WARREN THOMPSON: Welcome to the Moneyweb webinar with Old Mutual, I have the great pleasure today of hosting Tinyiko Ngwenya, who is the economist at the Old Mutual Investment Group, she’s joining us on the line from Cape Town. Good morning, Tinyiko.
TINYIKO NGWENYA: Good morning, Warren, how are you?
WARREN THOMPSON: Very good thanks and yourself?
TINYIKO NGWENYA: I’m fine thanks, hoping for some rain here in Cape Town, it’s a little bit cold today.
WARREN THOMPSON: Okay, the water levels are gradually increasing but they are nowhere safe enough at the moment are they?
TINYIKO NGWENYA: No, it’s actually quite scary if you fly over Theewaterskloof Dam and it’s still very dry and if we don’t get anything by the end of August, which is normally or rainy season, then we’re going to be in trouble in summer.
WARREN THOMPSON: We hope that some of that rain hits the Western Cape, I know it’s a big agricultural area and we’re going to be talking about the economy and it’s amazing how weather can create that kind of volatility. But, Tinyiko, the subject of the webinar that everyone is tuned in to listen to is investing in uncertain times. Just to begin, if you look back at human history, there’s always been a fair amount of uncertainty but certainly at this point in the country’s history and where we are from a markets point of view there appears to be more uncertainty than I think we’ve had in past periods since democracy. Just give us a perspective of this concept of always having to deal with uncertainty and where do we anchor our expectations over the long term because many of us will hopefully be saving for retirement, saving for future goals over extended periods that’s past the 24-hour news cycle. Just give us the basis on which we should anchor our view of what happens in the world and how we manage our investments with response to that.
TINYIKO NGWENYA: It’s very true what you mentioned, volatility is pretty much the new norm now, especially in the markets, and in South Africa specifically it’s more around political uncertainty, the economic direction, as well as the rating outcomes in the next six to 12 months. But as an investor the most important thing is to know what your long-term plan is, so if you’re invested for the long term you should look at three to five and five-plus. I know for any balanced fund or any other investment vehicle the long-term view is what most of these portfolios will always bring in terms of returns. I think the most important thing now is just understanding what the macro is telling us, so in the short term here in South Africa we are looking at a cyclical recovery, we are seeing short-term growth pick up, especially since we had that recession in the first quarter, the second quarter growth looking to track at about 2.5%. So all of those first quarter sectors that contracted the financial, retail and so on are starting to pick up now, which is good news. What’s also good news is the fact that inflation is coming down, remember we had the drought in the previous year and that put a lot of pressure on food prices, so now we’ve seen the last inflation print came out at 4.6%, so that’s right within the mid-point range of the Reserve Bank’s 3% to 6% inflation target. So this is definitely giving the Reserve Bank some room to cut interest rates for the second time this year. A lot of brokers have started to bring back that rate cut expectation to September, so the market is expecting that to come in in September. Then, of course, that obviously means that lower inflation, lower interest rate, which gives consumers some kind of relief, although it’s not the best relief because wage growth is not fantastic but it’s giving you some relief. So that’s positive for retail stocks, the SA consumer-type sectors would do well in that kind of environment. I suppose the most important thing here is that active management has a place in investment because if you think about it at this point where the JSE has done about 10% in the year, financials have done more than that, about 28%, and then you have resources that went down. So in terms of having an active portfolio where you have a manger who is looking at what’s happening in the macro and managing your portfolio is very important for long-term investors.
Find self-help companies that can do well in this environment
WARREN THOMPSON: Just an important point before we carry on, this idea around the economy and markets don’t always tie up, you look at South Africa’s economy at the moment that’s in recession, confidence is very low, activity is very suppressed, there are probably more people losing their jobs than being hired at this point but many times you see a very contrasting story in the financial markets, just outline for us the difference between the two and especially how people need to separate the fact that you can have your investments performing well at a time when the economy, for instance, is not doing very well.
