Equity investors often expect positive returns when there’s good news about economic growth, but sometimes good economic news results in poor returns. Because it is difficult to predict the impact that economic news will have on investment returns, it’s important to stay focused on factors that are within our control when investing for the long term.
So much about the future is unknown, and share prices reflect the market’s assessment of the future.
This article expands on the theme of an article we wrote in January, ‘The danger of making short-term decisions when investing for the long term’.
The list of things that can impact the future, and therefore a portfolio, is long and includes politics, taxes, weather, growth, innovation, and consumer habits, to name a few. Despite our best efforts none of us can, with any certainty, say how these will evolve or unfold over time. Sometimes better economic growth is good news for share prices and sometimes it’s bad news.
As an example, let’s look at how South African markets and US markets have reacted to good economic news recently.
In South Africa, improved GDP growth and business confidence made for a positive start to 2018.
Since December, following the election of Cyril Ramaphosa as president of the ANC, there has been a lot of positive economic news flow for South Africa. GDP data released in early March showed that the economy had expanded faster than had been anticipated. Market participants had expected growth of 1.8% for the final quarter of 2017 but the economy grew by 3.1%. Business confidence, which had been depressed for some time, has turned, with the highest level since October 2015 recorded in February 2018. The Standard Bank Purchasing Managers’ Index, which is an indicator of business conditions, jumped to 51.4. This is the highest level since December 2016.
There has also been some renewed comfort about the ANC’s policies.
As one example, on 21 February the Minister of Finance raised VAT from 14% to 15% because ‘unlike other major taxes, the VAT rate . . . is lower than the average rate across peer countries . . . [and] is less harmful to growth than raising other taxes.’ In addition to improving growth prospects, this confirms that growth is a policy priority.
The result: Good economic news was good for investors.
The global growth environment that we are in now is beneficial to South African exporters; when our trading partners prosper, we have the potential to prosper too. At the end of February, we saw that the confluence of improving growth and lower risk had a positive effect on the share prices of companies that are dependent on the South African economy.
In the US, higher-than-expected growth triggered an expectation of interest rates hikes.
On the first Friday of every month the US Bureau of Labor Statistics (BLS) publishes non-farm payroll statistics. On 2 February, it reported that the US labour market had added 200,000 jobs in January, instead of the estimated 184,000. In addition, estimates for December were revised up from 148,000 jobs to 160,000 jobs. These stats indicated that the US economy was growing faster than was widely anticipated. The market saw the strong employment numbers as a possible trigger for increased interest rates and potentially higher-than-expected inflation. In an environment where an economy is growing, it’s very difficult to justify near-zero interest rates and, if short-term interest rates stay low, inflation may well end up rising.
The result: Good economic news caused share prices to decline.
Rising interest rates create an opportunity for investors to improve their risk-adjusted returns by including interest-bearing investments in their portfolio, such as cash. Higher returns from these lower-risk assets allow investors to earn more attractive returns while taking less risk. As markets started to expect higher interest rates, prices of higher-risk equities declined, which had a negative effect on investors’ returns. The news therefore caused a market sell-off.
Focus on making investment decisions based on the factors within your control.
1. Identify your investment objectives
Be clear on what you are saving towards so that you can choose the right type of investments or assets that are most suited to your investment objectives. For example, investing in a high-risk equity fund when saving for a home deposit (likely to be needed in a few months’ time) is inappropriate.
2. Invest with a portfolio manager whose philosophy you understand and trust.
When investing, be sure you are happy with how a portfolio manager makes investment decisions. Only invest with them if you trust them to stick to an investment philosophy that you understand and that you believe can generate attractive returns.
3. Ensure your time horizon is aligned with that of your portfolio manager.
Over a short period of time, the value of a company’s shares can and will fluctuate. It is only over longer periods that a company’s ability to generate sustainable returns will be revealed. Investors who do not remain invested for the long term cannot benefit from the company’s ability to generate value, nor from the portfolio manager’s ability to identify and acquire these companies at attractive prices.
4. Diversify to improve the likelihood of meeting your investment objectives.
Investing entails risk. Adequately diversifying between different sectors, geographies, economies, and even philosophies, helps to protect your capital if things go wrong.
We can’t control economic news or its effect on returns, but we can control our choices.
As portfolio managers, we try to ignore the short-term noise and apply a disciplined investment process to generate returns for investors, focusing on what can be known. We analyse the factors that contribute to a company’s ability to sustainably grow shareholder value and we aim to buy shares in these companies at attractive prices.
Denker SCI Stable Fund
Denker SCI Balanced Fund
SCI stands for Sanlam Collective Investments. SIM stands for Sanlam Investment Management.
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