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All cycles turn eventually

Covid-19 is the trigger, not the cause, for global recession.
Image: Bloomberg
  • Covid-19 is the trigger, not cause, for global recession
  • Volatility and risk repricing after years of complacency
  • Long-term asset class return expectations improve
  • Coast is not clear in short term
  • Value in South African real interest rates
  • Ripe conditions for active management and hedge funds

We have warned about volatility and low investment returns for a long time. The coronavirus is just the trigger to take the global economy and financial markets into a period of correction, lower returns and heightened volatility. We are never likely to predict the exact cyclical trigger and we did not predict the virus. However, we were aware of the underlying imbalances in financial markets and the global economy pointed towards the need for this correction well before the coronavirus ensued. While painful correction is what we require to generate a better and more sustainable outlook, long-term return expectations are improving, but we are still cautious and expect further challenges over the coming quarters.

We cannot avoid our problems forever

After the longest and weakest economic expansion cycle on record, the United States (US) economy will enter a recession in 2020. The 2009-2020 cycle was 11 years compared with the post-World War II average of five years, and real GDP expanded 2.6% annualised during this cycle compared with the post-war average of 3.9%. It seems contradictory, but one of the reasons for the uncharacteristically weak cycle was deliberate attempts to avoid a recession. Policymakers used low interest rates and debt to stimulate the economy as much as possible. Developed market interest rates fell to their lowest levels on record during the most recent cycle and debt to GDP levels are at their highest levels since World War II, which highlights the overuse of monetary and fiscal policy. This is not just a US or developed market phenomenon. South African interest rates also fell to their lowest levels on record during this cycle and debt levels to its highest.

Hiding behind debt creates risks and complacency

Debt suggests a preference for consuming today, rather than in the future. This makes today feel better than it should, for example, a weekend shopping binge on credit. Persistent use of debt and interest rates is unsustainable. It is also dangerous because the low cost of debt induces less sensible investment and spending decisions. For example, cheap debt can make a risky business venture seem profitable, an expensive luxury car seem affordable or a leveraged investment into a speculative asset class seem prudent. These errors build up before recessions like deadwood that builds between forest fires. Regular forest fires burn off the deadwood, allowing the ecosystem to rejuvenate quickly and remain healthy.

Regular intervention to postpone short-term difficulty leads to a build-up in deadwood and greater pain when it finally ignites. Regular forest fires cause risk to be priced correctly and a healthy dose of scepticism keeps risks in check, whereas the longer the cycle extends, the greater the degree of complacency. The built-in economic errors reduce productivity, which is a major and under-appreciated cause of the declining trend in global economic growth.

During the boom times, it is challenging to see the deadwood, but once the correction emerges it is easily visible. Numerous countries and corporates will have their credit risk downgraded during this recession. These downgrades should have taken place many quarters before the recession but low global interest rates and reduced global volatility made the more inflated credit ratings seem palatable. South African and UK government debt downgrades in March 2020 are just two examples of this dynamic.

Cyclical challenges dictated defensive positioning

The late stage in the economic and financial market cycles advocated a defensive position over recent quarters. Nevertheless, absolute return performance for most investors is likely to be poor and tough to digest. Amongst South African asset classes, only nominal bonds and cash beat inflation over the past five years.

Globally, returns were still poor but were assisted by 8% annualised US dollar gains against the rand over the past five years. Despite the benefit from offshore exposure, the real return experience for South African investors over the past five years is comparable with the rare negative returns experienced around 1992 and 2012. This graph shows the performance of a generic regulation 28 South African pension fund portfolio with 45% in SA equity, 25% in SA bonds, 20% in global equity and 10% in global bonds.

Prospects improve as we uncover errors

The long-term return outlook improves as equity market prices correct lower. It is by uncovering our problems and admitting that they exist that we can solve them and invest in a better future. Real return 5-year expectations on global equity recovered to 7% annualised at the end of March 2020, while South African equity expectations recovered to 5%, which is encouraging but not outlandishly cheap. South Africa’s weak economic growth outlook remains a constraint for South African equity. A better long-term return outlook does not eliminate the possibility of further short-term pain.