TINYIKO NGWENYA: Warren, the truth is money can always be made in any kind of environment. So in a low-growth environment you can have bonds that are doing better as an asset class than equities but equities in this case, as you mentioned, we had growth of 0.3% last year and the JSE still did well. So in those kinds of instances…I love what Michiel Le Roux of Capitec says, he said either look at the unemployment rate, so you can either look at how high it is or you can look at the number of employed people that there are and try to benefit from those people bring some kind of return to your shareholders. So it’s finding the companies that are self-help that can always win in this kind of environment, so even when growth is low you need to find those companies that still are self-help companies and still do well in this environment. Capitec is one example.
WARREN THOMPSON: I think the other point is we’re a very open economy, so there are many companies that are either earning dollar-based income or they are exporting and doing very well, as we are going to cast our eye around the world shortly and yet the local economy is not performing that well.
TINYIKO NGWENYA: So pretty much the Top 40, most of them are rand hedges, so companies that have exposure globally like Naspers has to Tencent in China. A lot of rand hedge companies have exposure internationally and that’s helping because, as you know, at this moment global growth is picking up, there’s the Eurozone that’s doing extremely well, in fact the IMF upgraded their forecast for Europe to about 1.9% for this year from 1.7%, so we’re starting to see a lot of growth happening there. Even small economies that were not doing so well such as Japan, which was stuck in stagflation for a while, is starting to come out and it had 4% growth in the second quarter. So the global environment is actually helping South Africa, in fact, you can see it in the rand, it’s supporting the rand because you have the softer dollar, which is helping emerging market currencies, including the rand, and as well as a good Europe, which is one of the biggest export hubs for South Africa, so that’s benefitting us, as well as an open economy
WARREN THOMPSON: We’ve got a question from one of our webinar participants, Emmanuel, he says that he’d like to hear your thoughts on investments in South Africa now. I think we’ve touched on that a little bit but perhaps what you can do, Tinyiko, is just separate out the smaller companies, so those companies outside the Top 100 on the JSE that don’t have as much exposure to foreign markets, as I understand it, versus, some of those big firms at the top of the market.
TINYIKO NGWENYA: So the SA Inc. companies that are exposed to the rand are doing particularly well at the moment because of the rand, they are being supported. The problem is growth drivers, so in South Africa although we have the short-term recovery in place and we see growth, in our own forecast we have 0.8% for this year and 2% for next year, so you are seeing that cyclical recovery but there are long-term structural problems that need to be changed in order for us to grow at about 2%. So right now it’s quite low. If you think about that then in an environment where you have low growth then you don’t want to be too invested in your financials, you want to pick the right stock that can help in that environment, as I mentioned previously, the self-help companies and because we are asset allocation I don’t want to speak more about stock picking. But in terms of looking at those sectors that can perform in a low growth environment those would be what you’re looking for and stay invested for the long term. Although in the short term it does look like we have some structural problems that need to be changed, companies always tend to evolve with that time, FirstRand, for example, moving away from home loans and moving more into your personal loan, so they will evolve with the time in order to give some returns to your shareholders.
North Korea and USA: Long-term effects or short-term noise?
WARREN THOMPSON: That’s a very important point. Another question that we’ve got coming up and I think this is a great one to perhaps illustrate your thoughts around looking into the long term versus being too drawn into the short term as a result of things like social media, 24-hour news cycles and news channels. We’ve got someone asking about North Korea and the USA, long-term effects or short-term noise and specifically perhaps you can then talk about how do you distinguish between something that’s just a headline today and something that might have a long-term or structural effect on the way you invest.
