Emerging Markets & Global ETFs: Capitalizing on Decreasing Interest Rates

He's Head of Cash and Income at Precent Investment Management and we're talking all things global inflation and interest rates , and actually what does that mean for you and I as investors ? So welcome back , Henk . It's nice to have you back on the show .

And the kind of only real medicine that the reserve banks have around the world to deal with this illness of inflation is interest rates , and interest rates have been high .

And now we're in an environment where it looks like and I always think you know we call the end of inflation too early when we're investors because we're desperate for it to kind of get past , but I'll be brave enough to say it looks like we're on the other side of this inflation story .

How long it takes and how much it's going to come down , I think we don't all know , but that's what we do know . Is that ? That's the starting point . So , henk , when that happens , when inflation starts to come down , kind of , what are the next steps ? What do we start to think about now as investors ?

But the other side of the point when it comes to interest rates really is around the growth story , right , and what we have found and what we will find going forward is a lot of talk around the US . The growth Are they going through a recession ? Where are they in terms of growth , et cetera , et cetera , right .

So at Pressing again , we're very systematic in the way we do things . So we look at the numbers , we look at the data , the evidence , and if we look at what we call our now cost , our present economic indicator for the US , we've seen them growing around 0.9% currently , right . So what we do with that is that is where they're growing right at this moment .

So , if you think back to about last week , there was a GDP print . That was for June . We know in September we have spring , thank goodness , that was a long week in Cape Town , so that information doesn't really help us right from an investment perspective , but 0.9% growth in the US is still a good story , right ?

So we're not seeing a recession on the horizon . Yes , growth is slowing . Yes , we are seeing the impacts of the high interest rates , but we're not going into recession .

That is important , because if you had the other side of the coin , where we saw recession and quite a drastic downturn in economic growth , you'll see the Federal Reserve in the US react quite aggressively and that's usually followed by what we call risk or fright , and for us as South African investors , that's not such a good thing .

Okay , so yes , on the growth story , that's a good thing . There's still some growth not really a lot , but certainly not a recession . Then , on the inflation story 100% one . We've seen the back of it . So if you told me 10 , 15 years ago that we would see 9.1% inflation in the US , I would have told you you're crazy .

That is what we saw , sort of post the disruption from COVID , et cetera , et cetera , and all the talks around .

Was this 9.1% the new normal or was it a transitory thing and were we going to go back to the normal sort of 2.5% interest or inflation rates that the US sort of got used to throughout the number of years right , and what we are seeing , if we again look at the data , is that inflation is normalizing quite quickly .

So the key driver there at the moment is really house prices in the US or shelter , and that's the component that looks towards rent and that's coming down quite quickly , and we are seeing US inflation going back towards that 2 percent in the not too distant future .

So by the end of the year you should see the inflation sort of story back to something a lot more normal . So what does that mean then for us as global investors ? When it comes to interest rates , the interest rates in the US really the risk free rate around five and a half percent or 5.4% currently that is exceptionally high .

So there's an absolute fantastic opportunity in that . But what we are seeing is that rates will start coming down not too long from now . The first expectation for rate reduction in the US is priced for this month , so 18th September , if I'm not mistaken , is the Wednesday .

We see the Federal Reserve meeting and the market is saying there's a strong probability that they will reduce rates by a quarter of a percent , so 25 basis points in our world , and that should tick off a series of great events for global markets , a lot of risk , a lot of opportunity and certainly still opportunity in the fixed income space as well .

tailwinds of falling interest rates . And I think it's maybe just worth touching on how difficult it is for a central bank to control inflation , because it's very sticky . You feel like you've beaten it , but then the following month you'll find some number suddenly shooting .

You know , and I think people don't really appreciate that , you know economies don't work , you know , exactly at the same time . So all the sectors of the economy don't all rise at the same point and then all fall at the same point . They do it in in kind of a mess . You know a general pattern and and and .

So for a reserve bank to kill very high levels of inflation without putting the economy in recession is actually almost miraculous .

I always think back to that airline pilot who managed to land the jet plane on the Hudson River , and that's what they will have done If they can get the American economy through this without recession and normalize inflation and normalize interest rates , they will have landed a massive jumbo on a very small river 100% .

So for them to be able to do something like you said , land this juggernaut of a plane in an environment where , globally , we saw an enormous existential stock shock to the global system in the form of covert um supply chains getting decimated , um was actually I mean , it is miraculous um , and that's what we're seeing .

I mean they are able to get inflation back down to the two percent handle . They haven't started cutting rates yet in the us economy or the global economy hasn't fallen yet . So certainly a win for all of us , and we should all start experiencing and expecting some relief on the rate side as global investors and as people on the ground .

And I'm not putting words in your mouth . It's my view that those big tech shares are ridiculously expensive and so kind of . You know , I'm sitting and thinking to myself .

When you're in an environment where a general market has gone up for quite some time and , you know , not in a straight line , but it's been fairly consistently going up that does pose some risks . So I'm sitting and thinking in my head we've got very good news , which is falling interest rates .

That always gives an impetus to the property market , the bond market and the equity market , but then we've got a situation where a portion of the world's biggest stock market is very expensive . Now , if I'm an investor , I'm looking at this whole world . I mean , you know I don't have answers to those kinds of questions .

So how do you look at that and then say , okay , no , you know , this is what we do going forward 100% .

Then you need to think about the economic situation . Then again we're looking at sort of things like the present economic indicator , um , surprises on the economic data , etc . You need to think about monetary policy , or financial conditions , as we would call it . That's really the interest rates , the strength of the dollar , etc .

