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Our dearly beloved rand

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

Over the past year, the rand has been battered and it seems as if there will be no relief any time soon. Consequently, we have had to revise our year-end USD/ZAR forecast up from R16.50 to R17.50 and we will consider taking money offshore for our clients at R18.00 levels.

At first, it was the United States (US) Federal Reserve that started to increase interest rates, together with recession rumours that began to spread, which caused investors to run to the safety of US markets. As short-term capital flooded the US markets, the US dollar (USD) got stronger and stronger, and the rand, consequently, weaker and weaker. History told us that the USD usually started to depreciate again 12 to 18 months after its initial increase, as the US economy came under pressure. This usually causes investors to start looking for yield elsewhere, which, in turn, helps to support other emerging market currencies, like the rand. Unfortunately, 12 to 18 months later, the US economy is still the healthiest economy out there and shows very few signs of slowing down substantially. Because uncertainty scares investors, and because developed countries now offer even more attractive yields and their listed companies seem to be getting through tighter monetary conditions, emerging market currencies are bleeding (note that this is not something that can be sustained indefinitely). Unfortunately, owing to a failing state in South Africa (SA), the rand has not only been battered by global waves but local waves too. We all know about government’s inefficiencies but the rate of deterioration has recently weighed more heavily on the rand.

Failing state-owned enterprises, like Eskom, have led to rumours about rolling blackouts. In fact, many larger corporates have already started to plan for a “no-grid” eventuality, when Eskom will simply fail and take the economy back to the dark ages. We do not believe that we are close to this point but markets seem to be starting to price this in as a potential eventuality. Even if we do not have a total grid collapse, government’s persistent erosion of the business environment is weighing down any potential we have for growing our economy sustainably.

Failing state relationships, poor political allegiances, and news about SA’s support of Russia’s war in Ukraine have soured our association with important trade partners who represent the bulk of our annual trade volume. Markets fear that we will be excluded from important trade agreements, like the US-based African Growth and Opportunity Act, as well as that other trade partners will enforce trade restrictions against us, fuelling concerns about lower growth, more unemployment, and higher inflation.

Failing state finances mean that we continuously allocate scarce resources ineffectively and inefficiently. Ineffectively means that most of our budget is allocated to the wrong expenditure items, like salaries and grants, instead of to capital, which includes infrastructure, healthcare, and education. We also allocate resources inefficiently, which refers to wasteful and irregular expenditure, and the horrific performance of those items that we do spend on. Compared with most other countries, and on a range of performance indicators, we still have the weakest performing education and healthcare results in the world. Put this all together and it is no wonder the rand is having such a hard time!

For now, we believe that the rand will remain weak but that the recent fall to levels beyond R19.40 is a bit too much. Markets are a collective of emotional human beings and, therefore, tend to overreact. We should see the rand strengthen back towards levels closer to R17.50. However, the longer the rand stays above trend, the more it gets used to staying there.

How to avoid permanent capital destruction

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

We all know the age-old adage that has held true throughout history: “It is not about timing the market; it is about time in the market”. As investment managers, we have the pleasure of celebrating the wisdom of this adage with our clients when they achieve their long-term investment objectives. Unfortunately, we also witness the flipside of the coin, when clients sell out of underperforming investments and buy into the flavour of the month based on short-term return differentials. This is when the risk of permanent capital destruction is at its highest, and many investors make mistakes that are detrimental to their long-term financial planning.

Looking at historic returns data, performance between active investment managers diverge over time and, more importantly perhaps, tend to out-/underperform following a period of out-/underperformance, as each investment strategy has unique performance characteristics during different market conditions. This is common knowledge for most investors but clients tend to become short-term focussed when uncertainty is elevated. And who can blame them! The past three years have been somewhat of a rollercoaster ride, not only in the financial markets but in daily life as well. In the scope of less than three years, we have witnessed a pandemic that virtually shut down the planet, an ongoing war in Europe, a cost-of-living crisis caused by multi-decade high inflation, and two bear markets. Unsurprisingly, investors are cautious and feel as though they must do something, which is often erroneously changing investment managers.