TINYIKO NGWENYA: I don’t know if you read the book Sapiens: A Brief History of Humankind by Professor Yuval Noah Harari but he liked to talk about how geopolitics now in the modern times is likened to a fly and the reaction of a fly going into a bull’s ear and we make it a big thing but it’s really just a fly buzzing. So at the moment we believe that North Korea and the US is just some noise in terms of geopolitics, neither of them want to start a nuclear war, we know the impact of what that would bring. But the message around that noise that you are seeing in the US just shows you the direction in terms of US policy. I recall in November 2016 when President Trump was elected the dollar surged and investors went into the S&P 500 in the hope that you would see this fiscal reform happen in the US so that the US would pick up and the Fed would hike. So that was the expectation in November but now with all this noise happening and Trump being sidetracked from that fiscal reform that he was supposed to propose in terms of policy that’s now taking away expectations of that growth factor that was going to drive the Fed to hike more aggressively and, as you can see, that’s now reflected in the dollar weakening to the euro. The dollar has weakened mainly because of relative growth so the euro is doing a lot better in terms of growth, as well as the fact that you’re not going to see those promised fiscal reforms and if you do see them they might be muted. We saw the Obama repeal that failed in government, so there are questions around Trump’s ability as a president to reform the country, especially the fiscal reform implementation so that the US economy grows to a point where the Fed hikes more aggressively and obviously brings in money into the US economy in terms of the US bond yields rising.
WARREN THOMPSON: I think that’s an important distinction to make. Just a question around diversifying here, if we live in South Africa we earn an income in the country and we save in South Africa, the question that we often get asked is how much money should a person be investing offshore. Have you got a broad guideline as to what people should do based on if you are sitting with all your assets in South Africa, if you are invested in the Top 40, as we’ve mentioned, you’ve probably got exposure to quite a large chunk of that income that’s coming from global but how much of that balance should be have actually taken out of the country and investing in American, Europe or emerging markets?
TINYIKO NGWENYA: In terms of pension funds Regulation 28 does limit South Africa to having 75% of your assets invested here in South Africa, so you have that limit. But even within that limit, as you mentioned, you are investing in Top 40 companies that have global earnings so in any case you could be long global in your portfolio just by being invested here in South Africa. So in terms of how much of a percentage you should put in there depends on the investor, what is your plan, that’s very important because as a long-term investor you would want to be long growth assets, have a little bit of income, generating income, generating assets, so it really depends on the investor and what their financial goals are.
How quickly will US interest rates rise?
WARREN THOMPSON: I think one of the most powerful things that affect the stock markets is the rise and decline of interest rates and you alluded to earlier the fact that the Fed in the US might be beginning a gradual process of raising interest rates, which have been at very, very low levels over the last seven years. First of all, how quickly do you think interest rates are going to rise in the US and secondly, what effect do you think that will have, if any, on its stock market?
TINYIKO NGWENYA: The Fed has said that they want to move to normalised rates and normalisation to them is reaching a 1.5% target. As you mentioned, we had low interest rates since the global financial crisis, where the US had rates of 0.25%, that has started to come up since the first hike that they had in December 2015, so rates are now at around 1.25%. But the Fed has a dual mandate in terms full employment, as well as maintaining price stability, on the full employment side the labour market is very tight, unemployment is at the lowest it’s been in the cycle, the number of unemployed workers per job opening fell to 1.1 that’s the lowest in the history of the series. So you have a tight labour market and that part of their mandate seems to be doing okay, the only problem is the price stability part; which is inflation, inflation is still below the 2% target, the core PCE which is their preferred inflation measure that’s at 1.5%, so it’s below that 2% target. So you would have expected for employment to have moved to higher average wages because that’s the true transmission mechanism of a strong labour market is that you’ll have increased wages but we’re not seeing that. The Fed has done some study on why this could be the case, perhaps is it because we have temporary employment rising, is it because people are coming in at lower rates but the point is that inflation is still below the 2% target, which means that the Fed won’t hike too aggressively, they still want to see inflation tick up towards that 2% target before they continue hiking. What they have mentioned, though, is that they would unwind the balance sheet, so the Fed holds about $4.5 trillion in their balance sheet, so to put that in context they could buy the top ten biggest companies in the S&P 500. So what they’ve started saying is that they’ll start unwinding that instead of hiking too soon, so that’s one way. But in terms of what this means for the market, at the moment, as I mentioned, the market has priced in the normalization towards 1.5%, so that’s expected. As you know, the market really moves on sentiment, so if the Fed hikes more than we’re expecting then that would drive more money into the US, versus where it is if expectations are at the level then you won’t see too much of a jerk reaction of money leaving emerging markets and going to the US.
