Offshore SUPPLEMENT
WHAT’S INSIDE ...
The best time to invest globally
Inflation and the road ahead
Offshore vs local? Both
There are widely available solutions packaged simply and cost-effectively to enable SA-based investors to invest offshore immediately
Investors should consider their portfolio positioning for the inevitable fading of the ‘reflation trade’
The secret is always to have a long-term mindset, focus on valuations, and diversify
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30 June 2021
OFFSHORE INVESTMENT SUPPLEMENT
Does an emissions scandal await the real estate sector? The property sector must agree on a coordinated approach to environmental standards if it is to reduce its carbon footprint. BY TOM WALKER Co-Head: Global Real Estate Securities, Schroders
What has the VW scandal got to do with the real estate sector? Firstly, much like the car industry, the real estate sector has one of the highest carbon footprints of any sector. It currently contributes 30% of global annual greenhouse gas (GHG) emissions and consumes around 40% of the world’s energy, according to the UN Environmental Programme. Secondly, the real estate sector does not seem to be regulating its emissions or pathway to net zero carbon (NZC) in any co-ordinated fashion. There is a danger that participants are relying on lazy metrics that are easy to achieve and will lead to no real reduction in GHG emissions. Analysing real estate companies from around the world, investing in many different types of real estate, means we are well-placed to identify hollow promises made by industry participants. Why are the sector’s green credentials problematic? The industry’s focus is almost exclusively on ‘operational’ carbon rather than on the ‘embodied’ carbon. This is a short-sighted and controversial methodology. Operational carbon comes from the daily usage of a building, from actions such as heating, lighting and cooling. This is different to the embodied carbon, which is the emissions created in the process of manufacturing materials required to construct the building. The key components of any development are concrete and steel, both of which produce significant carbon emissions.
BY GLYN OWEN Investment Director, Momentum Global Investment Management
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n September 2015, news broke that Volkswagen (VW) had been selling cars in the US that had a so-called ‘defeat device’ that could detect when they were being tested and change performance to improve results. Modifying an environmental test and masquerading as ‘doing the right thing’ will obviously have no meaningful impact on the environment. You would expect that everyone would have learnt lessons from the car industry’s shameful episode. However, it is possible to identify another industry that is attempting to self-regulate its environmental standards in a bid for green bragging rights. And that industry is real estate.
The best time to invest globally
It is therefore nonsensical that a building can claim to be ‘green’ or net zero carbon (NZC) when it ignores the environmental cost of building the asset. A building cannot be truly net zero until it has paid back or offset its initial carbon debt (the embodied carbon) and has also considered what happens to the building at the end of its life. The key issue for the real estate sector is that there is no widely adopted market mechanism that aims to reduce embedded emissions. On the contrary, by focusing on operational energy consumption, the owners of many buildings are not even aware that new construction is contributing to the climate crisis instead of helping.
“The real estate sector has one of the highest carbon footprints of any sector” How can the real estate sector prevent its own emission scandal? The major impediment to success is the lack of agreement within the sector as to which sustainable metrics to focus on. As you would expect, there are vested interests that can make for difficult discussions. In addition to the focus on operational carbon, there must also be a ‘whole life cycle carbon’ assessment for new developments, something that regulators in the Netherlands have forced on developers since 2013. The sector must move forward together, only then will significant progress be made. From being the focus of controversy in 2015, the car industry is now becoming a case study for reducing GHG emissions. For the real estate sector, the direction of travel is clear: act together to enact positive change before it is too late.
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South African-based investor who restricts investments solely to domestic stocks is leaving behind approximately 99.6% of equity opportunities. The SA economy represents 0.4% of global GDP, and the stock market is a similar proportion of the global equity investment opportunity set. These stark statistics highlight the incentives of investing offshore. The SA market is one of the most concentrated: almost 30% of the market capitalisation is represented by just two stocks, and 50% by only five. Add to that the diversification benefits of investing in economies growing sustainably more quickly, in currencies that offer the prospect of long-term strength against the rand, in industries that are largely unavailable domestically, as well as in the world’s established and emerging growth stocks, and the case for global diversification becomes compelling. Fortunately for South Africans, regulations have been progressively eased, and there are increasingly efficient means of investing offshore, with a range of solutions to meet the wide range of risk preferences and objectives of retail investors, as well as investment platforms that remove the administrative burden.
