Novare bets on local bonds as it awaits better equity opportunities

Novare has taken refuge in South African bonds over equities as the asset manager prepares for share prices to drop before boosting its stock allocation. Domestic bond prices have dropped over the past two years, with 10-year treasury yields one percentage point higher to 9.56%, after having reached a high of almost 11% during the Covid sell-off.

“There is a lot of value in South African bonds, especially in the longer end of the yield curve, as the yield curve is currently very steep,” says Jacobus Brink, head of investments at Novare.

While bond prices have remained volatile and somewhat range-bound, the benchmark JSE All Share Index has soared more than 70% over the past 19 months, reaching all-time highs. Record low interest rates and economic stimulus programs from governments and central banks to offset the fallout from the 2008 global financial crisis and the Covid-19 outbreak have fuelled a prolonged equity bull market.

“Locally, shares could continue trading sideways until we have more clarity on the macroeconomic outlook and the outcome of the elections.”

With the US Federal Reserve indicating it will need to raise rates and pare back its asset-purchase program, risks of a correction in global equity markets are increasing, says Brink. The European Central Bank said last month that it would trim emergency bond purchases in the final quarter of this year.

“We are at an inflection point,” says Brink. Adding that there is a confluence of factors coming together that pose increased short-term risks to global equities. Supply chain shortages, inflation, a global energy crisis, mounting concerns over China’s property sector, and a slowdown in the world’s second-biggest economy add to the worries. The increased uncertainty means that investors will have to change tactics and not rely only on passive strategies like buying index-tracking funds.

In the past few months, the asset manager of than R40 billion says that it has been shifting its clients’ money toward value-orientated managers, who use a strategy that invests in companies perceived to be undervalued by the market.

If rates start to normalise in the US, then it will prompt the South African Reserve Bank to start hiking local rates and we could finally see the return of value, more cyclical-type sectors as a sudden normalisation in rates tend to drive these valuations in the shorter term, he says.

While there will be some short-term pain, the long-term outlook for equities is still bullish, especially for emerging markets, where higher commodity prices could underpin economic growth, says Brink.

A rising interest rate environment could still delay the emerging markets versus developing markets trade, but the longer-term demographics are only one of the key themes Brink highlights in betting on developing markets. A depreciation in the rand could also bolster domestic stocks that earn income in foreign currencies.

“We are not taking our equity exposure off the table. We are waiting for a pullback to buy into better levels,” says Brink.

He says that they have seen a strong run since the onset of the pandemic and that over the next six months, investors can expect a lot more volatility, especially in equity markets.

“Central banks have their work cut out for them as they normalise rates in an environment where transitory inflation can stay transitory for longer and the delta in growth rates start to decline.”