Last week’s Medium-term Budget Policy Statement delivered by Finance Minister Tito Mboweni did not deliver significant surprises and was largely in line with market expectations in terms of overall deficits and borrowing requirements.
This is the view of Old Mutual Investment Group portfolio manager John Orford who adds that potentially higher issuance of government bonds in coming years might weigh on longer-dated bond yields. This is likely to keep real yields high and the yield curve steep until growth picks up significantly or domestic reforms, including cutting the wage bill, become actions rather than policies.
“South African bond yields have already discounted the weak fiscal position with the South African yield curve very steep – longer-dated bonds are much higher than shorter-dated bonds.” He explains. “Nominal yields are high relative to cash yields, and relative to expected inflation and inflation-linked yields in South Africa, remain high compared to global real yields. For example, South African inflation-linked bonds’ offer an after-inflation yield of 4.5%, which compares to the negative -0.7% offered by US inflation-linked bonds.”
He goes on to say that of course, there is risk in South African bonds given the rising debt to GDP levels and weak growth, but with a real yield, very high investors get some compensation for this risk. “This is hardly the case in the US and most developed economies where investors receive no reward despite facing a considerable risk of rising yields in the coming years.”
Zain Wilson, Investment Strategist for Old Mutual Investment Group believes that as we move out beyond the recovery in the next 12 months, asset allocation will be guided by how relative valuations have shifted, as well as changes in the global environment and our assessment of how successful government has been in executing their plans announced in the Medium-term Budget to rein in spending and implement policies to support the economy’s growth potential.
“We expect the improving global environment to be the dominant theme driving domestic assets over the next 12 months. We are already seeing feedthrough into better export performance and, in particular, the mining sector, which maintains strong linkages to both fiscal performance and the rest of the economy,” he says. “This should support domestic fundamentals – better growth off of a low base, improving external balances, revenue collection and sustained low and stable inflation.”
However, he warns that this perspective is vulnerable to any policy shifts to the left which may reset the price investors pay for those fundamentals lower. “But, we are broadly happy that Government’s response to the crisis has been a shift in the direction of reform, as opposed to populism, thereby reducing the risk,” says Wilson.
Orford echoes this view, adding that overall, South African assets — including bonds and equities — remain attractively priced and would be beneficiaries of any improvement in global growth in 2021. “This will likely be supported by progress in the development of vaccines and therapeutic treatments of Covid-19 and ongoing fiscal stimulus in developed economies – j particularly if the Democrats win a Presidency and Senate in next week’s election”.
He adds that of course, near term, the surging Covid-19 infection rates in Europe and the US are weighing on global equity markets, including South African markets.
“Our funds are overweight government bonds given the very attractive real yields available. We have also added to equity exposure since the equity market crash in March, in particular, adding to cheaply priced local equities where we feel the weak earnings outlook is largely priced in,” he concludes.
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