Investment markets came down substantially last year as soaring inflation drove central banks into a sharp interest rate hiking cycle. But although inflation appears to have slowed in the US – from 9% to 5% – financial analysts are not sure the worst is over and we may still be in for a recession of sorts by the end of the year.
In an Allan Gray investment update in Cape Town this week, Tim Acker, portfolio manager and director at Allan Gray, made a comparison with the high-inflation era of the 1960s and ‘70s. He said there are two things one can draw from this period.
The first is that it took quite a long time for inflation to subside. “We’re talking 10 or 15 years for inflation to properly come down,” Acker said.
The second point is that inflation can be volatile and unpredictable. “Just because it’s slowly coming down now in America, doesn’t mean it’s going to stay there. In the ‘60s there were times when inflation came down and everyone was celebrating, and then it went up again. So it’s a hard and unpredictable thing to manage,” he said.
Interest rates are the tool central banks use to fight inflation, but it is a delicate balancing act. Already the sharp rise in rates has had ramifications for the US banking industry.
In a recent report dealing mainly with the banking crisis in America, Old Mutual Wealth Investment Strategist, Izak Odendaal, says the US Federal Reserve Bank (Fed) is in a tricky situation. “On the one hand, ensuring the stability of the financial system is the responsibility of central banks, and indeed the Fed was set up for this purpose primarily. It will therefore continue to play the lender-of-last-resort role to banks who suffer from poor liquidity rather than insolvency. On the other hand, inflation remains too high, and the Fed and other central banks are still raising interest rates.”
However, Odendaal says the Fed’s hike of 0.25% (25 basis points) at the beginning of this month could be the last in the current cycle, although the European Central Bank “still has more ground to cover”.
Just as inflation may take time to subside and there may be bouts of higher inflation still awaiting consumers, so the drop in equity markets last year does not mean that the bad times are over for investors.
At the Allan Gray conference, Matthew Spencer, head of the Investment Counsellor Group · at Orbis Investments, Allan Gray’s offshore arm, said the huge amount of money the US government pumped into the US economy during the Covid-19 crisis caused a bubble in the stock markets. He termed it the “Everything Bubble”, although it manifested primarily in high-growth companies in the tech space.
He said the drop of 18% in global markets in 2022 was significant – the third-largest we’ve seen in the last 30 years – and it was necessary to bring share prices down from their lofty levels at the beginning of 2022. But he said that earnings from US companies, which have generally been strong until now, may yet collapse in the face of higher wage bills, higher debt repayments and inflation, “so we’re not sure we’re done yet … and I’d be surprised if there wasn’t a little bit more pain to come”.
In a report released this week looking at the local economy, David Rees, senior emerging markets economist at Schroders, says inflation in South Africa has continued to surprise to the upside in the past couple of months. “The South African Reserve Bank (SARB) unexpectedly hiked rates by 50bp to 7.75% at its last meeting in late-March, and the further increase in headline inflation is likely to concern policymakers.”
However, Rees says there are three reasons to think that inflation should come down in the months ahead, and that the SARB will eventually start to consider easing policy again.
“First, fuel inflation has already begun to drop sharply and should fall a bit further before stabilising. Second, while the upside surprise to March inflation was due in large part to the food component, our leading indicator suggests that it should now be around its peak. Third, tighter monetary policy is a clear downside risk to economic activity and a recessionary environment would usually cool core inflation. If that happens, then the focus of markets and policymakers would eventually start to shift back from fighting inflation to supporting the economy.”
* Hesse is the former editor of Personal Finance
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