Navigating Interest Rate Cuts: Strategies for Global Diversification

But I'm feeling fairly confident that before the end of 2024 , we will see a cut in interest rates in the US . I'm not going to ask you to comment , I'll give the market the stick to beat me with , but we're in an environment where interest rates are likely to come down sometime soon .

And then the kind of question I'm holding is , when we're in this environment whether it's now or in 10 years time again , whenever that will be and you're sitting there as someone who looks at all the assets classes that are well , let's say , the investable ones , at least the responsible ones , and you're trying to put together those assets in a long-term kind of

balanced portfolio , how do you look at that and say , on a global basis , this is now how I'm going to kind of allocate money to the different asset classes .

But for me , within investments , you have to prepare for all different types of eventualities and we work in probabilities right . So I mean , as we said here , there is essentially a market implied probability of rate cuts in the United States and in South Africa going into the end of the year .

So the market is saying there's a greater than 50% chance , according to their view and they being us as well that there's going to be rate cuts going to the area . So it's important , within a multi-asset portfolio , to prepare yourself for that . And I think where I always come back to is diversification .

What I talk around there is that you need diversification across geographies and asset classes to prepare yourselves for all types of eventualities and what I mean by that is not just South African asset classes but offshore asset classes to prepare yourselves for all types of eventualities .

And what I mean by that is not just South African asset classes , but offshore asset classes like the United States , or be it China or Europe , wherever it might be , because the United States might be cutting rates and let's come back to that in a couple seconds time but China might not be . China might be hiking rates .

So two things that I wanted to come back to the United States , the question is always why might they be cutting rates ? And there can be two reasons for that or two outcomes of rate cuts . The one can be that they're cutting rates because the economy is slowing down , markets are struggling and they need to stimulate the economy .

That's one potential route for cutting rates . The second path for cutting rates is that they think the economy is running strong , but it can run stronger . So one's kind of a negative outlook . The other one is , I guess , in a positive outlook , and I think that's important for us to think about as well . So why is the United States cutting rates ?

Well , the United States naturally doesn't have rates sitting at 5 , 5 and a bit percent . They sit just north of 2% . So they want to re-anchor back down to that 2% , reduce inflation and if they achieve that , they're coming back to inflation targets . So we think that there is quite a high probability they do cut rates .

Our central bank has one mandate Take care of inflation and don't worry about anything else , and everything else will be taken care of if you take care of inflation . I'm really summarizing , but I think it's not far off the mark .

And so when the Fed in the States says we think we might start cutting interest rates , and we kind of back to your examples about why it will also be because they'll look at the situation . They've been applying the kind of heavy medicine which , to their credit , was required , which is high interest rates to cool inflation .

But too high interest rates for too long will kill the patient . And in this instance the patient is the US economy and you kind of measure that if you're the US central bank by employment they can't kill the patient , because then they're going to create unemployment and then they're in trouble .

So that's , you know , just summarizing that's what they're looking at With all of the data that everyone's kind of analyzing all the time . There are a couple of these they're mostly gray-haired people , hopefully intelligent , kind of experienced , you know economists looking at this and saying how do we balance the two ?

And so now we get to the environment where it's possible that they will cut rates . I'm going to just jump back to the start of the show . I'm very confident Americans will cut interest rates before the end of the year . I'm not as confident South Africa does it , kind of the next day or the next week .

I always think we're not going to cut first , we'll cut after the Americans cut . Otherwise that kind of hurts Iran somehow . But now we're in this environment , rupert , so let's just say it doesn't matter whether it's September or October 2024 or September October 2064 .

You're looking at this and you're saying the environment starts becoming ripe for a world where the biggest economies have very high interest rates , unnaturally for them , and they're likely to start cutting . I mean you made the point around diversification .

So do you just kind of stay the course , don't adjust anything , or do you look at it and say there might be some opportunities in this , or stay with my asset allocation decisions ?

So if we see inflation falling within South Africa and the United States , that means that if you're getting 10% on an instrument , on a fixed income instrument , you're getting 10% yield today , and that's a nominal yield and you can lock it in as of today .

Then , if you know that inflation is going to go down further and further and further going forwards , you can actually make a higher return profile if you can somehow lock in that forward yield at 10% . Right , because 10% , if inflation is 8% , is only 2% real , whereas 10% , if inflation is 2% , is only 2% real , whereas 10% , if inflation is 2% , is 8% real .

So that's the theme that I think a lot of investors are looking into right now , and one of the interesting asset classes that has popped up on the radar , that has been out of favor for 5 , 10 , 15 years , is global fixed income .

What's happened in the global fixed income space is that you've had significant's happened in the global fixed income space is that you've had significant rate heights within the United States and also Europe and the UK and , as a result , a lot of fixed income instruments price on top of base rates , base rates being essentially like a fair funds rate .

So you've had these yields going up and up and up . You're now getting 6.5% on very much vanilla , low-risk income-type asset classes in dollars . If you bring that back to RANDs , let's call it a 4% differential that's 10 , 10.5% in RANDs on a US very low-risk treasury-type investment .

That's pretty attractive and what investors are now looking to do is to take on more and more of the risk in that type of bucket .

The other side of the coin and this goes back to the reason that central banks cut rates central banks cut rates , especially in the United States , because of economic growth outlooks , and economic growth is directly tied towards growth assets like equities .