Ripe conditions for active management and hedge funds

Asset managers that make it through the next few months should outperform their benchmarks over the coming years, seizing on market dislocations. Hedge funds have benefited in these conditions and added value. In contrast to active management, many global exchange traded funds (ETFs) have experienced uncharacteristic illiquidity lately. It is frustrating for investors to experience illiquidity within vehicles that were sold for their liquidity characteristics.

Externalities of falling developed market bond yields

Illiquidity has become a challenge with major US fixed income markets too. We will remain circumspect on the broader market outlook until these US dollar funding challenges alleviate. The weak growth and low interest rate outlook have resulted in a dramatic fall in developed market bond yields. The lower these yields fall, the more pressure on the long-term return outlook from these bonds, which poses a challenge for pensioners and insurers in developed markets. At some point these lower yields will force investors to take allocations elsewhere. Non-growth sensitive store-of-value assets like precious metals are a likely beneficiary.

Extreme real rate differentials in South Africa

The dramatic weakening in South African government bonds makes the real yields attractive. South African bonds are yielding more than 10% above their US counterparts and could return above 5% real annualised returns over the coming years. The South African rand blew out to R19/$ in early April 2020 – its highest levels on record and two standard deviations away from its purchasing power parity valuation. Challenges within US funding markets imply that the pressure could remain on the rand in the short term, but this type of extreme currency valuation is noticeable and an opportunity for some.

Opportunistic value emerging but caution still advised

Global authorities will try to circumvent the economic and market correction through doubling down on low interest rate policies and expanding government balance sheets. We are aware that these can buoy financial markets over the short term but also cognisant that these policies reduce the long-term growth potential because they intervene with the market-clearing mechanism and reallocation of capital, which is so desperately needed. These policies have already been overused, so the market should be more sceptical when assessing their efficacy. There is a balancing act between long-term opportunities, shorter-term risks, much needed corrections and policymakers who want to avoid adjustment. We continue to balance these factors, through our risk management framework, allocating across a diverse range of opportunities and using asset allocation to support clients on their journey towards their savings goals.

Rob Price is head of Asset Allocation, Alexander Forbes Investments.


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This is a “Plandemic.” There are .0002% deaths in South Africa and the ruling party decides to kill the economy over it? I just think they are morale narcissists. They had no plan for the economy BEFORE, what do you think it will be now?? I’m guessing a thumb suck.Don’t forget to vote. To add context Tuberculosis deaths 6.4% (no shut down.) H I V 4.5% (No shut down.) What the heck is going on? Who is really making these decisions putting this beautiful country into free fall?????????????

Wow Zokey – I had no idea that TB kills 3.5m South Africans every year. Good thing our borders are open. Otherwise animals would have taken over the deserted streets in the 70s already.

As for your Covid mortality rate… Please do 15 minutes of stats 101 on YouTube before commenting on a public platform.

I agree with many of your sentiments but the arguments behind them are ridiculous

Yep … Youtube ranters seem to be the self-appointed experts for a lot of lazy thinkers.

Do the exponential math as demonstrated in the chess game parable of the Indian prince and the sage .. take one grain of rice on the first square and double it as you progress along the board: 2,4,8.16,32 64 132, 264 528, etc by the time you get to the last square, there would be enough rice to cover India to the depth of a metre.

Replace rice with COVI-19 infections.

i think it has something to do with communism

Yup, I personally am NOT aware of any C19-related deaths nor aware of any infections (amongst all family, friends, neighbors, colleagues, clients, acquaintances)….yet I will need more than a pair of hands to count people I’m personally aware of that are financially affected as result of lockdown.

Govermnents’ global Covid-19 lockdown approach will go down in the annals of history as humankind’s most stuffed-up response to a flu virus!

Dare I say “Where is the virus”?!

Just because you are not personally aware of it, doesn’t mean it doesn’t exist. I know 3 people who have had it (all thankfully recovered) and they all say it is not a picnic. Still out of breath just walking weeks later. Having said that, I think it’s time for lockdown to end now. Medical services have had ample time to prepare

@Runbird. For sure, the virus is real. You personally aware of 3 persons. Accepted.