WARREN THOMPSON: Let’s unpack that there because if I’ve understood you correctly the Federal Reserve, which is the US central bank, is going to start raising interest rates again and that’s been because unemployment in the US has fallen to such a low level that the next logical development would be that as there are not enough people to supply the economy with they are going to start demanding higher salaries and wages, and that in turn is going to generate inflation and inflation, of course, is the great enemy of central banks. So the central bank is going to start raising interest rates to suppress that inflation and that’s why you expect at some point the US interest rates are going to go to about 1.5%?
TINYIKO NGWENYA: But it would be very gradual.
WARREN THOMPSON: Very gradual, so this would be over a period of about maybe two or three or four years?
TINYIKO NGWENYA: They’ve indicated until 2018 but, of course, this is knitted by the fact that inflation hasn’t come to the party. So inflation is still low and this is one of the reasons why the dollar hasn’t been as strong as it was last year and it’s because the market is wondering whether there will be hiking again this year and if the guidance of two more hikes next year will still happen. So at the moment they’ve kept that as guidance but the market is starting to discount whether that will happen next year.
Baby boomers are being replaced at well below average wages
WARREN THOMPSON: Yes, this was quite an interesting topic that we spoke about off air is that inflation hasn’t come through as quickly and there are a couple of reasons for that, what is the market speculating the basis for that inflation not coming through?
TINYIKO NGWENYA: As I mentioned, in terms of wage inflation there have been studies on that in terms of the rise of temporary jobs and new entrants entering the market at well below average wages and you also have the baby boomers who are retiring now, so baby boomers are being replaced at well below average wages as well, so that’s keeping wages subdued. Consumption in the US has also not been picking up as much, we look at indicators like vehicle sales, as well retail sales to kind of get a feel of what consumption is like in the US and both of those indicators, vehicle sales has been declining, where retail sales has been quite flat, so we’re not seeing a lot of private consumption happening in the US and that should be what lifts inflation.
WARREN THOMPSON: Okay, great. Let’s have a look at the merging market, I think you referred to it earlier as Goldilocks, tell us about why it’s being called Goldilocks and why it looks and sounds like we should be fairly interested in having at least a portion of our portfolio in these markets?
TINYIKO NGWENYA: Goldilocks implies that this is a beautiful time for emerging markets and this is mainly driven by the fact that you have a weaker dollar. So the dollar, as you know, undermines emerging market currencies, so when that’s weak then you have stronger emerging market currencies, which helps in terms of lowering inflation in these countries. So Brazil, for example, have had inflation coming down to about 4% from the peak that it had last year of 10% and that’s helping the central bank in Brazil to start cutting rates aggressively and cutting rates also helps the consumer. Brazil had a lot of job losses because it had one of the harshest recessions that it had in a while, the consumer now is under a lot of pressure, so by the central bank cutting that’s helping to give the consumer some kind of relief. So emerging market currencies are doing okay in that the dollar is weaker at the moment, as well as the fact that the Eurozone is growing at a very strong pace, the Eurozone is important to a lot of emerging markets like South Africa and, as I mentioned, a big export hub for us. Another economy that’s also important to emerging markets is China, the Chinese government have a growth forecast of 6.5% for the end of this year and there are a lot of worries that it will mean that China will be slowing, what does that mean for commodity prices, especially for commodity exporters such as South Africa. Right now commodity prices have stabilized, they are looking okay, single-index, which we look at, is very positive, you’ve had that up-tick in iron ore prices, you’ve had coal prices return, so that looks okay. China also look to reach that 6.5% growth target, the first half of this year China grew at 6.7%, so it does give it some legroom to implement some policy reforms to manage the financial risk around China. So China is looking okay, the Eurozone is looking very good, so that’s helpful for emerging markets and a softer dollar as well helps in terms of not undermining the recovery that is going on in these emerging markets.
