The main concern facing South African investors should not be whether there will be a rate hike, but rather when it will occur and the quantum of the change.
With inflation concerns increasing throughout the world and South Africa being one of the many countries at record low interest-rate levels, the South African Reserve Bank is coming under continued pressure to keep inflation at bay.
It is well documented what happens to the bond and money markets during changes in the interest-rate cycle but it is just as important to try to determine the impact on equities, especially in the South African environment and, more specifically, in the various sectors.
Plexus thus conducted a study, comparing the performance over 11 years of the FTSE/JSE resources, industrial and financial indices during different interest-rate cycles.
An interesting outcome can be detected. While the financial and industrial indices performed progressively weaker as interest rates moved in the cycle from down to flat and then up, the resources index showed the weakest performance in the down interest-rate cycle, but was strongest in an up cycle.
Normal expectations would suggest that companies perform better with a less onerous interest-rate obligation. With resources, however, the inflation concern seems to have a greater effect.
As interest rates move into a down cycle as inflation drops, the effect is a moderation in commodity prices. Gold, in particular, is regarded as an inflation hedge and rises on the back of increased inflation concerns.
The negative effect on financials in an up cycle can be explained by the higher debt burden on borrowers from banks, resulting in fewer loans and more bad debts, while bank margins on loans remain unchanged.
As inflation and, in turn, interest rates increase, the opportunity to obtain real returns becomes increasingly difficult. Bonds and cash generally do not provide positive real returns in an increasing interest-rate environment.
Even though companies do not operate in a vacuum and there are many aspects to ponder, it is important to carefully consider one’s equity allocation in terms of both overall weight and allotment per sector. It is apparent that real returns can be obtained from equities in a rising interest-rate cycle, even when it is negative for other asset classes.
Paul Stewart is managing director of Plexus Asset Management
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