We, as investment managers and financial advisors, are required to not only provide prudent financial advice but also to educate clients on behavioural biases that are more psychological in nature and that may lead to suboptimal decision-making. Behavioural biases are unconscious beliefs that influence our decisions and decision-making processes. We have found that investors often struggle with loss aversion, a bias that causes the investor to experience greater discomfort from losses than they find value in an equivalent gain. Compounding the problem is regret avoidance, in which investors fear the regret of not changing investment managers that are underperforming in the short term (experienced as a loss) without looking at the facts and remaining emotionally neutral during decision-making.

Historical analysis, therefore, unsurprisingly suggests that the probability of achieving long-term investment success increases as we manage biases and limit short-term decision-making – reducing the risk of permanent capital destruction by staying invested and by maintaining a long-term focus. The notorious investor, Peter Lynch, once said: “Stocks are a safe bet but only if you stay invested long enough to ride out the corrections”. We believe that this holds true for the stock market as well as for investment managers. It all comes down to trust. Trust your financial advisor to guide you through the process of planning your financial future. Trust your investment manager to invest your assets prudently. Trust is at the core of what we do here at Efficient, and we maintain it by investing time with clients, helping them stay true to their financial plans, and celebrating with them as they achieve their long-term financial objectives.

The good times are here to stay – or are they?

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

“We believe in what people make possible.” This is the slogan of one of the fastest-growing companies in the world, Microsoft. Currently, Microsoft seems to be achieving feats beyond what is possible. Growth within the world’s largest economy, the United States, has recently slowed down. Gross domestic product figures show that the number of goods and services created in the last quarter registered the weakest pace of expansion since the second quarter of 2022. At a business level, the majority of corporate America is feeling the pinch of higher interest rates and slowing growth. The impact of higher interest rates is usually only felt 12 months after the original hiking decision was made. It is, therefore, apparent that the worst effects could still lie ahead. For the time being, however, tech stocks, such as Microsoft and Alphabet, seem to be bucking the trend. Since the start of 2023, their respective share prices are already up 28% and 23%. But, on an even broader scale, the top performers all seem to be tech-related stocks.

There are a few reasons why tech is performing strongly in 2023. One of these is investors hopping back into some of 2022’s worst-performing stocks, smelling a bargain. Investors also seem to like certain unique qualities in tech, such as resilient demand and growth, which stand in stark contrast to an environment filled with concerns about failing banks and inflation-strapped consumers. There are also company-specific reasons. For example, Microsoft has achieved a new 52-week high because of the current optimism around its artificial intelligence (AI) services, following its investment in OpenAI in 2022. This investment is already beginning to have an impact on market share and performance, and there is a lot more scope as Microsoft starts to merge its cloud (Azure) and AI (OpenAI) services. This combined service already has 2 500 customers, including Shell and Mercedes-Benz, with more customers being added at breakneck speed.

Investors’ attention has, therefore, been diverted away from the economically sensitive areas of big tech. For example, the weaker economic backdrop has resulted in consumers buying fewer personal computers (PCs) globally. This has not only affected Microsoft’s PC sales but also other areas of its business, i.e. the demand for its software. Other companies, such as Intel, have felt the effects of a softening in PC demand more acutely as many of those PCs are powered by Intel chips. Other segments of the market are also struggling. Google, for example, reported a second consecutive drop in advertising revenue, while Facebook informed its employees to expect a slower pace of hiring following the company’s latest round of layoffs amid uncertainty in advertising spending going forward.

Tech’s stellar performance over the last several months represents a unique problem for the market: Overdependence on big tech gains has done little to provide assurance about the health of the wider economy, which leaves investors especially vulnerable if tech should stumble again. Signs of this could not be reflected more clearly than by the ongoing layoffs at big tech, which serve to boost near-term figures but is also likely to signal a weakening in the intermediate-term outlook.

While investors have been rewarded for their contrary positioning in big tech, despite a weakening global economic backdrop, they will certainly have to exercise caution going forward as we continue to move into a stock pickers environment.

Investment Management vs. Wealth Management

While investment management is an important segment of financial planning and overall wealth management, wealth managers take a more holistic view of a client’s financial health. Our expert financial planners at Efficient Wealth are proven leaders in the financial industry in South Africa. We specialise in wealth and investment management. With this in mind, in this article, we will explain how the two professions differ and why you may need the professional services of both.

