By: Luke Meiklejohn
As South Africa, and many economies globally, navigate through the aftermath of peak interest rates, investors find themselves at a crucial juncture, contemplating the next strategic move for their portfolios. The recent halt in the rate-hiking cycle signals an opportune moment to reassess investment strategies, with the likelihood of interest rate cuts looming on the horizon over the next six months.
Behavioural finance principles shed light on the psychology driving investor decisions during such pivotal times. It's natural for investors to gravitate towards safe havens like cash assets during periods of uncertainty, and indeed with rates rising, holding cash becomes more attractive as it offers a higher 'risk-free' return. However, it's essential to also recognise the potential drawbacks of this approach. Firstly, history has shown that remaining overly cautious in times of shifting monetary policy can lead to missed opportunities for portfolio growth. Secondly, as rates fall, that 'risk-free' return becomes increasingly 'risky' - with a diminishing likelihood of an investor maintaining their purchasing power and achieving a real return over time.
In anticipation of interest rate cuts, it's prudent for South African investors to consider reallocating their assets towards riskier investments. This shift is not merely a leap into the unknown but rather a calculated move backed by historical performance data.
During previous rate-cutting cycles, risky assets such as equities have demonstrated resilience and delivered favourable returns. The influx of liquidity into the market, coupled with improved economic prospects brought on by lower rates, often fuels a rally in stock prices. Additionally, sectors sensitive to interest rate changes, such as real estate and consumer discretionary, tend to flourish in a declining rate environment. As illustrated below, over the two years following rate cuts, equity markets have performed somewhat better than typical - although the response has varied widely. Importantly, the reason why rates are being cut matters - and equity market performance will correspond with the broader economic reality and forward-looking views on this. The performance prior to rate cuts is also telling; as investors grapple with a weakening economy, the equity barometer has historically fallen over the previous year.
For those anxious about the prospects of equities, fixed income may also be an appealing way to allocate away from short duration cash-like investments, and the conclusions drawn here from the last four rate cutting cycles are more convincing, with performance strongly positive over the following two years in each of the cases in Figure 3, and the bond market rallying even before rates are cut.
While the allure of higher returns from riskier assets may seem enticing, it's crucial for investors to approach this transition with a well-thought-out strategy. Diversification remains key to mitigating risks associated with market volatility. Allocating a portion of the portfolio to defensive assets can provide stability during periods of turbulence while still allowing investors to capitalise on the growth potential of riskier investments.
Moreover, staying informed and adaptable is paramount in navigating the evolving market landscape. Keeping abreast of economic indicators, central bank policies, and geopolitical developments can provide valuable insights for making informed investment decisions.
One other area that has received much attention over the past two years is allocating offshore. Interestingly, over the past four rate cutting cycles, offshore equity markets have underwhelmed relative to local assets, with a median performance roughly flat over the two years following the South African Reserve Bank's (SARB) first rate cut, and underperforming the typical performance expected. One direct cause of this is due to the performance of the rand relative to the US dollar. In the cases of 2001 and the Covid-19 pandemic, we saw initial strength of the dollar, as investors flocked to it as a safe haven, but over each of the last four SARB rate-cutting cycles, holding dollars has resulted in a median negative return for South African investors over the 12 to 24 months following the SARB cutting the repo rate.
As we look beyond the pause in the rates cycle, South African investors are urged to embrace a proactive mindset. By strategically reallocating assets towards riskier investments, investors can position themselves to capitalise on the anticipated rate cuts and potentially unlock greater returns for their portfolios. We view well-diversified multi-asset investment solutions as attractive investment options in the current landscape, particularly as our investment approach aligns target investment horizons with appropriate return objectives and risk constraints.
In conclusion, the journey beyond peak rates presents a prime opportunity for investors to reevaluate their asset allocation strategies and embrace the potential of riskier investments. By understanding behavioural finance principles and historical performance trends, investors can navigate this transition with confidence and seize the opportunities that lie ahead.
