Don’t be swayed by Trump’s trade tantrums
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The first quarter of 2018 has seen a stark contrast between renewed optimism on the streets of SA and struggling global financial markets.
Our economy is benefiting from three major drivers. First is clearly the prospect for improved governance and the return of sensible policy-making under President Ramaphosa. Secondly, the global economy is humming along nicely, and as a small open economy, South Africa tends to follow the global cycle with a bit of a lag. Thirdly, local consumers are already benefiting from lower inflation, which has boosted real incomes and spending power. The 0.25% interest rate cut in March will also help consumers.
This is all a huge improvement from a year ago, when we suffered downgrades, a technical recession and great political uncertainty. Moody’s has recognised this, announcing that they are maintaining South Africa’s investment grade credit rating, and upgrading the outlook to stable.
Compared to this happy picture, equity markets have experienced a torrid time in the first quarter as volatility returned after a long quiet stretch in 2017. The JSE has followed global markets lower, while global markets are increasingly worried that central banks might overreact with interest rate increases. Market swings are being driven by concerns that there may be an all-out trade war between the US and China, with potentially massive ramifications for global economic growth. Hopes are that a compromise will be reached after reasonable negotiations, but markets will remain highly volatile until this has been resolved. Unfortunately, markets tend to sell first and ask questions later.
Investors who follow a more considered approach, grounded by a proper financial plan, can avoid knee-jerk reactions. After all, while corrections are always unpleasant, they are also fairly common, especially after a strong run up in equities. To benefit from the superior long-term real returns from equities, one has to experience some short-term pain. An appropriately diversified portfolio will reduce this discomfort, but can’t eliminate it completely in funds that aim to generate above inflation returns. Investors attempting to time the ups and downs are very likely to see their capital eroded.
It is also worth considering that a portion of most balanced funds – usually around a quarter – is directly exposed to global markets, and a strong Rand has been a further dampener on returns. Should the Rand continue to depreciate in the near future – as we have started seeing in the past week – this situation will reverse itself. The importance of diversification is precisely that we do not know what the future holds, and therefore need to be prepared for a range of outcomes.
For investors, it is hardly comforting to hear that they should “sit tight” or “focus on the long term” when faced with dramatic headlines and disappointing returns. Instead, the “fight or flight” response tends to kick in. This is normal. But remember that the fight or flight response evolved in a very different set of circumstances, certainly before we were able to do proper financial planning. The general principle remains that financial plans should be amended in response to changes in your personal circumstances, but not in response to changes on financial markets.