SIMON BROWN: I’m chatting now with Daniel King, head of fixed income at Counterpoint Asset Management. Daniel, I appreciate the early morning time. You put out a note last week around our bonds, and you make the point that South African bonds are – we’ll get to the vigilance part in a moment – cheap, particularly relative to their peers, offering opportunity here.
DANIEL KING: Yeah. Thanks, Simon, thanks for having me. I think the fixed-income space globally is actually quite a tricky space right now, because there are risks everywhere with inflation and rates moving all over the show. But in terms of preference order, we do generally prefer emerging-market bonds to developed-market bonds right now, because we have this legacy in the developed-market universe of massive central bank involvement in government bonds. While we don’t necessarily know the exact extent of the impact of that on yields, it does raise a question mark there about how appropriately those bonds are being priced. In emerging markets we don’t have that problem and so we believe that the market is at least free to appropriately price the risks. Although the risks are of a different nature they’re free to price those risks that exist and compensate us for that.
South Africa sits within that space. And so in particular our government bonds actually screen as one of the cheaper outliers in the valuation spectrum, providing yields of up to 10.6% right now – which, if you use historical inflation rates, might be a real yield of up to 5%.
Plausibly, if the inflation target is lowered to the peer level over the next decade, it could be as much as 6%/7% real at some point in the future. That is just unparalleled in the developed-market space, where real interactions for the most part are still negative. So yeah, we are generally quite overweight South African bonds, but we’re also quite sensitive to the risk involved as we highlighted in the note which we published. It’s why we’re still being careful to diversify those exposures to a reasonable degree; and the situation can change. If it changes, we’ll be obliged to change our view, but for now we are overweight.
SIMON BROWN: I’ll take that point. It’s fluid and things can change in a hurry. But you also make the point [that they are] obviously attractive, not without risk. There’s always going to be some risk, particularly when we are cheap. Turkey is an example. I suppose the point is that we are not Turkey. In South Africa you can lay many blames at our door, [but] being Turkey is not one of them. We have, if nothing else, a very independent central bank.
DANIEL KING: Exactly. I think so. So that’s very important when you’re thinking about the fundamental pillars of a smoothly functioning government-bond market. The first is monetary integrity, and the second is fiscal integrity. We think that South Africa actually scores quite well on monetary integrity.
Arguably we have more central bank independence than even the [US] Fed or the ECB, which have arguably become quite politicised in a way.
Our central bank’s basic mandate, which is to maintain the monetary integrity of the country, is actually encoded in the Constitution, which requires a two-thirds majority in parliament to change. So I think we really do have that going for us, but that perhaps the more important and more imminent risk, in our case at least, is the fiscal side.
There are scenarios in which GDP growth does continue to be low, and tax buoyancy declines and expenditure discipline is undermined. Those are not necessarily pretty scenarios for us. A lack of growth I think in particular could usher in some unhealthy macro policy-making over time, and those are the kinds of structural changes which create the negative feedback group psyche, like the one you’re seeing in Turkey right now. That is something to be cognisant of.
But, having said that, under our current baseline scenarios – and this is true for Treasury and true for the IMF as well – the government debt-to-GDP ratio is anticipated to stabilise in the next five years, and obviously the market is wise to these risks. Our point is actually that it’s well priced. So we’re actually more comfortable taking a well-priced risk in an emerging market context, being one in the DM space, for which we are not necessarily being compensated.
SIMON BROWN: I take that point. The actions of the central bankers in the developed markets are distorting that price. But also, as you were saying that, a thought occurred to me. They are almost becoming beholden to markets rather than sort of good old-fashioned economic policy. I think of that taper tantrum from 2014. We’ll see what happens this week with the selloff that we are seeing.
Daniel King, head of fixed income at Counterpoint, I appreciate the early morning.