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[TOP STORY] A look at dollar direction, commodities, interest rates and valuations

Izak Odendaal of Old Mutual Wealth on whether 2021 could bring a change in the view of SA as a perennial underperformer.

SIMON BROWN: I’m chatting with Izak Odendaal. He’s an investment strategist at Old Mutual Wealth. Izak, good morning. I appreciate your time. A great note has come out from you and your team, rather than predictions, which is the sort of trend we see around the January period when everyone is trying to predict the future. You’re saying, hang on, there are some questions here. And you’ve got five of them. We won’t touch on all of them. Time is tight. 

The first one I do want to touch on is dollar direction. We saw a weak US dollar in 2020. Massive stimulus should weaken it further. Of course, the stimulus could boost the US economy. So it’s a bit touch-and-go (as to) whether it’s going to be weaker in ‘21. Of course, the world perhaps likes a weaker dollar, and we’d like to see some weakness going through the rest of the year.

IZAK ODENDAAL: Yes, absolutely. I think that’s one of the key issues, and it also speaks to the future of commodity prices, which you spoke about with your previous guest. I do think you’re going to have those two forces rubbing up against each other. The US is printing more money or stimulating its economy more than other major countries. That will tend to put downward pressure on the dollar. 

But, by the same token, if that leads to a relatively stronger US economy, and perhaps rising interest rates there, that that will have the opposite effect. So I think those two forces are probably pushing up against each other,

… and I wouldn’t expect dramatic moves from the dollar either way during the course of the year.

But as things stand, the world is quite happy with the dollar being much weaker than it was a year or so ago.

SIMON BROWN: As you say, it’s weaker. We can quite like it if it just stays more or less where it is. 

The other thing is a bubble in stocks, particularly US tech. You make the point (with) the phrase ‘this time is different. It’s very, very scary. In truth, valuations are 2000 levels, but it is different. These tech companies make profits – and truthfully lots of profits. We’ve got low rates, which obviously helps into that. So these tech counters are expensive, but perhaps they’re not so much “bubble” expensive, because this time it’s the real deal in terms of 2000; really my sense back then is that it was a lot of smoke and mirrors.

IZAK ODENDAAL:  Yes. I think there probably are elements of smoke and mirrors in some parts of the market – some penny stocks. And there’s that kind of retail day-trading element happening. But yes, those big companies out there are printing money hand over fist. So it is very different from what we saw in the late nineties. 

And I think the interest-rate story is also very important. The US bond deal was 6% in 2000 and now it’s around 1%. And those low-interest rates do kind of change the calculation on all stocks. But I think the other thing to remember is that, even though the big, big stocks are quite expensive, I think there are other areas in the US market that are not, and those areas will benefit from a stronger economy as the vaccines roll out, and as some of these stimulus measures start taking action. 

So I’m not bearish on US stocks, but I think the old lesson is just that when you have very high evaluations, that tends to dampen your future returns.

That’s not a timing mechanism. It doesn’t tell you when to get out of the market; it just suggests your longer-term returns are going to be disappointing relative to something that you buy at a more attractive valuation.

SIMON BROWN: That’s a good point. It’s the price you pay that informs that profit you’re going to make down the line. 

A quick last question. Your last one is, is this the year when things finally get better? We’ve seen second waves in the pandemic, but we also see vaccines rolling out. Locally, of course, we’ve got challenges around Eskom and the like. There are a lot of moving parts. There are a lot of risks out there, but we are off a low base. My sense is that there’s certainly some merit for perhaps the cliched sort of cautious optimism for 2021.

IZAK ODENDAAL: I think certainly in the local scene. We are all coming off an extremely low base – not just last year but also sort of four or five years of disappointment year after year in terms of growth, in terms of equity market performance, in terms of fiscal policy. And I think of a big, probably under-appreciated, boost that we’re going to get from commodity prices, which has obviously already helped mining shares. 

But if you think about this, the feed-through to a higher tax revenue for the government, that that could be the first time in probably seven or eight years that we actually have an upside surprise on tax revenue this year.

And I think that’ll definitely get a bit of a change in the narrative on South Africa as a kind of a perennial underperformer, whose the only direction is down.

SIMON BROWN: To your point, that will be huge. The base effect on all. But an upside effect on tax will be absolutely great. Izak Odendaal, investment strategist at Old Mutual Wealth,  I appreciate the early morning, sir. 

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Financial repression is the only tool that can lower the current record levels of debt in the system. The powerful combination of loose monetary policy at the Fed and deficit spending by the Biden government will force the dollar weaker against the Euro. The ECB can print all the money they want but the Euro zone does not have a single fiscal authority to implement the coordinated deficit spending to effectively fight in this currency war.

As the winners in the currency war, the US will support growth in Emerging Markets and may even turn the SA economy away from the abyss we are heading for. A weaker dollar will create a rising tide for the JSE, and a rising tide lifts all boats.

End of comments.

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