Issue: June/August 09
Editorials

FIRST WORD

Matters of interest

Rate cuts invariably get roars of approval. Those who don’t benefit rarely make any noise at all.

Nobody shouts for the savers. Yet is it is they who’re taking a double dip. Falls in share prices on the one hand, and reductions in interest rates on the other, strike them on both flanks.

Nothing can be done about the former. The JSE’s allshare index (Alsi) marches pretty much in lockstep with international bourses. Like the Alsi, in the year to mid- May such major indices as the S&P 500 and the Nikkei have shed over 30% of their value.

The JSE’s tandem movement is due partly to a handful of mega-companies (such as Anglo, BHP Billiton, Sasol and SABMiller) whose share-price performances derive mainly from their primary listings abroad. Because of their index weightings, they shape the Alsi. Hence, these shares impact heavily on investment portfolios – of retirement funds, amongst others – that are effectively obliged to include them.

Partly, too, it’s an inevitable consequence of globalisation. Countries and companies obviously can’t trade in isolation. When developed economies enter recession, emerging economies are rattled by them. There’s no place to hide, even for those rich in commodities.

And so central banks, all of them, are cutting interest rates. Lower rates are supposed theoretically to stimulate, by making it easier for companies to invest and consumers to spend; no matter that their insupportable borrowings led precisely to the current meltdown in the first place. aBut theory flies from the window when banks are reticent to lend, consumers are too indebted to splurge, and companies are forced by weak demand and weakened balance sheets to curtail expansion; no matter what the level of interest rates.

Similarly in SA. During the five months to end-April, the Reserve Bank has dropped its repo rate (for lending to private-sector banks) by 2,5 percentage points to 8,5%. The drop has pushed down the prime overdraft rate to 12%, higher than consumer-price inflation at home and much higher than the negligible borrowing costs abroad.

To date, the cuts have had little effect on the real economy; job losses continue to increase and retail sales to decrease. By contrast, their impact on the financial economy is debatable. Share prices were in freefall until early March, after which they soared on guesswork that the worst of the recession had passed. If interest rates had anything to do with it, the share market’s recovery would have started when the rate cuts started.

HISTORY LESSON

Equities are the only asset class to have consistently outperformed inflation over the long term, points out Association for Savings & Investment SA chief executive Leon Campher. He offers these examples where end values include interest and dividends:

  • Investors who’d held R1m in money market funds for the past five years, to end-March this year, would have seen an annual pre-tax return of 8,56%. Their lump would have grown to R1,5m. By contrast, investors putting the same amount over the same period into general equities would have received an annual return of 15,46%. Their investment would have grown to R2,1m;
  • Investors who’d held R1m in money market funds for the past five years, to end-March this year, would have seen an annual pre-tax return of 8,56%. Their lump would have grown to R1,5m. By contrast, investors putting the same amount over the same period into general equities would have received an annual return of 15,46%. Their investment would have grown to R2,1m;

All the while, local investors overwhelmingly preferred cash to equities. During the first quarter, according to figures released by the Association for Savings & Investment SA, collective investment schemes attracted net inflows of R23bn. Of this, almost R18bn went into money market and domestic fixed-interest funds.

At last count, money market funds were showing effective returns around 9,5%. Make the deduction for tax, and the investor doesn’t come close to beating inflation. That is hardly an incentive to save.

Which leaves the alternative of switching back to equities, with the attendant risk it implies. Nobody dare say with confidence that recent strengthening of share prices, dramatic as it’s been, doesn’t represent a false dawn. The prudent advice, as always, is to diversify portfolios and sit it out because over the longer term equities outperform inflation.

Shorter term, the advice has a hollow ring. It doesn’t indicate, because it can’t be indicated, how much switching there should be in any individual portfolio. A financial advisor is as much in the dark as experts proven wrong.

Those who’ve been stung are understandably nervous. The preference for cash at least protects their nominal capital in the event of another equities reversal, even at the expense of ostensible bargains passing them by, until company earnings show glimmers of improvement to underpin the apparent bargains.

For those whose watchword is caution, the perpetual brouhaha to keep cutting interest rates holds little cheer.

Allan Greenblo,
Editorial Director