“There are widely available solutions packaged simply and cost-effectively to enable SA-based investors to invest offshore immediately” Momentum Wealth International (MWI) is one such platform. As a truly offshore business with roots in Guernsey, MWI offers a myriad of benefits for clients wishing to invest offshore, including effective estate planning, tax reduction for higher-net-wealth clients, investor protection, multiple currency reporting and, importantly, investment choice and flexibility. With a broader investment opportunity set being available offshore, the ability to access various unit trust funds, exchange traded funds (ETFs) and personal share portfolios in multiple foreign currencies is a clear benefit of the platform. Against this background, a common question is: When is the best time to invest globally? Timing the entry point for investing is always difficult, and very few investors can demonstrate consistent success in doing so. ‘Time in the market almost always beats timing the market’ is never more relevant than when considering offshore investing. In the long term, international equities are more likely to deliver real growth in inflation-adjusted terms, as well as diversification across a wide range of currencies, economies, markets and industries, while companies will offer investors a much smoother, more reliable, and more rewarding journey to achieve their goals than investing solely in a narrow domestic market. It’s also no longer the case that the administrative burdens of investing offshore, alongside the ‘misery of choice’ (how do I begin to make selection decisions?), are a deterrent; there are widely available solutions packaged simply and cost-effectively to enable SA-based investors to invest offshore immediately. Our Momentum Global Managed Solutions fund range, as an example, takes the ‘guesswork’ out of navigating the investment choice as it includes three well-diversified, multi-asset-class funds that cater for a variety of risk appetites and time horizons. Investing globally should be for the long term. Whatever your starting point, careful selection, diversification and patience is likely to be rewarded, and will ensure your clients’ personal goals are met. The best time to invest globally might well have been twenty years ago, but the second-best time might be now. The information in this editorial is for general information purposes and not intended to be an invitation to invest, professional advice or financial services under the Financial Advisory and Intermediary Services Act, 2002. Neither Momentum Global Investment Management nor Momentum Wealth International, make any express or implied warranty about the accuracy of the information herein. Momentum Global Investment Management Ltd (FSP 13494) is an authorised financial services provider. Momentum Wealth International Ltd (FSP 13495) is an authorised financial services provider.
Our range and diversity give your clients an edge. Because with us, it’s personal.
We put a multitude of investment tools, solutions and capabilities in your hands. Select from a wide range of investment options to suit each of your client’s individual goals. Because with us, it’s personal. Speak to your Momentum Consultant or visit momentum.co.za
Momentum Investments
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Momentum Investments is part of Momentum Metropolitan Life Limited, an authorised financial services (FSP6406) and registered credit (NCRCP173) provider. MI-CL-08-AZ-46060
30 June 2021
OFFSHORE INVESTMENT SUPPLEMENT
Going global: Navigating the complexities BY NICK JEFFREY Relationship Manager, Sanlam Private Wealth
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nvesting offshore has always been a hot topic for South Africans – to protect wealth from domestic political or economic risk, to gain access to markets and opportunities unavailable locally, or to diversify across multiple geographic locations and currencies. There are different ways of accessing the global market. The simplest way is to invest in rand-denominated options such as dual-listed or rand hedge companies on the JSE, or local feeder funds providing access to offshore versions of these funds. Many South Africans prefer to invest directly offshore by owning hard currency assets, however. If your clients aren’t restricted by the SA Reserve Bank or SA Revenue Service from holding direct offshore assets, they can use their R10m foreign investment allowance and their R1m single discretionary allowance per year to transfer their after-tax funds abroad. Alternatively, if they don’t have the required regulatory approval or wish to invest more than their annual allowances, they can
