By Charles Snyman
Prices of just about anything anyone can think of have been falling over the last months. Not at the petrol pump or in Woolworths of course – the man on the street is being hammered by huge inflation - but on the financial markets.
The prices of agricultural products, which reached a peak generally somewhere between April and June of this year, have fallen to, and below, the price levels extant before the Russian invasion of Ukraine.
This includes wheat, corn, oats, barley, soy beans and soy oil, sunflower seeds and oil, palm seed and oil, canola, cotton, sugar, wool, cocoa, rubber, Brent oil, and coffee.
Orange juice is an interesting exception which is trading at about US$185 vs around US$133 perimperial pound on 16 February 2022.A 37% increase. Other less dramatic exceptions are sugar and rice.
At the time of writing Brent crude traded around US$84, vs US$97 just before the invasion of Ukraine.
This price peaked at US$126 earlier in the year (intraday trading reached almost US$140) and has thus since retraced by about 35%.
The same has happened to a wide range of metals, from aluminum through to zinc. The platinum price was US$1055 on 16 February 2022,reached a closing high of UD$1166 in March and closed at US$859 on Friday 23 September.
Gold is no different: it traded at US$1862 on 16 February 2022, reached a high of US$2057 on 8 March and closed at US$1667 on 23 September 2022 - a price pull back of almost 20% Inflation has remained elevated across many of the major developed markets.
Of course, the same, if not worse, has happened in many emerging economies(the inflation rate in Nigeria is 20%,for example). But the emerging economies do not really affect international interest rates or asset prices: the USA remains the main manufacturer of sentiment on all manner of free markets, interest rates, equity markets, currencies, and virtually the entire range of agricultural and mining and other commodities.
High inflation rates in the USA and Europe have forced their central banks to increase interest rates. In fact, almost 80% of central banks have increased interest rates. These central banks are most likely to remain in a hawkish mode if inflation remains above their respective targets.
Setting the tone, in the US the Federal Open Market Committee announced a 0.75% hike in short term interest rates to 3.125% on Wednesday 21 September 2022. Throughout the course of the year the Fed’s messaging has been quite consistent and clear – interest rates will keep on rising to curb inflation, even at the expense of economic growth.
This important point was reiterated last week.
Goldman Sachs Global Investment Research now predicts a 0.75% increase in November, a 0.5% increase in December, a 0.25% increase in February and April 2023.
This will bring the Federal funds rate to about 4.6% during the first half of next year – rates last seen the best part of two decades ago.
In the UK, the Bank of England raised its key interest rate by 0.5% to 2%. This rate is also expected to be around 4.5% by mid-2023.The European and Japanese Central Banks are well behind the curve on this, driving a large devaluation in their respective currencies relative to the US dollar(more on this below).
On the back of these renewed hawkish warnings from the Fed and other developed nation’s central banks, equity markets around the globe were soft. In fact, the lows of early July were tested after a relief rally to about mid-August.
The latest round of commentaries by central banks in Europe and the USA renewed recession fears in the first world. Neither did the escalation of war rhetoric in eastern Europe do much to calm the lurking fears of direct war between NATO and Russia, with its potential drag on economic growth.
Markets generally expect interest rates to be higher for longer than anticipated a month or so ago.
Synonymous with higher interest rates over longer periods comes the expectation of slower economic growth. Investec expects world economic growth to slow to 2.5% this year and 2% in 2024, just a tad lower than their previous forecast of a month ago.
Dollar Strength
The high and rising US interest rates have increased the carry cost of all assets. In general parlance, money has become more expensive, and it is likely to remain more expensive and for longer than most people like.
It is therefore not surprising that we have seen a decline in the prices of all assets, driven by falling demand or the anticipation of weaker demand going forward as interest rates really start to bite.
Dollar strength stemming from high and rising interest rates has been supported by US energy self- sufficiency, and a reduction in dollar liquidity has been smashing all manner of assets, currencies and commodities like AB de Villiers in a T20 on an easy pitch.
Oil and gold are prime examples. So are the equity markets around the globe. Even the white-hot property sectors in the US and UK have started seeing prices go south.
The weakness of the His Majesty’s Great British Pound stands out.Since the early eighties (approximately 1983),theUS$ / Pound Sterling exchange rate has oscillated around 1.5 US$ per Pound.
From early 2017the dollar strengthened to about 1.3 (mostly as reaction to Brexit) and traded around there up to March/April this year. During the last few months Sterling collapsed to around parity.
A weakening of around 25%.
The final straw for the pound/US$ exchange rate is the new British government. The new Chancellor of the Exchequer has delivered a surprise budget comprising substantial tax cuts in addition to the new energy price subsidy, and all not very long after the Covid rescue programme.
Financial markets are concerned about the resulting huge tax loss the Treasury will suffer over the next number of years.
The newly announced tax cuts amount to 2% of GDP or about 72 billion pounds. The British government’s debt is already at 100% of GDP: not the stuff of nightmares, in fact the best of all G7 economies, but the perceive trend towards ever greater fiscal irresponsibility is evidently disconcerting market participants.
The Pound / Euro exchange rate oscillated significantly over the last 10 years but traded at 1.15 Euro per Pound in October 2010. The rate yesterday was 1.12 Euro per Pound. It follows that the Euro / USD$ followed the same path as the Pound / US$ over the last few months: where a Euro cost 125+ US cents a little over a year ago, Americans can now buy a Euro for 95 cents and still get five cents change on a Dollar. Scary stuff!
Of course, various currencies have much to do with domestic monetary and other policies, but the very same thing happened to almost all currencies. Our own ZAR is a case in point. Since April this year, the ZAR weakened from 14.51 to 18, a weakening of around 2%.
Except the Swiss Franc. I almost said of course!! It has traded around parity to the Dollar since late 2010.
But for everybody else,the mighty Dollar reigns supreme, underscoring the United State’s status and the one and only global economic (and military)superpower.
The US dollar has been a haven for money over the last few months. This will be even more inflationary for non-US countries and probably more so for emerging economies like us, as food and energy are traded in US dollars.
So, Quo Vadis?
From experience over many years, we know the future is impossible to foretell. Not very much has changed since our previous essay: the big topic in the investment world at the present time is still very much macroeconomic by nature. Our previous essays this year have touched on these issues, but it is probably important to reiterate:
- Slower economic growth and recessions does not affect all companies and economic sectors in the same way.
- The depth of a recession will vary among sectors.
- The timing of a general reduction in economic growth will vary among sectors.
- The full impact of interest rate increases will take time to manifest and will differ substantially among economic sectors and types of businesses and their levels of borrowings.
- Inflation will be good for equities and other quality assets
- Inflation will be good for businesses that are price-makers rather that price-takers.
It follows that careful stock picking will be very important over the next number of months.
At the current time, our investment portfolios are very well diversified and consist of quality companies with international exposure, listed here and elsewhere. We tend to avoid exposure to companies that do business in SA only as much as possible. Exposure to the latter in our portfolios is currently at levels of around 10%, or less in many instances. This has been our approach for the last three years or so.
Typing up this essay powered by a UPS, while Stage 6 loadshedding is wreaking havoc on the South African economy, rather poignantly sums up how SA companies are at a massive disadvantage to global peers.
Well-diversified portfolios of quality equities, with worldwide revenue exposure across many economic sectors, will remain key.
Charles Snyman is the CIO at FAL Invest
BUSINESS REPORT