The 2022 calendar year was undeniably one of meaningful financial market upheaval, worsened by negative portfolio returns of a quantum that many investors have only witnessed once or twice in their professional careers. The most widely quoted US equity index, the S&P 500, lost 18% of its value over the year, while many “popular” US technology shares fell in excess of a whopping 60% as investors washed their faces with a healthy dose of realism: The price one pays for an asset matters. Meanwhile, the traditionally “safe-haven” US 30-year Treasury bond fell by 30% in price terms due to the Federal Reserve materially raising ultra-low interest rates to do battle with eye-wateringly elevated levels of inflation. Several highly speculative asset classes imploded spectacularly, as a tightening of central bank monetary supply saw outflows from the financial system, laying bare the ill-conceived risk frameworks and corrupt practices of several cryptocurrency exchanges and token providers.
In such environments, the adage “cash is king” is often used to denote the idea that the decision to have taken refuge in money market and cash investments has been a wise and prudent choice – protecting the holder of cash from negative nominal returns and allowing them the flexibility to invest in equity or bond assets at depressed valuations, should their risk appetite allow. Cash was certainly king in 2022, with the lazy US-dollar bank account beating both US equity and fixed-rate bond returns. Similarly, the classic rand-denominated money market fund beat both JSE equity and rand-denominated bond index returns, even though neither of the cash investments mentioned kept up with the pace of their home-country inflation (which peaked at 9.1% in the US and 7.8% in South Africa in 2022).
Some reprieve for equity and bond prices arrived in the last quarter of 2022, as inflation began to come off its peak levels. Given that inflation is a year-on-year calculation, it is natural to expect that a large “base effect” will have a disinflationary impact in 2023, but it is important to consider that there are powerful structural forces that may see inflation re-emerge in the medium term beyond just a one-year outlook. For the SA local economy, we need look no further than our self-inflicted energy shortage and large electricity tariff hikes, which were recently approved at 18.7% in 2023 (the single-largest increase in the last decade) and then close to 13% in 2024. We are not alone in terms of living in such energy-constrained conditions, and many continents beyond our borders have also faced an elevated cost of goods, manufacturing and production as a result.
Globally, the forces of deglobalisation and protectionism are key in the inflationary equation. Exclusively sourcing local goods, restricting import-export traffic and using short supply chains are the enemy of low and stable prices. Much of the global disinflation seen in years past was fed by China’s mass exports of cheap manufactured goods produced by low-cost, in-country labour with various raw inputs from a long supply chain spanning several continents. This is a phenomenon that should not repeat itself, in part due to demographic decline but also due to East versus West trade tensions. As such, 2022 also saw an abundance of worker strike action globally. Demand for pay increases are increasingly met where a “local-made” model is given priority and imported alternatives are restricted or excessively tariffed.
A lesson of the 1970s was certainly that once given life, pricing feedback loops can run amok, leading inflation to become deeply entrenched in the global economy. For the span of that decade of the ‘70s, every two years the pendulum seemed to swing between rampant inflation to disinflation and then back with a vengeance. The stability of much of the prior 10 years’ prices had vanished. While in such inflationary super-cycles, one can traditionally expect money market investments to offer a poor return, the hawkish nature of the South African Reserve Bank (SARB) and elevated level of local interest rates offer some reprieve for money market savers.
Given that global inflation appears to have peaked for the immediate term, it is credible to anticipate that South African money market investors may again enjoy positive real returns. The current SA overnight rate of 7% (which will rise further) and one-year deposit rate of 8.5% should easily trump local consumer price inflation this year.
Article written by: Thalia Petousis, fund manager of the Allan Gray Money Market fund.