make use of the asset swap capacity of a financial services provider such as Sanlam Private Wealth. If your clients are going the direct route, it’s essential to obtain expert advice to ensure they don’t get tripped up by the complexities that often accompany global investments. These could include complications around estate duty or inheritance tax, donations tax, local legislation and restrictions on investing offshore, and the overall effect of currency fluctuations. Key factors to consider include:
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• The most appropriate structure. The most common ways of structuring a global investment strategy are investing directly in a client’s own name, integrating assets into a life insurance policy (often referred to as a ‘wrapper’), or lending money to an offshore trust to make investments. • Setup and administration of offshore trusts and company structures. Offshore trusts and company structures remain a popular option for asset protection, tax relief and estate planning purposes. However, setting up and managing these structures can be costly and complex. • Global life insurance solutions. Investing through an insurance ‘wrapper’ offers flexible investment options and some tax efficiencies, and your client’s estate won’t have to pay executors’ fees. • A joint tenancy arrangement. In certain instances, it might be a costeffective solution to invest directly in your own name with a joint tenancy arrangement. However, given the potential complexities, it may be a less flexible option. • Local and offshore tax advice
and structuring. Factors to take into account include local and offshore taxes, and SA Reserve Bank regulations. • Global estate planning. To ensure the orderly transfer of assets to the next generation, it’s important to consider: • Local and offshore inheritance taxes • Drafting and reviewing of local and offshore wills • Safekeeping of deeds of title, and original trust documents and share certificates • Executorships • Power of attorney to administer offshore estates. • Global asset management. Your clients will need an investment team with strong global asset management capabilities to ensure optimal longterm growth and preservation of their offshore assets. At Sanlam Private Wealth, we have all the key skills to assist your clients on their offshore investment journey, from start to finish. We can provide world-class advice and integrated onshore-offshore wealth management solutions – if you need further information, please contact us on info@privatewealth.sanlam.co.za
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Why limit yourself to only 1%? Discover the full picture by investing offshore with Allan Gray and Orbis. Most investors tend to focus their attention on seeking opportunity locally, but with South Africa representing only around 1% of the global equity market, we understand the importance of seeing the full picture and unlocking investment opportunities beyond the local market. That’s why Orbis, our global asset management partner, has been investing further afield since 1989. Together we bring you considerably more choice through the Orbis Global Equity Fund and Orbis SICAV Global Balanced Fund.
Invest offshore with Allan Gray and Orbis by visiting www.allangray.co.za or call Allan Gray on 0860 000 654, or speak to your financial adviser.
Allan Gray Unit Trust Management (RF) Proprietary Limited (the ‘Management Company’) is registered as a management company under the Collective Investment Schemes Control Act 45 of 2002. Allan Gray Proprietary Limited (the ‘Investment Manager’), an authorised financial services provider, is the appointed investment manager of the Management Company and is a member of the Association for Savings & Investment South Africa (ASISA). Collective investment schemes in securities (unit trusts or funds) are generally medium- to long-term investments. The value of participatory interests or the investment may go down as well us up. Past performance is not necessarily a guide to future performance. The Management Company does not provide any guarantee regarding the capital or the performance of the unit trusts. The Orbis Global Equity Fund invests in shares listed on stock markets around the world. Funds may be closed to new investments at any time in order for them to be managed according to their mandates. Unit trusts are traded at ruling prices and can engage in borrowing and scrip lending. A schedule of fees, charges and maximum commissions is available on request from the Management Company.
