Last week, the South African Reserve Bank (SARB) increased interest rates for the eighth consecutive time since they started their rate-hiking cycle in November 2021. Since then, the prime interest rate has increased by 3.75% to 10.75%, its highest level since 2009. This means that every R1 million debt that a household has, will now be roughly R3 125 more expensive each month; a thought that is keeping many South Africans awake at night. Data shows that the middle class, roughly 4.1 million adults earning between R8 000 and R30 000 per month, are now spending almost two-thirds of their salary on servicing debt. In general, South African consumers seem to be hanging on by a thin thread with very limited room left to manoeuvre in their personal finances. We are, however, confident that we have reached the end of the rate-hiking cycle in South Africa (SA) and that there is, most likely, only one more hike left. The next hike will probably be 0.25% or 0.50% and should be announced in the upcoming months. Our view is also that South Africans can expect to see the first rate cut early in 2024.

But why all these interest rate increases? Interest rate increases are usually applied to dampen demand, which they can do effectively and, therefore, they assist in cooling demand-driven inflation. This is why the Americans have also been increasing interest rates at such a rapid pace. But unlike the United States (US), we do not have enough demand to push prices up. In SA, consumers have been battered by a poor-performing economy and market for many years now. Our economy is not even growing fast enough to slow down the pace of unemployment, which is fast approaching a new all-time high, and our equity markets have been underperforming for many more years.

On the other end, the US economy has only recently come out of its longest expansionary cycle ever; for more than 10 years the US economy grew without a recession. Consequently, US unemployment reached a historic low, US incomes flourished, and household wealth ballooned as property prices soared and the US equity market delivered unbeatable returns. If that was not enough, the US government gave out cash to all US households to support them during the pandemic. So, while excessive demand in the US helped to boost inflation to near 40-year highs, demand in SA has had an insignificant effect on prices. In fact, the current, slightly higher-than-normal inflation levels that we have in SA today have very little to do with what is happening in SA. External factors, such as a strong US economy, put pressure on the rand, which increases all of our import prices, which are more than 30% of our gross domestic product (GDP). Other external factors, such as the war in Ukraine, tensions in the Middle East, oil supply constraints enforced by OPEC+, and droughts in high-yielding agricultural countries, all put pressure on the prices of important necessities, such as food and fuel; the two items that contribute most to inflation in SA. Local interest rate changes have a very limited impact, if at all, on external forces and supply-based inflation forces such as these.

Nevertheless, the SARB has been trying to keep short-term interest rates as high as possible, albeit at a high cost to South African consumers. This is done to attract short-term capital inflows, which can boost the rand’s performance, which, in turn, should help to reduce import inflation. Although, until now, the SARB’s efforts have been as useless as fighting against a tsunami, they should pay off soon. We believe that the rand can strengthen to at least R16.50 against the US dollar in 2023, although it might appreciate well below R15.50 for brief periods. This is not because of a success story in our local economy (load shedding is making that impossible), but because of a slowdown in developed economies, a shift towards emerging markets, a normalisation in global currency markets, and the frontloading done by the SARB to attract capital to our markets. As for inflation in SA, it should gradually decrease as markets grow more certain about external forces, and supply-based forces are resolved.

Global markets were all over the show the past week, trying to digest the myriad of, often opposing, data that was released from all around the world. When considering the likely growth trajectory of the global economy market, observers turn towards the large economic blocks: The United States (US), Europe, and China (which is often also used as a proxy for growth in Asia). Data from the US and China stole the show last week. Jobs cuts from large corporations, a plunge in manufacturing data, and a slowdown in job creation numbers, highlighted the bumpy road ahead for the US, the world’s top economy. However, optimism around inflation and the interest rate outlook improved. Meanwhile, China, the world’s second largest economy, will attempt to increase its economic output after a dismal 2022.

Analysts have been warning that there are still plenty of bumps in the road ahead for the world’s leading economies, with concern now turning to the effect that higher interest rates will have on corporate earnings. It was, therefore, no real surprise when Goldman Sachs, a banking titan, released weak earnings results, but they were not the only ones. Google’s parent company, Alphabet, announced plans to cut about 12 000 jobs worldwide, propelling shares up by nearly 6%. The move came a day after Microsoft said that it would be reducing its staff complement by 10 000 in the coming months. Similar layoffs by Facebook owner Meta, Amazon, and Twitter have also been announced.

US nonfarm payroll numbers boosted riskier assets with slowing wage growth, helping to temper expectations about the size of the upcoming US Federal Reserve (Fed) interest rate hikes. Many expect the Fed to only increase interest rates by 0.25% at its next meeting. Although the recent job number was robust, the trend in the US job market is that of a slowdown as is evident from the layoffs at large US corporations. It is, however, worthwhile to note that the US economy added 4.5 million jobs last year, the second-best year on record, after 2021 when 6.4 million jobs were created. These large increases led to the multi-decade low unemployment rate of 3.5%. For this reason, a slowdown is probably a natural occurrence. But a persistently strong labour market also means that the Fed needs to keep interest rates higher for longer, despite the cooldown in other macro-economic variables. The reason we say this is because we believe that central banks’ attitudes are changing.

