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Investment thinking in these uncertain times

Audio Version

In these uncertain times, there are widening opinions on how to treat your investments. Below is a snapshot of Allan Gray’s latest thinking on the investment environment.

Economically, governments globally have reduced interest rates and bought bonds

As the US Dollar is the world’s reserve currency, the actions by the US will have a key effect on global investment markets. The US government has pumped trillions of Dollars into the economy by buying bonds and money market assets, which has driven the sharp rebound in equity and bond prices.

As most other countries (including SA) have also reduced interest rates and bought bonds, the strains on SA’s finances are intensifying. We cannot simply print money like the US. We need to rely on our domestic savings pool and external funding from investors and institutions, such as the IMF and Development Bank.

SA was very fortunate to have high real interest rates heading into the Coronavirus crisis. Subsequently, the Reserve Bank has cut interest rates by 2.5%, down to 3.75%, which will give relief to borrowers that are under extreme pressure. But further rate cuts appear unlikely, as we need to maintain financial stability and remain attractive to foreign bond investors.

Bond yields are attractive

The aim of the Allan Gray Bond Fund is to achieve decent absolute returns. Over the long-term, this has been a return above inflation. However, there are risks, as were seen in March when bonds declined sharply due to intense foreign selling. This was abnormal and the Reserve Bank stepping in to buy bonds stabilised the market. Since then SA bonds have recovered most of their losses.

In evaluating bonds, one tries to anticipate major global economic trends with assessing the direction of inflation, which ultimately drives bond returns. Supply (issuers: government and corporates) and demand (local and foreign buyers) also drive short-term movements. Currently, SA bonds offer the most value relative to other emerging markets and are the cheapest relative to US bonds since 1980.

Investing with uncertainty and risk

Since early April, further volatility has been anticipated and expected and a less active approach has been taken, as one waits to take advantage of better opportunities.

The news is bleak, and headlines are expected to get worse, as COVID-19 cases in SA increase exponentially. However, there is little that can be done to stop the spread of the pandemic. Hence, there is no shortage of risk, with the biggest risks being the unpredictable actions taken by politicians.

Government finances are weakening, as a lot of money has been spent to prop up the economy and tax revenues are falling. Although low interest rates are giving relief to borrowers, they are putting pressure on savers seeking safety in Money Market accounts, where returns will drop below 5% this year.

Over the long-term, and assuming a return to more normalised conditions, many equities offer great value, but opportunities should be approached cautiously as some businesses will not survive in their current form.

Putting a country into lockdown is relatively easy. But, implementing and managing a successful exit strategy is far more complicated, and no one knows with any certainty how this is going to be done.

Investonline’s view – A bumpy-ride ahead

The offshore stock market is overvalued after the recent rally and there is downside or sideways volatility in the short term. However, we do think the JSE will be higher in three years’ time, despite the negative economic effect of COVID-19 in 2020 and 2021. However, it is likely to be a bumpy ride, and not for the faint-hearted.

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