30 June 2021
OFFSHORE INVESTMENT SUPPLEMENT
Are there real long-term opportunities in the US? BY MATTHEW ADAMS Portfolio Manager, Orbis Investment Management
ERIC MARAIS Investment Counselor, Orbis Investment Management
Inflation and the road ahead BY SCOTT COOPER Investment Professional, Marriott
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ith just 30% of assets invested in US shares versus 66% for the MSCI World Index, the Orbis Global Equity Fund’s current underweight to the US market is the largest in its history. In recent years, the stock-picking environment in the US has been characterised by rising aggregate valuations, surging liquidity, dwindling concern for risk, and increasing speculation. Yet, despite stiff valuation headwinds at the broader market level, some of our highest-conviction ideas still come from the US market. By applying a bottom-up approach, we have uncovered shares of businesses that are cyclical, but also competitively advantaged, and that continue to offer attractive long-term risk-adjusted returns. One example is XPO, a transportation and logistics company that has been one of our largest holdings for many years, and since 2011 has outperformed the S&P500 index by 14% per annum. The market regime of the last decade in the US benefited the shares of the defensive growth businesses, which we have largely avoided in recent years. Below-trend economic growth since the global financial crisis (GFC) created an earnings headwind for cyclical businesses, while by comparison, earnings of many disruptive growth businesses look unusually attractive. At the same time, inflation remained subdued. Finally, with low growth, low inflation and aggressive central bank intervention, long-term interest rates were depressed to historically low levels, disproportionately benefiting long duration assets, such as the shares of richly priced growth companies. As this regime became entrenched, relative valuations for such businesses, which started low, were steadily amplified
by the circularity of the capital cycle. Growth managers outperformed, attracting new assets, spurring further buying of the same growth shares, pushing such shares ever higher, while the reverse happened to value managers and their shares. Yet, developments since the pandemic offer the tantalising possibility that this may be changing. Consider that the pandemic unleashed the most extreme increase in US government spending since World War II: $6tn of stimulus. The magnitude of this fiscal response is difficult to overstate and may well produce a period of unusually high economic growth in the coming years. Even without these extraordinary measures, the ‘real’ economy stands to benefit from accelerating vaccine deployment and the end of lockdowns, combined with enormous pent-up demand and the highest individual savings rate in decades. Additionally, the combination of surging demand, limited supply of both labour and goods, ongoing de-globalisation and exceptionally loose monetary policy potentially set the conditions for much higher rates of inflation and interest rates. Such a development would be a significant headwind to richly-priced growth shares. By owning individually attractive companies, though, we don’t need to bet on a regime change to find attractive investments, and the handful of ideas that make up our allocation in the US are among our highest-conviction holdings anywhere in the world. A clear lesson from history, though, is that big shifts can unfold dramatically, and it is critical to avoid areas of the market that look most overvalued. Therefore, it is less about trying to find the next Amazon, and more about trying to avoid being left holding the next Pets.com.
“The market regime of the last decade in the US benefited the shares of the defensive growth businesses”
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he past 15 months have been an interesting but uncertain time in global markets. As several major economies started to emerge from the pandemic, the first quarter of 2021 was all about ‘reflation’ – a belief that massive fiscal stimulus, historically low interest rates and the reopening of economies on the back of COVID-19 vaccinations will drive an economic boom, placing upward pressure on inflation. Although we expect a strong recovery in GDP growth and a pick-up in inflation in 2021, we do not believe these inflationary pressures will be sustained. This belief is driven by four core considerations: 1. Base effects. Annual inflation statistics over the coming months will be distorted by the disinflation that occurred in many economies in March and April last year as COVID-19 took hold. In the USA, for example, base effects are expected to contribute approximately 1% of headline inflation in April and May 2021. The important consideration is that these base effects are transitory and do not indicate longer-term inflationary pressures. 