Global Markets:

It’s astounding how much can happen in a month! The Olympics came and went. The overpaid footballers of the English Premier League kicked off their season. We had an election. Once again the MSCI Emerging Markets Index was up a further 2,3%.

This emerging market rally is not a change of heart by global investors’ who now consider the growth prospects of emerging markets to be golden. No, it is a symptom of the disruption started by the global financial crisis of 2008. The number of developed market bonds that now yield a negative interest rate has risen substantially since the Brexit vote. Yes, investors are actually lending more money than ever to the German, Japanese, French and Swiss governments. In return they are promised less than they lent?!? Why would investors accept such a proposition? Well, some pension funds and insurance companies are simply obligated to invest in bonds. Some investors believe they will make a capital profit on their investment (if yields fall further). Others are looking for a return on the currency in which the bond is denominated.

The result of this is that investors’ looking for a higher return, turn to emerging markets. By comparison the South African ten-year bond, currently yields 9%. To compensate for the additional risk associated with investing in South Africa, the reward is a significantly higher yield. The result has been increased flows into emerging markets which impacts positively on emerging market equities.

This enthusiasm for emerging markets is however dampened by the prospect of rising interest rates in the US. When Janet Yellen speaks the world listens. If the market interprets that her words imply a higher probability of a US rate hike, money shifts towards the US, and away from emerging markets.

The expected negative impact of Brexit on global growth means that investors have factored in a much lower probability of a US interest rate increase this year. This has given impetus to the flow of cash into emerging markets and the recent two month rally. The result is heightened volatility, something we are all having to see as the new normal in markets.

What does all of this mean for our clients? Offshore exposure is a critical part of an investment strategy, but diversification in terms of geography and currency remains paramount.

South African Market:

One can be forgiven for entering September feeling somewhat schizophrenic. Our election brought much needed optimism. The country took a positive step towards a more balanced political landscape. We have ended the month with the Hawks once again circling Pravin Gordhan.

No sooner had the ink dried on our July market update, which spoke of rallies in the Rand, bonds, and equities, then we were plunged back into painfully familiar uncertainty. Initially markets continued their July buoyancy on the feel good factor of the election results. However rating agency, Standard & Poor’s post-election statement, that political contests within the ANC and between it and opposition parties will now distract it from economic issues, appears to fast becoming true.

The two imminent risks to our markets are political. The “Zuma factor” is one, and the potential for a rating downgrade when S&P make their next rating announcement on 2 December 2016 is the other. There is a clear correlation between the two and the outcome remains unclear. Given the current political shenanigans less focus is being paid to the economy with the result of a downgrade in December becoming an increasing reality.

As it stands, South Africa, for all of its foibles, is a credible emerging market investment destination when compared to other less transparent markets. We are, however, navigating a fine line between being considered investable and not. The battle between National Treasury and our State Owned Enterprises, or Pravin Gordhan and Jacob Zuma, embodies this. Unfortunately, the outcome of a risk of this nature is “binary” – it can only be one way, or the other – and so the negative scenario, will be extremely hard for local markets and vice versa. For now, we sense that the balance is tipped towards a positive outcome over the long term, but not without a few bumps and bruises.

On the economic front, at a presentation to the Labour Law Conference this month the Reserve Bank governor Lesetja Kganyago did not rule out another interest rate hike. He also said inflation appeared to have settled around the top of the target range, close to 6%. This is contrary to what fixed income managers are reporting to us. They feel that concerns about rising inflation have diminished for now, and that domestically interest rates have peaked, barring any external shocks that change the status quo. Either way it appears that the likelihood of a cut in interest rates anytime soon is unlikely.

Finally, through all of the uncertainty we can take some comfort from the words of the world’s most successful investor, Warren Buffet, penned for the New York Times in October 2008, when the world was mired in a financial crisis:

“I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”