We have been waiting for this moment for a long time. The interest rate in the US was lowered by 0.5% last Wednesday and South Africa followed with a 0.25% cut. As we have mentioned before, this move signals a cycle that will see rates coming down, supporting bond and equity prices. The loser in this cycle will be cash. The only potential risk we are left with now, is a recession in the US. This will be negative for equity prices but positive for bonds. As things stand now, your safer investment option is to be overweight in bonds and neutral to underweight in equities. The reason for this is the fact that whatever happens in the economy, lower interest rate will boost bond performance, even if there is a recession in the US. This will not be the case for equities. A recession will see shorter-term weakness in equity prices but if there is no recession you can expect shares to outperform bonds hands down.
If we go back to the longer-term performance of different asset classes, we know that equities outperform bonds and cash. This has not been the case in South Africa, however, where bonds and equities have been on par when it comes to returns over the last ten years. This is rather unusual, but it stems from the gross mismanagement of our economy, and therefore investor confidence, under a very corrupt government. This might be changing now, but we still have the problem of finding quality companies to invest in in SA compared to some international alternatives. What we are seeing now is a very satisfactory strengthening of the rand, and this should be supported by a weakening dollar as interest rates drop further. As a South African investor the question is always whether you should wait for the rand to strengthen before investing offshore. If you look at what has happened year to date, you will see that the S&P500 is up almost 20% but the rand is only 4.5% stronger against the dollar, so it has been better to just convert your rands and invest immediately.
So as an investment case, holding bonds now is the better risk/return option for medium-term investments, which will be enhanced if the US go into a recession, but this will not be a long-term preference. At some point the run on bonds will taper out and equities will be the better performer, as well as the long-term winner. For now, the only sector of the market that is still struggling is commodities and unfortunately the South African equity market has a lot of them. Other sectors like property and retailers are doing very well year to date but that is because they have been underperforming so badly over the last few years. All in all, we are happy with what is happening in markets at the moment and can only hope that the US elections in November will not upset the apple cart too much.