2. Temporary upward pressure on inflation as economies begin to reopen. It is expected that there will be some supply chain bottlenecks that cause temporary upwards inflation pressure. Importantly, however, it is expected that these will reduce over time as the bottlenecks clear. 3. An uneven global recovery. Much focus has been placed on increasing US inflation – as the vaccination levels increase, so the economy begins to reopen fully. The global recovery, however, is not equal. For example, the IMF, despite increasing global growth projections in April this year, noted that while China had already returned to pre-COVID GDP in 2020, many other countries are not expected to do so until well into 2023. This will act to curtail global inflation. 4. Global debt levels. The underlying health of the global economy has a major influence on how quickly it can recover from shocks. One concern is the relatively high amount of debt that was held prior to the pandemic (and subsequently increased by fiscal stimulus measures). The IMF notes, for example, that public debt-to-GDP of advanced economies was 105% in 2019 (in contrast to 72% before the 2008/9 financial crisis). This debt burden will likely prove deflationary in the years ahead. The impact of these factors is perhaps most aptly summarised in the US Federal Reserve statement made on 28 April 2021. Despite undergoing an extended period of accommodative monetary policy, the Fed believes “longer‑term inflation expectations remain well anchored at 2%”. Looking ahead, Marriott believes investors should consider their portfolio positioning for the inevitable fading of the ‘reflation trade’ as the market comes to realise that the economic road ahead will be a challenging one. We continue to believe a portfolio of high-quality, diversified, multinational companies with robust balance sheets and track records of delivering increasing dividend streams will serve investors well. Companies of this nature tend to be less volatile and more resilient, making them more predictable and less likely to come under pressure in the months and years ahead, if growth and inflation do not live up to the elevated expectations currently being priced into the market. The table below highlights the performance of one of Marriott’s offshore offerings, The Marriott International Growth Portfolio: A low-cost, tax-efficient portfolio where investors are the beneficial owners of shares in some of the world’s best dividend-paying companies, such as Johnson & Johnson, Nestle and L’Oréal:
Investors can also invest in these companies with Marriott via: • Marriott’s offshore share portfolio (International Investment Portfolio) • Marriott’s international unit trusts (Using your annual individual offshore allowance of R11m) • Marriott’s local feeder funds, which invest directly into our international unit trust funds (Rand-denominated).
International Investment Portfolio Invest in high quality companies for more predictable investment outcomes.
Contact our Client Relationship Team on 0800 336 555 or visit www.marriott.co.za
30 June 2021
OFFSHORE INVESTMENT SUPPLEMENT
Offshore vs local? Both BY IZAK ODENDAAL Investment Analyst, Old Mutual Multi-Managers
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ffshore equity markets have run really strongly recently, led by the US and its giant technology firms. As a result, there is no question that global investments are more expensive than South African shares, bonds and property at the moment. At the end of April, MSCI put the forward price earnings (PE) ratio for the world market at 18x, the highest since 2002, while SA equities traded at 10x. Similarly, the South African 10-year government bond yield is double the Reserve Bank’s 4.5% inflation target, while the US equivalent is still below the Federal Reserve’s 2% target. This implies positive expected real returns from SA bonds and negative real returns from US bonds. So why would anyone take their money offshore? The answer is risk management through diversification. If I told you that Russian equities traded on a 7x forward PE, bonds offer attractive real yields, fiscal and monetary policy is conservative, and the rising oil price bodes well for economic recovery, you might say, “Great, let’s put 2% or 3% of my portfolio in Russian assets.” You wouldn’t bet 70% of your wealth on a single country, no matter how good the story. Yet, that is what South Africans do. Home bias is common, even in countries where there are few or no restrictions like our own Regulation 28. People tend to invest in what they know – whether it’s the savings account of a local bank, or the shares of the brand
names they consume every day. But it’s a big world, and home bias can mean missing out on opportunities. For many South Africans, their biggest assets are probably a company pension fund and their home. Some own businesses. The more affluent might have a holiday property. That means they are overexposed to the domestic economy and its cycles. Therefore, there is a strong case to be made that a significant portion of discretionary money should be offshore, but of course the size of the allocation depends on individual circumstances.
