The mood in the markets has been cautious in recent weeks as the higher-for-longer interest rate narrative has dominated, with US treasury yields rising to more than a decade high, putting pressure on riskier assets.
Meanwhile, the conflict in the Middle East has added a further layer of concern as investors consider the potential effect of the Israel-Hamas war on the global economy.
Business Day caught up with Lubabalo Khenyane, portfolio manager at INN8 Investments, to make sense of these events.
Investors are keeping a close eye on the war in the Middle East. Oil prices remain elevated, having jumped 4% as the fighting broke out three weeks ago. Investors are concerned that the rising tension could have further implications for the oil market, inflicting further inflationary risks and causing more volatility in global financial markets. What is your outlook on this?
The two countries on their own are very small, they have a total population of 16-million people and contribute just 0.6% to world GDP, so from an economic and market point of view, the effect of the conflict should be small.
The issue [for the global economy] could lie in the allies they have, the US in the case of Israel and most of the Arab countries in the case of Palestine, especially Iran and Saudi Arabia.
We are concerned that if Palestine’s allies get involved, the oil price and inflation will likely shoot up, making it very difficult for central banks to cut interest rates in 2024 as the market expects.
In such a scenario, emerging market assets like SA equities, bonds and the rand are likely to struggle as investors look for safer investments like US treasuries, the dollar and gold.
In this volatile environment, have the markets priced in much of the bad news so far? And what would be the catalysts in either direction?
We posed the same question to three asset managers in our recent INN8 Invest Conference, and the response was that most of the bad news is priced in, especially in SA. Take SA bonds for example — the R2032 is yielding 11.7% while the R2040 yields 12.9%. For a country with an inflation target range of 3%-6% and the Reserve Bank unofficially targeting 4.5%, present yields are unjustifiably high even with the risks of a weaker medium-term budget policy statement.
In the domestic economy, a catalyst for a rally in local assets could be an improvement in confidence, resolving issues at Eskom and Transnet. Globally, a [US Fed and other central bank] pivot could be the catalyst.
On the opposite end of this, the strong US labour market could keep interest rates high, and an escalation in geopolitical tension is another threat.
Heading into the medium-term budget policy statement on November 1, what would market participants want to hear from finance minister Enoch Godongwana?
Investors will be looking for confirmation that the government is still committed to its fiscal consolidation plan.
They will want to see how the government intends to finance the budget deficit. On the one hand, it could borrow more, but the challenge with this is that the cost of borrowing has gone up significantly since central banks started raising rates.
On the other hand, it can raise taxes (possibly VAT). But doing this in an economy that is not growing puts a lot of pressure on the already struggling consumer.
Either one of these options comes with implications for domestic asset classes, and investors will be cautiously assessing those.
With so much uncertainty in global markets, what local assets are you bullish on?
We [at INN8 Investments] make tactical asset allocation decisions and at this point we like most of the domestic asset classes except SA cash.
We are particularly bullish on SA bonds as there is a low likelihood of default given the low exposure the SA government has to hard currency debt.
The government’s fiscal position is, however, a concern as load-shedding and other factors have stunted economic growth. We could see a relatively good return from SA bonds if inflation is contained and interest rates start to fall. These bonds offer high yields with the risks to the downside somewhat priced in.
Is there anything else market participants should look out for in the remainder of 2023 — both locally and internationally?
While the war in the Middle East has dominated headlines, investors need to remember that there are other factors at play and thus consider all available information when making investment decisions. They also need to remember that opportunities to create wealth in the stock markets often come during periods of heightened volatility as people tend to panic, creating opportunities to buy good assets at very low prices.
Investors need to also remember that the Fed has two more meetings left this year, and these will possibly give direction to other central banks on their interest rate decisions.
US companies are in the process of reporting their third-quarter earnings, and this should give investors a peak into the consumer’s balance sheet.
Any escalation in the Middle East conflict is another thing to monitor.
Locally, the stability of the electricity grid over the festive season is something investors need to monitor closely as we wrap up the year.
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