CAPE TOWN – Perhaps the biggest impact on investment markets since the 2008 financial crisis has been the way developed banks in many big economies have engaged in quantitative easing (QE). Essentially, this increased the supply of money with the aim of stimulating economic activity.
Although the effectiveness of this strategy remains questionable, it has persisted for many years. And one of its major outcomes has been to support equity prices.
As the chart below shows, the S&P 500 Index in the US moved consistently upward between 2011 and mid-2014, as the easy money provided by QE went looking for a home.
Source: INET BFA, Rezco Asset Management
This, has however now resulted in very abnormal market conditions.
“You have a situation where there is too much money chasing too few assets,” says Brian du Plessis, executive director at Rezco Asset Management. “There’s this creation of a pool of money that just keeps growing.”
At the same time, low and negative interest rates have forced investors out of safer assets into risker ones in search of yield.
“Savers have moved out of traditional safe-haven assets in search of some sort of return in equity markets,” Du Plessis explains. “With really low interest rates, we have also seen companies borrowing money to buy their own shares, further reducing the pool that is available.”
All of this means that asset prices are being artificially supported, which creates a huge challenge for asset managers.
“Essentially you are trying to manage money rationally in an irrational time,” Du Plessis says.
The result has been the increased volatility in equity markets over the last few years. Since the middle of 2014, the uninterrupted upward movement of equity markets has been replaced by a series of ups and down.
This is indicative of how difficult it is to find conviction. Every piece of news brings a sharp reaction that only lasts as long as it takes for the news cycle to turn again.
As the graph below shows, the S&P 500 has moved 9% or more in either direction seven times in the last three years. The shortest of these cycles has been just one month, and the longest nine months.
Source: INET BFA, Rezco Asset Management
The only reasonable response in this environment is to be extremely conscious of risk. You have to be conservative in your positioning and prioritise the conservation of your capital.
“In a multi-asset portfolio, you have two tools at your disposal,” says Du Plessis. “Those are asset allocation and stock picking. And the former is the most important.”
At the moment, the key is to “play good defence”, in both your currency and asset exposures. Despite recent rand strength, Rezco believes that this still means being overweight offshore.
“The rand has appreciated a lot this year, but we still think the rand will depreciate long term,” Du Plessis says. “We don’t think government will do enough to structurally turn the economy around before the ratings agencies make the next decision in December, and there is still a very good probability that we will be downgraded. And that will have a domino effect.”
The challenges facing the local economy mean that local companies will also struggle to grow.
“As much as I want to be positive about South Africa, there are a lot of things that we structurally need to sort out,” Du Plessis argued. “So for companies generating all their revenues in South Africa, it is going to be hard to generate earnings growth.”
Rezco is therefore heavily underweight South African equities, and has a lot of cash in its portfolios.
“We just feel that if you can get 8.5% on NCDs, that’s not a bad return right now,” Du Plessis says. “Cash has been the best performing asset class over the last two years behind listed property.”
While these may seem like short-term positionings, the key is the long-term effect on performance. What is vital now is avoiding any major draw-downs that may take many years to recover in a low growth environment.
“We see the storm that we are in, so we have to trust the way we have managed money previously,” Du Plessis explains. “It’s like flying a plane. If you are a pilot and you get caught in the clouds, you won’t know where you are going if you don’t use your instruments. We have to trust what has worked before when things get precarious.”