Inflation peaked, bonds offer value

Against the backdrop of the latest positive inflation print (which came in lower than expected), the South African Reserve Bank voted to keep the prime lending rate at 11.75% – which will help offer some temporary relief to strained local consumers. There was not much reaction from the rand, which is still trading at the stronger level of around R18.00 to the dollar. In a perfect world, the rand should trade at around R16 to the dollar, but for now that is just a daydream.

We are at a point in the markets where the expected peak in inflation and resulting positivity in equity valuations have been reached. Once again, over the next couple of weeks, we shall have to see whether the actual earnings from companies justify their recent price increases. As we know by now, markets are forward-looking and the current valuations are based on expected future performance. If the actual performance is as expected, the price of the share will stay the same or even come down a bit; but if the actual performance disappoints, the price of the share can come down a lot. Consistent performance is the longer-term key driver of success in a company and not all companies can achieve this, as can be seen in this table:

The peak in inflation is also good for bonds. Just for those who do not understand bonds: when interest rates drop, the yield on the bond will also drop, which in fact means that the holder of such a bond makes a capital gain on the bond. So, lower interest rates mean lower bond rates mean bonds making money. That is why a lot of investors see the current high bond rates, with the expected lowering of interest rates, as a good time to buy some bonds for their balanced portfolios.

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