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4 Types of Financial Planning

Different types of financial planning can aid you in achieving discipline over your finances and a layout a concise direction of where you wish to be in your life. In this article, we’ll discuss the four types of the practice and how sacrificing funds to support them will benefit your life now and in the future.

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The 5 Steps of Successful Financial Planning

There is never a wrong time to begin with a financial planning strategy that will best suit your needs for your future. Starting as young as possible is always the best option but re-evaluating your financial situation later in life is also a healthy exercise. Having a financial plan assists you in assessing where you are today and where you want to be in the future. The leading financial planners at Efficient Wealth explain five steps to get you started.

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Comparing Business-related vs. Personal Financial Services

Business-related vs. Personal Financial Services

For your business, Efficient Wealth’s business-related financial services involve managing your income revenue streams, cash management accounts for debts, assets and liabilities. Business  assurance and fiduciary services also ensure that your business can continue even if you are not there anymore. Personal financial services on the other hand involve your financial security and the financial security of your family and loved ones. This could entail everything from expert advice on immediate budgeting adjustments and short-term insurance, to planning for a baby, dread disease and medical cover, retirement planning, and life assurance.

Competent, expert financial services for your personal and business ventures can help you to get a head start on your and your family’s financial well-being. The right time to seek advice on these sometimes-complicated, ever-changing financial decisions is always now. So, whether you are just starting out, re-assessing your liquidity or simply reaching a stage where you would like your money to start working for you, it is time to consider partnering with the trusted financial experts at Efficient Wealth.

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The Value of Partnering with an Expert Financial Advisor

If dreaded disease cover is left disregarded and you or a loved one is diagnosed with a serious ailment, it could lead to financial distress or even bankruptcy.

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The long-term effects of the tightening cycle

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

 

The global economic landscape has been experiencing a tightening cycle for roughly a year, and it is becoming apparent that its effects are both spreading and deepening as disequilibrium becomes more apparent. Recently, we have also experienced that the banking system is likely to be a contributor to the damage being done. The flow of liquidity from cash and credit to assets and spending is critical to the success of economies, and the combination of central banks raising interest rates and draining reserves, coupled with banks experiencing more constrained deposit and capital conditions and tightening credit standards, is likely to constrain the flow of money and credit to markets and economies. This, in turn, is likely to have a detrimental impact on spending and income.

Three major equilibriums and two major policy levers interact to drive markets and economies. The first equilibrium in the rich world is spending and output in line with capacity, which roughly translates into approximately 2% real growth with 2% inflation, a nominal spending growth rate of 4% to 5%, and an average unemployment rate. The second equilibrium is that debt growth must be in line with income growth, meaning credit growth that is not too high or too low, with interest rates that act as neither a major incentive nor disincentive to borrow. The third equilibrium is a normal level of risk premiums in assets relative to cash, meaning that bonds provide an expected return above cash, and equities an expected return above bonds, commensurate with these assets’ risks. The two policy levers are monetary policy and fiscal policy. The economic and market swings that we see reflect the never-ending struggles of the marketplace and of policymakers to achieve equilibrium. In the West, we are far from equilibrium, while in the East, we are closer to it. The closer an economy is to equilibrium, the easier it is to fix problems and the lower market volatility.

In developed economies, high nominal spending, when compared with the ability of an economy to produce more, remains the greatest disruption to equilibrium today. This leads to inflation that is significantly above target, leading to big policy shifts and high market volatility. Despite aggressive policy action, the United States (US), Europe, and the United Kingdom (UK) have not moved much closer to equilibrium. On the margin, the nature of the disequilibrium has shifted from too much inflation to not enough growth, with the risk premiums on assets decreasing relative to cash.

The path from disequilibrium to equilibrium allows for big market swings. When looking at why the economy is in bearish disequilibrium, we see that inflation is too high. Nominal spending, in turn, is too high to bring inflation down and unemployment is too low to bring wages down, and despite nominal growth being too high, the real growth rate is lower than desired. In the end, a weaker real growth rate, that is, an earnings recession of sorts, is required to resolve the other imbalances.