There it's all still very tight , right . So you think about the inverse , inverted nature of the us yield curve , um , the ability for businesses to do business , um , with the interest rates where they are . So that's still very tight , um . And then , finally , if you think about sentiment , um , and those factors are actually still quite negative .

So you have a strong case against valuations . Economics hasn't really turned , financial conditions will start turning , but not yet , and sentiment is pretty low . So we agree that US certainly US equity is not really the place to be . We're probably underweight there .

But what happens when the Federal Reserve starts stacking interest rates is that the global risk-free rate or the benchmark for assets to beat , which is really the US interest rate , starts coming down and investors who sit with money in the bank , who were earning five and a half now , all of a sudden start earning less and less and less and they need to start

finding houses for their capital . And then things like emerging market equities or South African bonds etc . Start streaming really , really attractive and you'll find money flow across the globe as this break in the US goes lower and investors need to find houses for capital . So we see a lot of lazy capital because of the rates being high .

That's going to change quite quickly and we do think that South Africa won , but globally , in the emerging markets et cetera , will be the beneficiary of that capital flow . And then things like global interest rates . So they are still quite elevated . There is still some opportunity in the US bond market , et cetera , et cetera .

So US equity is probably not so much , but the rest of the sort of complex does look pretty good .

That's why it's lazy , because they can just earn the interest rates and do nothing .

What are the opportunity sets for us here ?

And two , you need to think about the asset class that you decide to eventually invest into . And what we have found for a lot of South Africans , when they make that decision to go offshore , it's a pure decision to not have rands but to have some other currency , usually the wallet .

And then the second question then comes up later , which is actually quite interesting , is they don't really know what to then do with the money . Now you sit in a bank account . Luckily , it's been a good ride in your bank account , but that's going to change .

And for investors for South African investors who have money offshore , they need to really start , and what we are seeing and we're finding quite a lot of appetite in this is a lot of opportunities in what we would call the global income space .

So those would be sort of opportunities in the credit markets globally where you can still fix income , but floating in nature .

So that means you're not taking interest rate risk because you're floating with the market , but you're earning a spread or a compensation on top of your interest rate for taking on a diversified global basket of credits , um , one of different banks or very , very highly sort of great .

There's a lot higher , higher rate of things for africa , as an example , um , and you're earning one , two , three percent on top of your interest rate . So there's a lot of opportunity for you then to find those houses for your capital , uh , rather than sitting in the bank account .

I think for south africans or at least we , we think for South Africans that's going to be a very key decision that's going to be made going forward , as you've now made the decision to go offshore . Now what do you do with your capital ?

There's a lot of opportunity if you are a little bit more sophisticated , think about it a little bit more deeply and find some of those ETFs exchange-funded funds that give you diversified , cheap , global fixed income exposure as a South African investor .

So think about global high yield or emerging market corporate debt , emerging market government bonds all these sort of things you can now access via exchange-traded funds because of the sort of the privatization of them coming to market to grow in their size , etc . Etc . How cheap it is for us to actually access .

That has given us , as South African investors , the ability to now compete globally by buying these different asset classes , creating a process around that and then giving some African investors the opportunity to buy a portfolio of these assets managed by us , obviously , or different asset managers and get this global diversified income exposure at a very , very low cost

but also a very low risk level .

And that's the wonderful thing about the financial markets as things evolve and new products come to market and new sort of ways of innovation , it creates the opportunity for people investors South Africans or global to really have the opportunity to invest into these asset classes that previously was really just available to professional or institutional investors yeah , and

I must say , for me that's very exciting .

And so I think that now , getting to the point where accessing global ETFs inside portfolios becomes really attractive and gives us the ability to compete with anybody anywhere , which is really exciting .

So it really has changed the playing field and gives us , as Africans , the opportunity to compete globally .

That's the difference , 1.5% to 0.1% and being able to offer a good solution on the other side for a client becomes much more viable . I think it's very exciting , Henk .

We're almost out of time and I wanted to give you the opportunity for someone who's listening to say what should they be thinking about in this environment and what's kind of the golden nugget that you want to give them to take out of the next few months .

I would hazard a guess to say that that's probably incorrect . There's still a lot of opportunity in the global income space to earn really good real returns .

As inflation normalizes , interest rates will stay at a level that will give you that and , as we've said before , there's a lot of asset classes , specifically US equities , that has been sort of the traditional house for money going offshore .

That is very expensive and , with the slowing growth environment , credit spreads being arguably very tight , one needs to think about a global diversified solution when it comes to finding real returns in the offshore space , and we're certainly finding that in the income space from a global diversified ETF perspective .

So we see a lot of opportunity , a lot of appetite for that , and we would certainly tell investors to think about that very carefully when you've gone offshore . Make sure what you're buying gives you that real return at a fair price . That's also very well managed from a risk perspective .

You've always got to have proper diversification in a global context , and I think you know we too often I know especially me , because that's kind of where I grew up you know we tend to focus on equities too much and that can come at a huge cost to investors , both from a risk point of view , but also from a risk per kind of unit of growth as well , and

managing that growth at the right risk is key , and I think diversification is a solid point that we forget about a lot . We think diversification is South African equities versus global equities , and that's just not true . There's so many more asset classes out there . Honestly , I did say at the start that this would be an interesting show and it was .

We managed to talk about interest rates and actually keep a very nice topic . I appreciate your input . Thank you so much for being back on the show Henk Kortse , our Head of Cash and Income at Prescient Investment Management . It was a pleasure and I'm sure we'll have you back on the show again .