WARREN THOMPSON: From a general valuations perspective are the emerging markets starting to reflect that kind of sentiment, are they looking quite expensive if go onto the equity markets of China and Brazil?
TINYIKO NGWENYA: Not expensive relative to S&P, so emerging markets are looking cheaper than developed market stocks. So there’s a lot of growth that’s available there in terms of return profile, so definitely China, Brazil and also emerging Asia, where there’s still some value that you can get there from the growth that you’re seeing in these economies.
WARREN THOMPSON: When it comes to South Africa, I know it’s becoming more and more trickier to pigeonhole our market because of the presence of these large companies that earn a large majority of their income from overseas, would you say on the whole, if you look at our stocks that the bad news about the economy and the state of the country is reflected in those prices?
TINYIKO NGWENYA: That’s the dilemma that we are sitting in in South Africa in that stocks are not cheap at all. Yes, there are a few that are relatively well priced but we haven’t had that big crisis hit like economies like Brazil where you had the recession and stock prices fell and that was a good time to go in there and pick up. Here in South Africa we haven’t had that big crisis that hit our equity market. So the equity market isn’t cheap, yes there are some stocks that you can pick up but as a whole it isn’t cheap, it doesn’t really reflect the downward spiral scenario that some people have if the end of December is a bad outcome, no, the equity market is not reflecting that yet.
The Goldilocks environment is great for South Africa
WARREN THOMPSON: The equity is not reflecting that and certainly I think while the rand has been weaker it’s certainly not as bad as I suspect it could have been. So for many people considering what they should do with their money would you say that the rand at this point is probably a bit overvalued and it’s not a bad time to take some rands and go and buy some investments offshore or take some money offshore?
TINYIKO NGWENYA: The rand, remember, is being supported by the global environment, as I mentioned, emerging markets, the Goldilocks environment is great for South Africa too. Local things that are also helping the rand is our trade balance, we’ve had a positive trade balance since this year and that helped to narrow the current account deficit. So why that’s important is because once you narrow our funding requirements then it’s positive for the rand in that we won’t have as much funding requirements. I know the number has come down to about R80 billion which we need in terms of our funding requirements, whereas in the previous year it was R200 million. So that’s a big portion that’s contributing to the fact that the rand is doing well is that the current account has narrowed. Other drivers, of course, are cyclical recovery, as well as the fact that inflation has come down, as well as the possibility of more rate cuts. So the rand in terms of its trade-weighted average isn’t particularly expensive, it still has some room to go in terms of strengthening. I think the most important thing is that December is binary, so whatever the outcome is will be reflected in the rand, it’s going to reflect the political outcome, it’s going to reflect moving forward in terms of the February budget and it’s going to reflect the rating outcome because S&P need to resolve the negative outlook that they have by June 2018, so that’s very important in terms of the drivers of the rand.
WARREN THOMPSON: Without venturing too far into the political arena but talking about December there I would suspect, if I’ve read the situation correctly, that Cyril Ramaphosa’s successful ascension to the presidency of the ANC would be positive for the rand and the country in general, whereas with any other candidate it might not be as positive, in fact it might be negative, would that be a fairly easy way of summarising it?
TINYIKO NGWENYA: It is but the only reason a Cyril Ramaphosa win is positive is because of what it represents. So without being too fussy about the names it’s about the direction of where policy goes following the December elective conference. Cyril represents a policy direction which means getting our minimum wage sorted out, which means implementing some growth-enhancing labour reforms and things that can grow our economy because at the moment without private investments, this builds on the fact that business confidence has been so low that businesses are not investing in our country. So without private investments, without consumption coming from the consumer there really is no growth driver at the moment that we can see. So it really has to come from policy and that’s what the Cyril direction represents, so it’s about policy direction versus just a name and that will definitely help drive sentiment.
WARREN THOMPSON: Okay, great. We’d like to thank you very much for your insight and time.
TINYIKO NGWENYA: You’re most welcome, thank you, Warren.
WARREN THOMPSON: That was Tinyiko Ngwenya, economist at the Old Mutual Investment Group.
Brought to you by Old Mutual Investment Group.