Earlier this year, we saw the SARB cut interest rates for the first time and the view was that this could be the start of an interest rate cutting cycle. We are yet to see another rate cut since the initial move in July. Unfortunately, politics took its toll on the rand, and there are too many uncertainties as we move closer to December to even consider another interest rate cut this year. In addition, the rising oil price is exerting upward pressure to South Africa’s inflation, further reducing the likelihood of an interest rate cut.
Fortunately, the JSE ALSI Index [JSE: J203] has been thriving on the lower interest rate and weaker rand, having returned 11.57% since interest rates were reduced on 21 July 2017. The graph below shows the performance of the JSE ALSI relative to the start of the interest rate cutting cycle, for the past six cutting cycles. It can be seen that from six months before a cutting cycle commences, there is a relative underperformance, and in the months after a cutting cycle has started, there is a relative improvement.
With a lower cost of credit, consumers should be more willing to spend money, which boosts company profits. The ALSI pushed above the 60 000 point mark on Monday, 6 November, which is a record high. It is clear that history is indeed repeating itself with the JSE ALSI Index (pink line) currently outperforming the average ALSI (dashed line). Looking at the average, we could expect to see another 10% return for the index over the next eight months.
An alternative outcome to bear in mind is the impact that another credit downgrade and/or an unfavourable elections outcome could have on the South African market. This could paint a whole different picture to the one seen above. The rand should depreciate by a fair amount which, in the past, provided tailwinds for the ALSI as the large cap rand hedges kicked in. This may well be offset by a decrease in business and consumer confidence, profits and economic growth to the extent that the market declines significantly.
We currently face a budget deficit that is not receiving the action as required by credit rating agencies. The Finance Minister has adopted a path of fiscal expansion rather than much needed consolidation, and there is the possibility of free education placing further strain on the deficit. A sound investment decision would be to hedge these risks with increased offshore exposure and protect against a decline in the rand.
Joani van Wyk
Joani van Wyk joined the asset management team in January 2017, responsible for quantitative research of equities across all industries. Joani completed her degree in Mathematical Science in 2015, as well as an Honours degree in Financial Risk Management in 2016, both at the University of Stellenbosch. She is currently a CFA candidate.