CAPE TOWN – Until the recent market turmoil, the consensus view was that the US Federal Reserve was likely to start hiking rates at its meeting next month. However, after the global sell off in equities and commodities, this is now looking unlikely.
“Markets have become very concerned about the global growth outlook, mostly due to a continued slowdown in China and other emerging markets, but even the recent US data points have softened,” says portfolio manager at Investec Asset Management, Rhynhardt Roodt. “There is suddenly a general feeling that rate hikes could be pushed out further, while ‘the growth bears’ might say the Fed won’t hike at all. This is reflected in foreign exchange markets, with the USD weakening relative to the euro in the past few trading sessions.”
According to Bloomberg, trading in Fed funds/futures suggests that the market now believes that a rate increase will only come in December. Even that likelihood is however growing smaller, and it may be held off until 2016 if markets remain under pressure.
There is however a general view that, sooner or later, the Fed will begin a rate tightening cycle. The important thing for investors is to be prepared for it.
Fund managers canvassed by Moneyweb believe that because global economies are at different parts of their growth cycles, and since monetary policy is far from uniform across the world, the impact is going to be felt differently in different markets.
“Our expectation that interest rates will normalise in the US first among developed market peers, and that this is well based on sustainable economic growth,” says Dino Voulakis, senior portfolio manager at Nedbank Private Wealth. “This will incentivise the repatriation of capital particularly into in US money markets, and so we believe the effect will manifest more strongly in US equity markets.”
He adds that the Fed is also likely to raise rates very slowly and over a long period of time, which will also lessen the impact.
“We expect the interest rate increase ‘road-map’ to be more protracted in its path to normal, and shallower in extent as the global economy may still be dealing with over-capacity in certain areas that mitigate against inflationary pressures,” Voulakis says. “Consider for instance the impact of the lower oil price on the US consumer.”
Where then does that leave investors, particularly South Africans who are primarily invested on the JSE?
Roodt says that usually when rates go up, investors should consider moving into more cyclical stocks rather than the defensive counters that have performed strongly over the last few years. This is because interest rates usually go up as the growth outlook has improved, and that tends to favour cyclical sectors. However, because South Africa’s economy is still weak, the choices become more difficult as unlike the US, we seem to be hiking rates into a deteriorating growth environment.
“In our market we have some large consumer staple companies like SABMiller and Tiger Brands that are great businesses, but these stocks are expensive globally because of their defensive nature,” Roodt says. “Those might be the kinds of stocks that are at risk of going through a period of de-rating.”
He thinks that local retailers may be in the same boat.
“I think a lot of foreign investors see our retailers as defensive growth plays,” he argues. “So stocks like Mr Price have gone through a period of massive re-rating and I wonder whether that hasn’t run its course. If rates are going to go up they will be affected negatively as the consumer is put under more pressure, so I would be worried about those sectors.”
However, it doesn’t follow that all defensive sectors in South Africa could find themselves under pressure. Neither should one necessarily expect the usual later-cycle cyclicals like resource counters to enjoy a resurgence.
“I can see some sectors that might not do well in the US, like healthcare and telecommunications, continuing to do well here,” Roodt says. “We also have a lot of late cycle cyclical companies in the form of resource counters, but it doesn’t seem like the right time to buy there because the world’s biggest buyer of commodities is cutting rates, not hiking them.”
Roodt rather advocates considering other cyclical companies outside of the commodity space.
“Mondi is one that could benefit from an expanding European economy, as would Steinhoff,” he suggests. “A smaller company with exposure to the US markets that could see growing revenues is Datatec, as companies there start spending more and growing their IT budgets.”
The CEO of Contego Asset Management JC Louw says that in this environment investors should really steer away from companies with heavily geared balance sheets who would be more exposed to higher interest rates. They should also be wary of consumer-sensitive stocks like furniture and fashion retailers that rely heavily on credit sales.
Like Roodt, he agrees that there is still appeal in local healthcare stocks.
“I think Aspen offers great value at current levels,” he says. “It’s a very exiting company when you look at its consistency of earnings.
“Mediclinic is also attractive,” he adds. “It now earns most of its revenues offshore, so you get currency diversification and because its operations are in the UK, Switzerland and the United Arab Emirates those earnings are not related to US or local cycles.”
A smaller company that Louw thinks investors might consider is printing business Novus, which was recently unbundled out of Naspers.
“When a business like that is spun out you tend to see improved management focus and better returns,” Louw says. “Its already offering a nice dividend yield of 4% and we like its focus on Africa.”
For Voulakis, investors need to consider what any action from the Fed will mean for exchange rates and factor an increasingly stronger dollar into their portfolio positioning.
“Ideally one would like to find companies manufacturing a higher value product in local or other currency and exporting into the USA,” he says. “These opportunities are however few or diluted, and as such we consider the db x-trackers MSCI USA Index exchange-traded fund listed on the JSE an attractive proposition.”