The global financial crisis did not result in a new Great Depression, but central banks have become much more sensitive to the risk of deflation; for more than a decade they have reacted to every shock with overwhelming monetary easing. Similarly, the recent inflation surge will not result in hyperinflation, or even in a 1970s-style inflation spiral, but it will make central banks much more sensitive to the risk of entrenched higher inflation. Central bankers now understand that prolonged loose monetary policy contributed to the multi-year inflation overshoot that we are currently experiencing. We are, therefore, likely to see a structural change in central banks’ attitudes, that is, their safety nets might be less supportive than in the past and that, in turn, will force investors to recalibrate how they price assets.

Nevertheless, hopes for China’s recovery continues to provide much-needed support to the global economic outlook. Last year, when the Chinese economy grew by only 3%, the economy expanded at its slowest pace since 1976, excluding the pandemic-hit 2020. Looking forward, we expect to see a sustained economic recovery in 2023 because of the re-opening from the zero-COVID stance and policy stimulus. News is also starting to emerge that the clampdown on the internet sector is drawing to a close, offering the prospect of an end to two years of uncertainty sparked by regulatory interventions, including gaming restrictions for minors and online tuition. Overall, while attempting to see through all of the noise of the data that was released last week, we believe that the world will, most likely, not enter a recession.

Finally, we come to the end of another volatile year that tested the best of us. Since the latter parts of 2018, global markets have not been kind towards investors. Markets fell by roughly 15% in the final stretches of 2018, then recovered, and then the COVID-19 pandemic in 2020 beat down the markets by more than 30%. After governments stepped in with substantial fiscal and monetary support, which ballooned debt and overstimulated demand even more, the recovery was quick. Until 2022 came along. This time it was the historic shift in monetary policy that beat markets down. Unfortunately, 2018 is about as far back as investors remember. In this specific application of the recency bias it causes investors to make the wrong long-term asset allocation decisions because the short-term volatility we experienced since 2018 gets the best of their emotions. In the end, their long-term investment performance suffers.

In South Africa, interest rates have doubled from 3.5% in November 2021 to 7.0% at the end of 2022. This means that every R1 million debt that a household has, is now R35 000 more expensive each year. That means almost R2 920 extra expenses each month, an almost unbearable load for consumers who are already stretched thin. In the United States (US), the Federal Reserve (Fed), increased rates at a similarly historic pace. Although US consumers were fattened by plenty of government support, and more than a decade of overperforming equity markets and other asset classes. US consumers have therefore gone through their interest rate hiking cycle almost unscathed; albeit for now. Nevertheless, this historic shift in monetary policy shook the very fabric of markets as asset class returns and investor sentiment started to normalise. At one point in time, global markets were again down by roughly 30%. But year-to-date the MSCI All Country World Index, an index that represents most of the largest companies in the developed world, is only down -13.25% in USD (or -10.98% in ZAR). Closer to home, the Johannesburg Stock Exchange All Share Index (JSE ALSI), an index of all listed companies on the JSE, was up by 1.52%, outperforming global markets simply because it has been underperforming for many years.

Unfortunately, investors are plagued by recency bias; most of us cannot even remember what we did a few weeks ago, how can we be expected to remember how different asset classes performed over the last 15 plus years? Biases like recency bias and loss aversion, also cause us to interpret reality incorrectly, making it almost impossible to objectively, and therefore accurately, allocate assets for the next 15 plus years. This causes investors to become emotional and short-sighted and end up selling out of good long-term strategies. Even the new favourite, structured products, have not stood the test of time and we have seen many clients who were upset with the decision they made to allocate an overweight position to structured products. As an example, many investors who piled into various Eurostoxx structured products, the favourite of 5-10 years ago, lost out considerably as inflation and costs ate into their capital, which was at least secure. But that is not the worst of it… You must also consider the opportunity cost of getting your money back after 5 years and having missed out on the returns of alternatives; even the JSE ALSI outperformed many of these structured products. However, history is clear that after tax, inflation, and costs no other asset class in the traditional financial sector outperforms equities. History is also clear that trying to time the market rarely ever works out well for investors. Research is also clear that the objective and holistic assistance of reputable financial advisors and asset managers adds substantial value to investors in the long-term.

Where does that leave us for 2023? At the end of 2021, we advised our clients to prepare for steep interest rate increases. Those who listened are in a much better position now. We recommend that individuals should not allow short-term volatility to change their long-term asset allocation decisions; even in a worst-case scenario where a president might have to step down. Do not be too hasty in making decisions. Seek objective truths, and always speak to your independent financial advisor so they can help you to develop a holistic, multi-generational financial plan. With a clear objective, a time-horizon that stretches over generations, and an objective, independent analysis, you can allocate resources much more efficiently in the long-term and create the wealth you and your family deserve.