Is USD the Smart Bet Before the South African Election?

Our Chief Investment Officer, Duane Gilbert, is optimistic about 2024, expecting rate cuts from falling inflation to boost equity and bond markets. He also shares that South African equities are cheap but risky, requiring careful selection of companies with growth potential in a low-growth environment. Due to declining investor sentiment and rising government spending, exposure to South African government bonds has been reduced in favor of high-quality secured credit and substantial cash holdings, with a preference for USD over ZAR ahead of the election.

Global Markets
Global equities fell in April after the Federal Reserve Chairman, Jerome Powell, signalled that the Fed would wait longer than previously expected to cut interest rates following a series of stubbornly high inflation prints. Developed market equities ended the month down 3.7%, with US equities down 4.1%, European Equities down 1.7% and Japanese equities down 4.9%.

At first, the Fed’s announcement may look like a significant change in policy. However, the outlook for US interest rates remain remains unchanged, only the time frame for rate cuts has been moved out. The Fed has ruled out further interest rate hikes. Furthermore, global equities have run hard and have not had a meaningful correction since October 2023.

Some pull back after such a strong run is normal. With that said, at the start of 2024, markets expected the Fed to cut rates more aggressively than other major central banks in 2024. Now, markets expect the Fed to be the least aggressive.

Chart 1: US Inflation (Source: Infront)
 
Chart 2: Market Implied rate cuts in 2024 (Source: Rothschild & co, Bloomberg)


Global bonds also sold off in April as the outlook for rate cuts continued to be pushed out.  Government bond yields rose to new multi-year highs in the US, Germany and UK, where the 10-year bond yields reached 4.7%, 2.6% and 4.4% respectively.

As was the case in March, the sell-off in global bonds not only reflects an expectation for higher interest rates, but also a long term positive view on the global economy.

The US Q1 2024 GDP print came in at 1.6% quarter on quarter – its seven consecutive quarter of expansion. Meanwhile, Europe exited a technical recession, and monthly UK economic data points to a sharp rebound from the year-end contraction. Since 2014 ultra-low interest rates and economic uncertainty have led to a bizarre situation where some long-dated bonds traded at negative yields.

This phenomenon peaked during the covid crisis where yield hit all-time lows and there was a lot of fear around the outlook for the global economy. We have now passed this era of low-interest rates and fear. According to Bloomberg, there are now no longer any bonds that trade at negative yields. 

Chart 3: Market value of bonds with negative yields (Source: Bloomberg)


Emerging markets fared better than developed markets (up 0.4%) on the back of a sharp rebound in Chinese activity. Chinese domestic shares ended the month up 6.6% (up 16.6% over 3 months). This contributes to the narrative of good long term growth prospects for the global economy. Commodities benefitted from the rebound with the Bloomberg Commodities index up 2.3% 

Chart 4: Bloomberg Commodity Index (Source: Infront)  

Local Markets
SA equities outperformed global markets for the second consecutive month. Local markets performed strongly in April with equities benefiting from a rally in the resources sector. The gain in resources was boosted by gold, reaching an all-time high. 

Chart 5: Resource Index Performance (Source: Infront)


JSE All Share Index rose 2.95%, with Financials and Industrials up 3.0% and 2.3% respectively, while Resources posted a larger gain of 6.4%. JSE ALBI (Local Bond Index) experienced a gain of 1.5%. 

The rand strengthened by 0.57% against the dollar in April - USDZAR continues to remain volatile, and in April it was no different. The rand weakened to R19.37 mid-month and quickly reversed and closed the month at R18.77. 

SA inflation for March eased to 5.3%, while core inflation dropped to 4.9%. The SARB forecasted inflation to moderate throughout 2024, with an estimated average of 5.1% for the year as food and fuel prices ease. Furthermore, the SARB reiterated that a sustained downward inflation trend towards the midpoint target is needed before rate cuts can take place.

Chart 6: South Africa’s Inflation and Interest Rates (Source: Infront)



Commentary by Chief Investment Officer, Duane Gilbert
Our market outlook for 2024 continues to be bullish. Falling inflation will give the Federal Reserve scope to cut interest rates, which will be supportive of equity markets (and bond markets to a lesser degree). The improvement in Chinese activity (if sustained) will be another big driver of equity markets. As a result, we have become slightly more aggressive, with an overweight to defensive US equities. If the growth outlook in China continues to improve, we will look to add to our emerging market exposure. South African equities are particularly cheap but vulnerable to a global sell-off. One needs to carefully pick companies that can grow their earnings in a low growth environment. Given the continuing decline in investor sentiment towards South Africa and increase in government spending, we have further reduced our exposure to South African government bonds, which have been a value trap over the past year. We prefer exposure to high-quality secured credit. We also hold a lot of cash in our portfolios. We prefer USD over ZAR going into the South African election. The weakness we saw in 2023 despite a supportive global backdrop is testament to how fragile the ZAR is. Our large cash position gives us the dry powder we need to take advantage of bargains that may arise from a market sell-off. 

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