September 2024 newsletter

International

As we approach the end of the year, global financial markets may continue to experience volatility due to uncertainty surrounding the US elections, tensions in the Middle East, and broader concerns about economic growth. Despite these risks, the investment environment remains favorable, with interest rate cuts on the horizon and investor sentiment not overly optimistic.

We view any potential short-term market corrections as more technical than fundamental. Macroeconomically, we anticipate a modest and uneven continuation of the cyclical recovery, driven by resilient US demand, ongoing investment in artificial intelligence, and Chinese manufacturing exports. Central banks are increasingly shifting focus from controlling inflation to supporting economic growth, which paves the way for further interest rate cuts.

In China, regulators have intensified efforts to stimulate growth through fiscal spending and measures to stabilize the struggling property sector. These initiatives are expected to revive the Chinese economy, which will in turn contribute to global economic growth.

Key risks to consider:

1. Inflation: A rise in inflation would exert significant pressure on central banks. While they can lower interest rates to stimulate the economy, this becomes increasingly challenging if inflation is not adequately controlled.
2. US Unemployment rate: A sharp increase in US unemployment could put pressure on markets, as it is a strong indicator of a potential recession. However, we do not view this as a long-term concern, given the underlying strength of the US economy, which is likely to benefit from future interest rate cuts. The Federal Reserve, having raised rates considerably over the past two years, now has substantial room to reduce them.

US elections – Trump vs. Harris

According to Alpine Macro research, the most likely outcome of the US elections is a Trump victory, combined with a Republican-controlled Congress. This scenario could extend tax cuts, stimulating short-term economic growth, inflation, and interest rates. However, it may also lead to higher deficits and a weaker US dollar, with the potential for rising government bond yields.

The second most likely outcome is a Harris presidency without full Democratic control of Congress, which could limit the passage of significant legislation, potentially muting the market’s reaction.

Historically, US equities have shown resilience and strong performance across different administrations, indicating that market returns are driven more by underlying economic fundamentals than by short-term political events. Therefore, maintaining a strategic allocation to US equities remains a prudent approach, as the US continues to be a global leader in innovation and growth.

Equities

The spike in volatility in early August has tempered market exuberance, creating a stronger foundation for future gains. While we acknowledge the possibility of further market corrections, particularly ahead of the US elections, these could present attractive entry points for investors who have not fully participated in the current equity bull market.

The fundamental outlook for equities remains positive. Earnings growth is broadening, and historically, US equities have risen following interest rate cuts, provided that a recession did not accompany it. This is our baseline expectation. While the “Magnificent 7” companies have been driving earnings growth in the S&P 500, we anticipate that the earnings growth differential will be much lower between the remaining 493 companies and the “Magnificent 7” during the next three quarters.

Summary

We expect a period of heightened volatility over the next 3-6 months due to the factors mentioned above. However, we view this as an opportunity to add high-quality companies to portfolios, as the overall economic fundamentals remain supportive. While we aim to reduce volatility as much as possible, we remain committed to our long-term strategy. To mitigate short-term market fluctuations, we are incorporating alternative investment strategies and bonds.

The JSE All-Share Index rose by 3.3% in September, mirroring gains in global markets. South African shares experienced their strongest third quarter in 11 years (+8.4%), with investors optimistic that the rally will continue. Naspers (NPN), which is heavily exposed to China, led the advance (+14% MoM), surging as Beijing introduced measures to stimulate the economy.

Improved inflation forecasts, lower oil prices, a stronger rand and the U.S. Federal Reserve’s decision to reduce interest rates by half a percentage point provided momentum for an interest rate cut. In response, the South African Reserve Bank (SARB) lowered the repurchase (repo) rate by 25 basis points to 8% in September, marking the first rate reduction since the global economic fallout caused by COVID-19.

The rand strengthened against the dollar, buoyed by favorable sentiment following the rate cuts by both the Federal Reserve and SARB and a surge in the gold price. Gold rose 6% in September, reaching a new high of $2,672, driven by the Federal Reserve’s rate cut, China’s stimulus efforts and concerns over ongoing conflicts in the Middle East.

Chart 2 highlights net foreign outflows amounting to $60 billion since 2016. A minor net inflow, such as one triggered by a favorable election outcome from the Government of National Unity (GNU), indicates improved foreign investor sentiment.

Chart 3 shows how South African fund managers’ allocation to domestic equity has declined from 63% in 2008 to 37% currently.

According to Nedbank’s August 2024 report, data shows a notable jump in fixed investment plans during the first half of 2024. The total value of new projects announced for the year skyrocketed to an annualized R794 billion, a major leap from the R193 billion seen in 2023.