In conclusion, the effects of the recent tightening cycle are spreading and deepening, and the damage to the banking system is a manifestation of this tightening. Markets are in disequilibrium and the high level of nominal spending remains the greatest disruption to equilibrium today. Despite aggressive policy action, the US, Europe, and the UK have not moved much closer to equilibrium. The path from disequilibrium to equilibrium allows for big market swings, which is a frame of reference for longer-term positioning. It is thus crucial for policymakers and market participants to remain vigilant and proactive when managing these risks and when taking steps towards a more stable and sustainable economic environment.

Why more interest rate increases in South Africa do not help

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

To understand why more interest rate increases in South Africa (SA) may not effectively combat inflation, one must first understand the broader economic factors that contribute to higher inflation rates in emerging countries when compared with developed nations. According to research conducted by various institutions, including the International Monetary Fund (2018), the World Bank (2021), Alhassan and Biekpe (2020), and our own studies, weak economic fundamentals, political instability, commodity dependence, exchange rate volatility, and the United States (US) dollar surcharge, are major contributors to relatively higher levels of inflation in these countries.

Despite the South African Reserve Bank’s (SARB’s) status as an independent and healthy institution, the country’s poorly-managed state and lack of fiscal discipline negate many of the benefits that a strong central bank may provide. Political instability further exacerbates the issue. Also, as a commodity-dependent country, SA is susceptible to inflationary pressures when global demand for scarce resources increases. Furthermore, with a volatile currency and a reliance on imports, SA is vulnerable to import inflation.

Typically, exchange rate disparities are driven by inflation differentials between countries and a ‘sentiment’ factor, which represents consumers’, businesses’, and investors’ perceptions of a country. In SA, inflation differentials have accounted for nearly 73% of the difference in the USD/ZAR exchange rate since 1980, with sentiment contributing to the remaining 27%. However, sentiment can be volatile in the short term, resulting in exchange rate fluctuations. For example, negative long-term sentiment towards emerging markets, particularly SA, most likely caused the rand to depreciate by 7.75% and 16.42% in 2021 and 2022, respectively, despite having lower inflation rates than the US.

Developed and competitive countries, such as the US, Japan, German, and Switzerland, typically have strong exchange rates owing to lower inflation rates and supportive sentiment, which attract short-term capital for investment in their financial markets. In contrast, countries that are competitive but not developed, such as China, India, Malaysia, and Mexico, may have strong exchange rates in the short term owing to supportive sentiment but weaker rates in the long term owing to higher inflation rates. These countries often attract long-term capital in periods of positive sentiment where the return on investment can more than make up for an underperforming currency in the long term. The SARB’s attempt to attract either short- or long-term capital and support the exchange rate, and thereby inflation, is, therefore, rather futile. Higher real interest rates in SA have been largely ineffective in supporting the rand. Since 2008, while the SARB persistently kept real interest rates higher than those in the US, the rand depreciated more than 125% from R8/$1 to more than R18/$1 in 2023. It even depreciated more than the 96% average depreciation of counterparts such as Brazil, Russia, India, China, Indonesia, and Malaysia, among others. The only ones who have benefitted from higher positive rates in SA are the handful of households with more assets than liabilities.

Finally, there is the US dollar surcharge, whereby the US uses their reserve currency status and their ability to generate excessive demand for globally-traded goods and commodities by using tools such as record-low interest rates, quantitative easing, and large stimulus checks to drive up prices. When inflation eventually occurs in the US, the Federal Reserve will increase interest rates, causing the dollar to appreciate significantly, thus exerting inflationary pressure on emerging countries owing to their declining buying power.

For these reasons, we have consistently cautioned against the rate and the size of the SARB’s interest rate increases. In the past, this blunt tool might have been sufficient to address inflation. But today, where broader economic factors contribute to relatively higher inflation, it is more likely to be ineffective and places an unnecessary burden on a country that is already under severe strain. We agree that price stability is important for a healthy, growing economy, but we believe that the SARB has lost touch with the citizens they serve. Slightly higher inflation with lower interest rates would be easier for most families to stomach.