“No single manager has all the answers and performance tends to be cyclical” This is not about ‘fleeing’ South Africa at all, or implying the country is falling apart. It is simply about prudently spreading risk and widening the opportunity set. Yes, global equities are more expensive in aggregate, but among the thousands of listed companies there are those who are cheap relative to their fundamental value or growth prospects. In contrast, a big part of why South African equities trade on low valuations is because of high commodity prices boosting prospective earnings. These prices might stay high, but they might not. If they decline, it is a risk to local investments. Apart from mining, the JSE is simply very concentrated, with a single underlying exposure (Tencent) accounting for 15% to 25% of the overall market depending on the benchmark. If we look at the FTSE/JSE All Share Index, 60% of its market cap is contributed by the top ten shares. For the MSCI All
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Country World Index, the largest ten of the 2 974 constituents only make up 15% of the total market cap. If you think about local fixed income, the bond market is dominated by the government and its state-owned enterprises (virtually all junk status) and the money market by the big four banks. The global fixed-income universe is massive, spilt roughly half-half between sovereign and corporate (and other private) borrowers, and across all imaginable regions, maturities, credit ratings and currencies. Local property is mostly offices and shopping malls, which are at risk from work-from-home and shop-from-home, along with a big exposure to Eastern Europe (oddly enough). Global property is an extremely diversified asset class, including sectors that barely feature on our market, such as data centres, various residential options, hospitals, laboratories and communications facilities. What about the rand? Shouldn’t we wait for a more attractive entry point? The same conditions that cause the rand to strengthen – rising risk appetite, global economic growth, and firmer commodity prices – usually also result in global investments rallying. Therefore, waiting for a stronger rand to take money offshore often also means buying into more expensive investments on the other side. So, it’s swings-androundabouts. Finally, how do you go about investing abroad? Just as diversification across local and global investments is advisable, we think that investors should diversify across fund managers, because no single manager has all the answers, and performance tends to be cyclical. The new Old Mutual Multi-Managers global range of funds offers multi-asset class and equity funds. Our work in putting these funds together greatly
“The secret is always to have a long-term mindset, focus on valuations, and diversify” simplifies the difficult job investors face when selecting managers from the thousands of global options across a range of countries and asset classes. The Old Mutual Multi-Managers Global Moderate Fund of Funds has a strategic asset allocation split roughly 50-50 between growth assets (property and equity) and fixed income. The Old Mutual Multi-Managers Global Growth Fund of Funds focuses on long-term growth to beat inflation but with a small fixedincome allocation to reduce volatility. The Old Mutual Multi-Managers Global Equity Fund of Funds is, as the name suggests, a pure equity fund. While these particular funds are a little over a year old, we have invested with most of these managers for many years since we use them in our local strategies and know them well. We follow the same approach in constructing these funds as we successfully did locally for almost two decades. The secret is always to have a longterm mindset, focus on valuations, and diversify, diversify, diversify. About Old Mutual Multi-Managers Old Mutual Multi-Managers is a specialist investment boutique, within the Old Mutual group, South Africa's largest and most established financial services company. We offer affordable investments that blend together the best of South African and offshore asset managers. The above content is for information purposes only and does not constitute financial advice in any way or form. It is important to consult a financial planner to receive financial advice before acting on any of the above information. For more information, visit: https://ommultimanagers.co.za/
PROUDLY SOUTH AFRICAN OR A GLOBAL CITIZEN? SMART INVESTORS ARE BOTH. Diversity is the key to a well-balanced portfolio and with our significant global experience, Old Mutual Wealth can offer the expertise you need to expand your clients’ portfolios offshore and reduce their risk. Take your clients’ wealth further with our wide range of expertly managed offshore solutions, built around their unique needs.
Stay connected to expert advice. www.oldmutual.co.za/wealth
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30 June 2021
OFFSHORE INVESTMENT SUPPLEMENT
Inflation and the impact on financial markets NICO ELS Multi Asset Strategist, Ashburton Investments
CHANTAL MARX Head: Investment Research, FNB Wealth and Investments
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nflation concerns have been on the rise and investors globally are seeing it as one of the biggest ‘tail risks’ for markets over the next few years. Financial markets generally do not perform well when there is a sudden shift in inflation expectations. For bonds, inflation may result in tighter monetary conditions, including rising interest rates and less liquidity in the market. In the case of higher interest rates, fixedincome instrument yields adjust upward, and prices move lower. This is because the interest payments from existing fixed-income assets become less competitive relative to newer, higher-rate fixed-income instruments. Less liquidity and bond-buying from central banks will also have a negative impact on bond prices. For equities, potential tighter monetary conditions will also drag on prices. Higher interest rates erode company profitability because debt becomes more expensive to service. Consumer-facing companies have the added burden of reduced share of wallet because consumers are spending more money servicing debt, which can weigh on sales. Higher inflation may also result in fixed costs increasing – employees may demand higher salaries and general costs will increase, which will have an impact on operating margins. All the above will weigh on company earnings and, therefore, valuations. As with bonds, less money in the system impacts on equity market volumes and demand for stocks, which could impact valuations. As a second-order consequence, higher bond yields have a negative impact on equity valuations because the value of future cash flows from companies reduce when bond yields increase.
