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Expectations for the economy, markets and geopolitics for this year

Rand hedges are favoured at this point, but we need to be very careful: Adriaan Pask, PSG Wealth CIO.

CIARAN RYAN: The year 2020 was an extraordinary year in every way imaginable, most especially for markets, which dropped more than 30% at the start of last year and then rebounded with a gain of more than 60% from the bottom. The recent inauguration of President Joe Biden in the US creates an element of uncertainty as to whether he will overturn many of the policies of former president [Donald] Trump. What does this mean for geopolitics, the world economy and markets? Joining us to discuss this is Adriaan Pask, chief investment officer at PSG Wealth.

Good morning Adriaan. What were your main takeaways from 2020 in terms of economic and geopolitical developments, and what impact did those have on the markets?

ADRIAAN PASK: Hi Ciaran, and thanks again for having me. I think one of the key observations from last year was how predictably unpredictable the markets really can be. We saw near on 50% declines in equity markets globally. And I think there was a lot of communication just prior to that, that went out and said the US bull run is sort of long in the tooth, but everything is looking fine. And many people retained their exposures at the levels because, if you look at US unemployment, it was fine. There wasn’t really an inflation problem. But it just goes to show again that these things tend to catch you.

So I think it’s more a case of understanding that we don’t necessarily always know what’s going to cause the shock in markets, but you should almost, as a matter of routine, expect these big shocks every five to 10 years.

I think the developments with the US elections are going to result in a far more stable environment, at the very least from a trade policy perspective. So I think that’s good. And obviously now we’ve seen with Brexit as well, that’s coming to at least a point where a lot of the uncertainty has been removed. So we will see some negotiation around the fringes on the specifics. But, as for last year, I think far less on the geopolitical front, hopefully.

I think that’s 2020 in a nutshell.

CIARAN RYAN: Okay, so let’s talk about 2021, the year ahead. What are the things that you expect are most likely to grab the headlines this year? Can the market sustain the kind of prices as they are at the moment?

ADRIAAN PASK: Yes, I think from a growth perspective on the macroeconomic side, I think there’s a lot of stimulus that’s already been introduced in markets, and that’s probably set to continue. We saw last week that there’s further stimulus detail coming through on a regular basis. And I think growth will definitely rebound, even if it’s only off the low bases that we created in April last year. But with further stimulus around, it is very conducive to earnings growth and recovery.

I think the bigger concern is around the fiscal debt and how that will unwind over time. You know, typically we tend to think of debt as borrowing from the future. So, if we are borrowing fiscal support and liquidity and effectively earnings from the future, at some point in time we’re going to have to address the global fiscal debt issue now.

And in South Africa, I think the markets could well end up surprising investors.

We know that things are looking dire from a growth perspective, but it does seem that the valuations are very, very cheap and there is significant opportunity for reratings. Confidence is very low and we know that that can turn around very, very quickly. Our interest rates remain low and we saw again, now, that interest rates have remained stable – and that’s probably the expectation for the year ahead as well.

So we are also in an environment that’s very conducive towards companies doing well. I think the big question is around the lockdowns and where any stimulus that goes into the pocket of a consumer will ultimately reach the economy in a lockdown environment. And there are still elements of that, as we know, but I think if you cast your mind back to April last year, where we were under ‘home arrest’, I think the environment is very different the second time around.

So I think the environment bodes well for equities, given the amount of capital that’s being thrown and dumped into the economy. But then again, we’ve got to think very carefully about global bonds. I think there’s some pain on the way there. And cash rates are very low globally. So there’s also the inflation consequence from all this liquidity. So equities are not only good from a return perspective, but they also make a lot of sense from an inflation-hedge perspective.

CIARAN RYAN: Alright. Let’s just talk about South Africa for the moment, particularly on the equity side. Are there any sectors there that are grabbing your attention? And what about local bonds, because the yields in international terms are quite attractive – but there’s a reason for that. There is a premium being applied to South Africa because of the risk factor. Maybe just talk about that.

ADRIAAN PASK: In terms of the sectors, I think if we look at our financial space, how it was sold down with the other sectors in that period from March to April, actually more into April, it hasn’t really recovered in line with the other side; I think there’s probably some uplift potential there.

Many of the financial counters are very cheap and commodities, obviously, have done very well, but on a longer-term perspective, they are still very far behind what their longer-term averages are.

And obviously, again with all the fiscal support and monetary support around, we think growth is on the cards and commodities can continue to do well into this year. So I would say the commodities and the financials look strong.

We’ve got to think about the impact of a weaker dollar, and I think we know that rand hedges are favoured at this point. But it is something that we need to be very careful and mindful of. There’s a strong probability that the rand can strengthen more on the back of a weaker dollar than anything domestically, yet that will impact the returns of those rand hedges.

As for the second one on the bonds, I think we were in a very fortunate space because, if you consider how interest rates have been declining across the globe in an effort to stimulate economies, South Africa has been in a position where our bonds have actually been offering good value as an alternative to cash investments.