At VEGA, our long-term investment strategy is centred on identifying businesses with a sustainable competitive advantage, bought at a reasonable price. However, to manage short-term volatility, we also diversify portfolios with other asset classes and instruments. Given the potential for heightened market fluctuations over the next 3-6 months due to factors such as the US elections, Middle East tensions, and economic growth concerns, we are incorporating several strategies to maintain exposure to exceptional businesses while reducing portfolio volatility.

The investment ideas we are currently implementing include:

• Alternative investment strategies (Structured instruments): Our primary alternative strategy involves structured notes, which provide market exposure with reduced risk. These notes typically offer 20%-40% downside protection by combining the credit risk of a bank with options on indices such as the S&P 500.
• US Treasury bonds: In times of recession or geopolitical uncertainty, bonds—especially US Treasury bonds—serve as a safe-haven asset. Bonds generally perform well during periods of low inflation and high volatility, offering protection if global economic growth stalls or geopolitical risks escalate.
• Aerospace and defense: Global defense spending has surged after decades of underinvestment, driven by recent geopolitical events. Companies in this sector are now poised for revenue growth that is less reliant on the broader economy, as government defense funding will drive demand. Russia recently announced that its budget for defence spending will rise by 25%.
• Technology and AI leaders: These companies boast impressive profit margins and are growing their revenues faster than the overall market. As investments in AI continue to rise, many industry leaders argue the biggest risk is underinvestment. Despite their growth potential, these companies still trade at reasonable valuations, offering further upside.
• Smart infrastructure: Infrastructure development is set to accelerate, supported by technological advancements, climate change initiatives, aging infrastructure, and shifting demographics. With government policies and funding creating further tailwinds, sectors like renewable energy, power grids, and data centers are likely to see substantial growth.
• Consumer staples: During economic downturns, consumer staples companies typically outperform as consumers continue to purchase essential goods regardless of economic conditions. Companies like Walmart, which can outprice competitors due to the companies scale, are particularly well-positioned. Furthermore, as inflation eases, these companies stand to benefit from improved profit margins.

While some of these themes have already been incorporated into our portfolios, they remain relevant and are expected to outperform the broader market moving forward.

In Lesson 10, “Be Wealthy, Not Flashy,” Morgan Housel emphasizes a critical distinction between the appearance of wealth and the reality of true financial security. He argues that true wealth is not about how much you spend or the luxury items you can showcase to the world.

Instead, it’s about the financial freedom, security, and peace of mind that come from making smart, long-term financial decisions. This freedom allows you to live life on your terms, unburdened by the pressures of impressing others or maintaining a lifestyle based on outward appearances.

Housel points out that many people equate wealth with conspicuous consumption—fancy cars, designer clothes, lavish homes—but often, these outward signs of affluence mask financial insecurity.

In reality, those who spend excessively may be living paycheck to paycheck, accumulating debt, and foregoing long-term financial stability. By contrast, true wealth is often invisible. It’s the money that isn’t spent—the savings, investments, and assets that provide future security and opportunities.

One of the key takeaways from this lesson is that being wealthy means having the freedom to make choices that align with your values, rather than feeling the need to keep up with societal expectations or the material success of others. Housel encourages readers to focus on building a financial foundation that allows them to prioritize what matters most, whether it’s family, personal fulfillment, travel, or simply the peace of mind that comes with knowing they’re financially secure.

Another important point Housel makes is that flashy spending often stems from a desire for validation or approval from others. However, he argues that this approach to wealth is ultimately unfulfilling because it’s based on external perceptions rather than internal contentment.

People who feel the need to display their wealth are often caught in a cycle of trying to impress others, which can lead to financial strain, stress, and dissatisfaction. By focusing on true wealth—defined by savings, investments, and financial security—individuals can avoid this trap and find lasting contentment.

Housel highlights the importance of delayed gratification in building wealth. Instead of spending money impulsively or seeking instant rewards through material goods, true wealth builders understand the value of patience and long-term planning. The compounding effect of saving and investing over time can lead to significant financial growth, providing security and freedom that no luxury item can match.

In conclusion, “Be Wealthy, Not Flashy” is a call to rethink what it means to be rich. It encourages readers to prioritize financial security and independence over the desire to impress others with extravagant purchases.

By focusing on building sustainable wealth and aligning financial decisions with personal values, individuals can create a life of freedom, peace, and fulfillment—qualities that are far more meaningful and enduring than the temporary satisfaction of flashy spending.

Sources: Alpine Macro, Anchor, Bloomberg, BNY Mellon, Charlie Bilello, Credit Suisse, Compound Advisors, Edmond De Rothschild, ETFMG, FactSet, Haver Analytics,  JP Morgan, Julius Baer, Morgan Stanley, Refinitive, RMB, Statista, Sygnia, Strategas, UBS