So if we look towards equities and for those of you who know , the traditional dividend discount model , where you've got your dividends in the numerator , the denominators includes the growth rate and also your central bank rate going forwards , if you can have a lower central bank rate , a discount rate , that's pretty attractive , but it assumes that growth stays

attractive . And why I come back to that is that I mentioned earlier that often central banks will cut rates to stimulate growth and they're doing that because they think that there are headwinds coming in the next year or two for growth for the economy . So think about that from a fixed income and then an economic growth type exposure .

So equities , fixed income asset classes fixed income asset classes currently pretty high yield , equity asset classes potential , in the offshore space at least , to have headwinds towards growth and the result being that there is a thematic push towards global fixed income at the moment .

So I'm going to repeat back some of what you just said to emphasize so I can also look clever for the next 30 seconds , kind of in my investment thesis very simplistically , that generally rising interest rates are really not good for the stock markets or property markets and falling interest rates are generally good for properties , and when I'm saying properties I

really mean property companies that trade on the stock exchanges and their normal shares . But the point you're making is , in this instance , if interest rates are being cut because the economy is slowing down , then the companies who sell stuff to the consumers and to other businesses might be selling less stuff and they might be making less profit .

And so , even though they're not generating a bit more money because they're not paying as much for debt costs , they're actually not making so much money on revenue because they're selling this . And if that economy comes to a screeching halt , then those companies might be in trouble , even though the interest rate environment has become much better for them .

They don't really care about equities or fixed income , they're looking about economic growth . So , the person on the street they don't really care . If the person on the street owns Apple or owns Tencent , right , that's not what their mandate is . They're looking towards growth and growth comes from the bottom up in their mind . So , yes , you're spot on .

If the Fed does cut rates in time to keep growth on trend or above trend , that's fantastic for the economy . But I think for us as investors , we have to think about the asset classes in which we invest . So let's take , for example , us equities , currently trading at around 28 times PE ratio and growing with the massive rally we've seen in tech stocks .

That's a pretty top heavy market . And a top heavy market can be top heavy for a reason because the PE ratio is something that looks in the rearview mirror . It's the current price and last year's earnings . But people can often accept a higher PE ratio because they think that growth is going to be strong going forwards . But that's the key .

If growth now comes down , growth expectations fall apart . Then you have a very top-heavy stock market with lower growth expectations and that often leads to a correction .

Actually , what I should be doing is maybe finding some pockets of value in the stock markets , wherever they are , and I mean you mentioned diversification at the start . So for everybody , I mean you don't now , because Rupert says and he's correct that the US equity market is expensive , that doesn't mean you sell all US shares . That's not a good idea either .

But looking at picking up value in global bonds which have been ignored for gee , I mean it feels to me like a decade .

I don't know why it feels like it , but somewhere around there you might be locking in , as you said , kind of a good few percent above the inflation rate for very little risk other than if the US as a whole kind of country falls over I's , you know that's . I mean anything possible . It's probably .

It's very improbable at the moment , you know , for the next few years . So then you're getting good returns .

On one side , you're avoiding very expensive assets in terms of a good chunk of the US stock market and you know , if you are sitting on some cash especially if it's inside a fund where you're not paying all the taxes yourself then you're still in a position to make some money , even if the economy is actually slowing a lot more than everybody anticipated .

But at the moment you're getting pretty high returns , which opens up possibilities for us and naturally we wouldn't take off all of our US equity exposure . Again , things are based on probability , so we're never going to be 100% right . That would be fantastic , but it's not going to happen . So we moderate things in line with exactly what you're saying .

But just to say , there are opportunities elsewhere now that you can look into and look into the fixed income side of things . There are also opportunities in other equity markets around the world . So it's not just equity markets in the United States and on top of that , it's not just fixed income markets in the United States .

There's also gilts in the UK , euro bonds in Europe . You've got issuances across Asia as well . So there's a global sphere which has gone under the same hiking cycle as the Fed , and I know everybody always says , especially the Saab they say they don't track the Fed , they don't copy the Fed .

But you're spot on in saying , when we looked at the numbers , be it coincidental or not , the Saab pretty much always tracks the Fed a little bit delayed after the Fed , and that's because , as you said , one of the key mandates of the Saab is to control inflation and , by in doing so , control the exchange rate , and to do that you need to have an attractive

spread or an attractive yield for an offshore investor to invest in South Africa . So they do react to changes in global base rates and , as a result , we would expect them to cut largely in line with the Fed .

Coming back to South Africa , though , that's an interesting one , because global equities might be quite top heavy South African equities , on the other hand , and other emerging markets but South Africa is quite close to home they are quite attractive on a valuations basis . So think about this . You're having a situation where South African equities are quite attractive .

If you simply look at a P-E ratio , for example , they're pricing well below the long-term median , and that's because they've had a lot of headwinds when it comes to expectations and the outcome of the elections and uncertainty , which is largely falling away now , and we're having potentially higher growth expectations from the GNU , as we call it .

So , as a result , you've got lowering base rates , so the cost of borrowing for companies is lower and the higher growth expectation at the same time a price that's quite attractive . So South African equity is a very different story and that's why I say don't write equities off . You've got equity opportunities in different places .

It's just that in particular , for example , the US equities in the tech space very , very strong rally , and often it's a good idea to take profits in a situation like that .

Now , you know , you're kind of touching on some really positive stories that we should focus on , and so I think we're going to get you back for another episode very soon , rupert . Rupert here from Prescient , thank you so much for being on the show . It's always a pleasure . I always learn something .

I've done it again , and so I appreciate you and we'll be chatting to you very soon .