OK, in the same manner, how many people are you personally aware of that (i) has not received their April pay (ii) or had to accept a drop in pay, or (iii) business people closing completely, or (iv) pensioners lost some capital, etc?

Perhaps just 3 again??

(Yes, a life is more important than money, but in the end, with the current global economic destruction….humanity’s life expectancy will reduce, especially in poorer countries like SA. The state will collect less, i.e. less to spend on public healthcare & population getting poorer who had to either drop medical cover, or move to cheaper plan…affecting one’s ability to pay for healthcare. It will have a more SERIOUS long-term health impact, than the current Covid-19)

ZIRP ZIRP ZIRPedy ZIRP … gold backed crypto currencies

A very good macro view of the current markets, but only a brief mention of precious metals…
Surely the surge in Gold price deserves a mention as does silver. I don’t own any physical gold but perhaps a portfolio should have some, considering so many expect a blow out of the US economy due to 20 years of cheap interest rates and abundant money supply and no other currency ready as yet to fill the shoes of the green-back as the Chinese have cooked the books on their Real economy GDP

Gold is done. A myth as a store of value

And Miss Piggy and Shrek will soon be a couple..

The best investment in times like these is tangible gold..A ounce KR pre Covid’s value R22 000.. 6 weeks later R32 000..Not a bad return given that stocks went Sourh, pretty much like everything else !

A good International Gold Coin (Including the KR) is a hedge against our poor currency, even if Gold stagnates

It’s a proven fact

Thanks Rob – very interesting indeed.

Yep and oil prices will reach a record high again – some

Agree BT. Why don’t the author ask an African country about “all cycles turn eventually” Not in Africa. I would suggest asking Zambia or maybe Zimbabwe first about their economic cycles turning. And the eventual part.And then Angola or Moz or Malawi or Sudan and Tanzania. .

No, the world was already heading into global recession before Covid-19.

Covid-19 is just throwing a greater spotlight on the state of preparedness or lack thereof in all the countries where it is playing out.

It’s only when the tide goes out that you discover who’s been swimming naked.

Quote from the guru Warren Buffett

Interesting ratio is to plot total market cap : gdp over time. Also add Schiller ratio

If that does not scare you nothing will. The US market is overdue a slap to S&P around 2000

Great article Rob.

What this article also point to is the fact that too many money managers chase returns and cannot manage risk.

There are a handful of fund managers globally that are proven risk managers – Anthony Bolton, Peter Lynch, Yacktman Bros. SA very own Perpetua may also make this grade one day.

What fact sheets from perpetua support this view?…please post the link here to support the fact that they have been generating real returns for their investors. A good marketing pitch and a twitter profile from the CIO…doubt that the returns back it up

Thanks memory. I agree with the high active share reading that Colson has correctly commented on as well. This should be read in conjunction with the information ratio over extended periods (which is negative) . Being different and contrarian needs to be justified . The positions need to generate returns at some point.. judging by the long term returns..this is not the case. Other fund managers have had business under severe pressure (all claiming to be contrarian/value)….read Sam Houlie(momentum unconstrained fund, shut down), Recm (piet viljoen), element investment managers etc. They are not always justified positions or return generating positions.big egos and clever marketing are more often the case

Wow. Putting Perpetua in the same bracket as legitimate investment legends like Lynch and Bolton. You must know something we don’t. Keen to elaborate?

What I was referring to was the level of active share of this investment manager. This is evident from strong returns without reliance on market beta.

If one looks at performance history, one will notice no index-hugging and little momentum investing.

Don’t go to the market, let the market come to you!

Your reading of active share is flawed. A high active share is NOT an indication of investment superiority. It is merely a metric that shows the differentiation of a portfolio to that of the benchmark i.e. a high active shows a high degree of differentiation. It does not indicate or imply superior active management.

But that is exactly my point. Perpetua is not herd follower. He is happy to be contrarian in his investment approach. This is also evident in the historical investment performance.

As Johann Rupert has said, “This is the reset”

Back to the 50s and 60s. Low wages, low prices all indices reset to zero, healthy quiet life styles.

This is probably where the phrase – ‘history repeats itself’ comes in.

Economic growth at all costs…

End of comments.





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