If you take for example the US, yields are very, very low and there’s material risk there. So it isn’t the obvious migration from a cash portfolio into a bond portfolio – you might very well end up with a negative return there. So I think for that reason we’ve seen some of the dividend-payer bond-proxy type stocks do very well. But in South Africa we are very, very fortunate. Our bonds are yielding good returns. I think there are significant risks that we also need to be mindful of. And the difficult thing in South Africa is one of those default situations.

So we think the probability of a South African default on the bonds is very small, but therefore the risk is also very high, because they will sell off significantly in that event.

And I think the bond prices have already been pricing in an element of that to compensate investors. We know that there are many uncertainties around, but that being said, they do still seem quite mispriced. And if those default risks don’t materialise, there is very good upside on rerating in the bond space as well.

CIARAN RYAN: One of the things that happened last year which maybe surprised a lot of people was the relative strength of the rand in respect of other currencies. How do you account for that, and what is your prognosis for this year for the rand?

ADRIAAN PASK: I think, again especially from a South African perspective, we tend to obsess over the rand, and we try to make almost coincidental links with other things in our economy or politics. And although those things would filter through to a certain degree, I think we are far more susceptible to what the dollar is doing, and the dollar is a much bigger story than the rand. I think what we’ve actually seen is just dollar weakening on the back of more fiscal stimulus, and the rand has been a relative beneficiary on that front.

So, if the same logic applies and we see more fiscal stimulus coming through, which I alluded to before as something that’s on the cards, we could very well see a weaker dollar and a stronger rand.

With emerging markets there’s always this outside risk that there’s a negative surprise somewhere. For that reason, offshore diversification always remains important. But from a valuation perspective in terms of what the currencies have done, and where we see capital move, and where there’s a lot of liquidity, we think that the dollar is likely to be weakened, and that will benefit the rand.

CIARAN RYAN: Okay. So what are the big geopolitical events that we should be looking out for this year? We’ve just had the inauguration of President Joe Biden. You’ve already mentioned Brexit. The Chinese economy seems to be rebounding quite well. What other things should we be looking at?

ADRIAAN PASK: I think there are pretty much two different schools of thought on the topic. I think on the one side there’s a view that, with all the fiscal support that’s coming in, it might create a more polarised world in terms of the whole population argument. And so we might see more tension on that front between those who have and those who don’t have.

But then again, I think Biden will probably go through a process of restoring a lot of his international relationships from a US perspective. So I think there’s a lot of work to be done. I think we should expect a lot of meetings there to try and restore some of the damage that was done through Trump.

But it is a very difficult balance from a Brexit perspective. As I said, I think at least there, markets want more clarity and certainty; they’ve at least got that. I think there will be negotiations around specific industries, and people favour different parties. But as a whole, I think that the market will appreciate the clarity.

And then there’s always the debate around China and the US. So I think although in general the US will follow an approach of trying to restore some of the relationship, as I mentioned, the China-US relationship is a very complicated one. There’s quite a bit at stake. So that’s an interesting one to keep an eye on.

But if you think back to 2020, Covid took the lead role. It does sort of seem trivial to look at smaller things like trade when you’ve got massive problems from all sorts of economic perspectives produced by Covid. So it has sort of fallen into the shadow of Covid and I think this year might still be the same. So I would be somewhat surprised to see a lot of geopolitical turbulence on a global front. But, as I said, in South Africa I think we should always expect something to surface. It’s just one of those things that you get with an emerging market.

CIARAN RYAN: Alright. Final question. What should investors be looking out for in 2021? Are there any sectors that we should be paying attention to, or any events that are likely to crop up on the horizon?

ADRIAAN PASK: I think many investors tried to find some protection in cash last year. If we look at some of the unit trust flows as well, investors disinvested from multi-asset funds and equity funds into cash or fixed-income-type products. From a money market perspective, obviously returns aren’t great. We have historic lows in terms of interest rates – so that’s something that investors need to keep an eye on, not to be overly conservative. I mean, there’s quite a lot of uncertainty and we’ve just been through a big shock, but it can do a lot of economic damage to stay in cash for too long. We did mention that.

I think there’s good opportunity in South Africa, but again, I don’t think it’s as simple as just buying and holding. I think especially multi-asset managers who have the ability to do proper due diligence and research on the various bonds available, whether it be ILBs [inflation-linked bonds] or nominal bonds or other cash instruments. And also hedging in the portfolios. I think there are some returns on the table, but that needs to be done by a professional.

And then on the equity side the financials might be under strain for a little bit longer, but I think there’s a long-term opportunity. And commodities are probably set to do well still this year, but [with] commodity rallies you’ve got to be so careful when they end. So that’s also something to keep in mind

CIARAN RYAN: That was Adriaan Pask, chief investment officer at PSG Wealth.

Brought to you by PSG Wealth.

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