“The Fed views the current expected increase in inflation to be transitory”
Of course, certain instruments benefit from higher interest rates, including variable rate cash instruments and interest-rate-linked instruments like preference shares. Certain sectors in the equity market also benefit from inflation, such as consumer staples with pricing power, banks (if yield curves steepen) and utilities. Inflation across the world The US has been of particular interest because forecasts suggest that the US will breach the Fed’s 2% target inflation level of inflation this year. And we have already seen inflation fears inducing bouts of volatility in bond and equity markets this year. Producer price inflation (PPI) numbers worldwide have been surprising to the upside as a result of higher commodity prices and supply chain bottlenecks. This could potentially reflect in the consumer price index (CPI) going forward. We are also starting to see some wage pressures building in the US, especially in the lower wage segments of the market. Although the above pressures should eventually be ‘transitory’, it might persist for a bit longer than anticipated. The Fed, however, has been consistently ‘dovish’. Its latest Federal Open Market Committee (FOMC) statement indicated that, even with strong economic growth numbers and higher inflation, it will need to see an improvement in broader measures of employment (labour force participation and wage growth) before considering a rate hike. The Fed views the current expected increase in inflation to be transitory. It also said that it will act on actual numbers instead of forecasted numbers. This means that it will be reactive in its approach rather than pre-emptive. The market, however, is pricing in four rate hikes to the end of 2023. The ultimate market reaction will be dictated by the Fed. If the Fed caves and tightens policy earlier than projected, the dollar will appreciate and risk assets could underperform. If the Fed is right, thereby suppressing US real rates, the opposite plays out – the dollar will weaken and risk assets should do well.
In emerging markets, headline inflation remains well below five-year averages. As is the case in developed markets, we expect a short-term pickup in inflation on base effects, oil and commodity prices, and economies reopening. For the medium term, there are still very large output gaps, with high unemployment, weak fiscal policy and globalisation placing downward pressure on inflation. In South Africa over the short term, headline inflation could breach 5% on the back of base effects, oil, and electricity prices. This should reverse before the year end. The output gap in South Africa is still large, which should dampen inflation to some extent. We therefore expect policy rates to remain lower for longer locally as well. Cyclical versus structural inflation Forecasts already reflect a spike in inflation, but we propose that this is more of a cyclical phenomenon as opposed to structural. There are some major structural factors that should keep inflation in check longer term: • Demographics: Lower birth rates and ageing populations are purported to be disinflationary. Aggregate demand declines since older populations tend to consume less, labour supply decreases, productivity levels decline and a sectoral shift in consumption patterns occur. We would anticipate these demographic changes to persist as more women enter employment. • Excess capacity: When actual economic output drops below its potential, it creates a negative output gap. Output gaps globally are still quite high and, while we expect this to narrow in the US this year, it is likely to remain a deflationary force elsewhere in the world. • Technology – digitisation and automation: Technology reduces the cost of producing goods and providing services. These savings can be passed on to consumers. If they are not passed on to consumers, it could lead to competition entering the market that will place pressure on end prices as well. The information explosion has also increased pricing power of consumers over producers. • High levels of debt: We live in highly leveraged, highduration economies and highly leveraged financial markets. Even small increases in long-term interest rates will be enough to cause a major economic slowdown and ease any potentially building inflation tensions. Conclusion While investors are right to be concerned over current inflationary pressures globally, we believe that this is likely cyclical and that monetary policy responses will reflect this. This is not to say that markets will not react to cyclical inflation fears from time to time. For now, however, it seems as if economic recovery will remain the priority for policymakers, both at central bank and central government level. Ashburton Investments and FNB are part of the FirstRand group.
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