By: Sanisha Packirisamy, Economist at Momentum Investments and Herman van Papendorp, Head of Investment Research & Asset Allocation at Momentum Investments.

Momentum Investments have released their macro research note prepared by the Momentum Macro Research Team.

Highlights from the research report:

Markets:

• An envisaged macro environment of peaking inflation, high wage growth and a slowing economy are problematic for future corporate sales, margins and profit growth and as such is not providing a favourable underlying fundamental backdrop for global equities.
• As quantitative easing (QE) was an important positive United States (US) equity return driver since the global financial crisis (GFC), one should expect that a period of quantitative tightening (QT) should at least have some negative implication for global equity returns in the coming years.
• For risky assets, it does matter whether the global economy experiences a recession or not. History has shown that equity drawdowns were much bigger (and of longer duration) in recessions than in non-recessionary slowdowns.
• Risky assets typically bottom during US recessions once they start discounting interest rate cuts, not before the start of recessions, hence indicating that it is unlikely that equity markets have already bottomed during the current bear market unless a recession can be avoided.
• As the risk for global recession rises, the defensiveness of US bonds and cash within a diversified portfolio becomes more attractive, while the relative valuation of US bonds to equities are now also fair to cheap versus history.
• Global property fundamentals remain solid, but global property yields are currently expensive versus investment-grade bonds, capping the return potential of the asset class.
• Due to cheap absolute and relative valuations, South African (SA) equities could either hold up relatively better during global equity drawdowns or at least provide better returns during subsequent recovery phases.
• Not only are SA real bond yields attractive versus global yields, but they are also higher than their historical average. We are approaching a period of low monthly inflation accruals which should become less supportive for inflation-linked bonds (ILBs). The prospective SA real cash yield has been rising from a low level in line with policy rate increases and is now only slightly below its historical average.
• The potential for meaningful SA listed property return upside from undervalued levels needs to be weighed against some remaining negative fundamental factors.

Economics

• Investors are concerned about inflation remaining stickier for longer, tighter global financial conditions and the potential for the world economy to enter a deep economic slumber on the back of tighter monetary policy.
• Inflation could prove to be stickier for longer in markets where the inflation genie has escaped the bottle. In the United Kingdom (UK) and US, inflation has become far more broad-based in nature and as such it may take longer for inflation to get back to 2% even after food and fuel price pressures have eased.
• As more favourable base effects kick in for food and energy inflation and as the transmission mechanism of higher interest rates begins to weigh on demand and weaken inflation, the US Federal Reserve (Fed) should pay more attention to the growth outlook and could begin easing interest rates even if inflation has not yet reached target.
• The cost-of-living crisis has reinforced inequality within countries and across regions and threatens to inflame social tensions. This has added an additional layer of concern in emerging markets (EM), especially those which are on the brink of a fiscal crisis.
• In SA, inflation pressure is mostly visible at a headline level. We expect headline inflation to decelerate from below 7% this year to around 5% next year. However, fears of inflation persistence could see the SA Reserve Bank (SARB) hiking interest rates by a further 50 basis points. We continue to view the forward-rate agreement (FRA) market as overly aggressive and see hikes to that extent as detrimental to growth.
• Growth in SA is set to slow to around 2% this year and decelerate further to around 1.5% next year on slowing growth in household consumption and exports, due to higher interest rates and softer growth globally.