is imminent although we would expect it to be in very small steps. The SARB will probably pre-empt this, raising the repo rate sooner but in digestible steps.
While the exaggerated weakness of the Rand would dictate not to further diversify offshore until the Rand has recovered meaningfully the steep decline in foreign bourses in October makes up for more than the depreciation of the Rand and supports a strategy of moving to full offshore exposure. Full offshore exposure makes sense on the basis of the expected continued weakening of the Rand and relatively expensive local equities that are likely to under perform foreign bourses in the absence of strong foreign inflows.
Extremely depressed global interest rates have produced generally elevated equity prices across the globe. As the result, the most likely prospect is that this imbalance will start to reverse as we will see the first increases in US interest rates coming through over the next few years. In this adjustment phase it is principally tough to find value in either equity or fixed interest investments.
Locally we expect the consumer to suffer as interest rates will continue to drift upwards. From a macro economic perspective the weakening Rand should advantage Rand hedge shares, exporters and manufacturers locally. An investment in depressed foreign economies and bourses should be biased towards the consumer while any investment in stocks on bourses already at high levels should focus on finding value rather than on any particular sector. These expectations would shape our local and foreign asset and sector allocation views.
Download the complete Benchtest fund investment overview for September 2014 at http://www.rfsol.com.na/benchmark