History points to storms ahead for SA

History may not always repeat itself, but it often rhymes.” Dark clouds are beginning to hover over emerging-market economies. If history is anything to go by, these economies are faced with disappointing economic growth and rising interest rates.

Regulations often force us to hide behind a curtain of uncertainty to avoid making definitive statements about what tomorrow may bring. But when it comes to financial markets, history has an uncanny way of repeating itself.

In 2021, the global economy and SA are expected to record an impressive recovery in economic growth following the deep recession induced by the coronavirus pandemic. Based on history, this recovery was to be expected.

Since 1950 there have been five global recessions: 1975, 1982, 1991, 2009 and 2020. The shocks that contributed to each of these global recessions were different. The similarities in the events that followed are astonishing.

During all these recessions, the behaviour of macroeconomic and financial variables followed a similar pattern: economic growth contracted sharply in many countries around the world; oil consumption declined; financial markets and business confidence levels became depressed; global inflation rates fell, giving further licence for central banks to reduce interest rates; monetary and fiscal policies became expansionary; equity markets crashed, but recovered quickly after that; and value stocks outperformed growth stocks.

Given these similarities, the clues to what may transpire over the coming months may be hidden in the historical events surrounding previous global recessions. The environment today is beginning to smell a lot more like the 1979-1982 period, where oil prices rose sharply in 1979, partly due to disruptions caused by the Iranian revolution. This helped push inflation to new highs in several advanced economies. Monetary policies were tightened significantly in several major advanced economies, causing sharp declines in economic growth. The increase in global interest rates and lower commodity prices that stemmed from the weakening of global growth made it difficult for many Latin American countries to service their debts, resulting in debt crises in that region.

SA investors may face similar prospects of rising global interest rates coupled with weakening global growth. This may lead to highly divergent investment returns from the various asset classes over the medium term.

As in 1979-1982, the world is navigating an inflation shock of some sort. The sharp decrease in demand in 2020 led many businesses to slash their orders for inputs required for production. As the recovery picked up steam in 2021, some producers found themselves flat-footed and unable to ramp up sufficient supply again quickly.

This led to supply being unable to match the overall levels of demand. This supplydemand mismatch led to a rise in prices for many goods and services worldwide. Most of the major central banks have taken the view that this inflation shock is temporary and that inflationary pressures are likely to begin subsiding by the middle of 2022.

But like the shock in 1979, there remains a possibility that these disruptions and materials and labour shortages may be more persistent than expected. If these price pressures are sustained, rising inflation expectations will lead to a faster-thanexpected increase in interest rates, particularly in the US.

Our interest rates in SA may have to rise even faster to counter the strength of the US dollar and possible portfolio outflows from the local currency bond market if rate differentials narrow.

Like in 1979-1982, developed economies have been able to begin their recoveries quickly. Their economic growth is expected to regain the prepandemic level in 2022, while emerging markets (excluding China) are expected to remain 5.5% below the prepandemic forecast even in 2024.

As in the Latin American debt crisis of 1982, emerging markets face diminishing economic growth prospects similar to a never-ending circular reference. As global interest rates rise, these countries will face higher costs of debt.

The higher interest cost will crowd out other government expenditure areas, leading to further economic growth disappointments.

Given the huge increase in sovereign debt levels that we have seen over the past 18 months, it is possible that certain emerging-market economies may experience a debt crisis.

What does this mean for SA investors? First, during a potential scenario of falling global risk appetite, the offshore asset classes may be more attractive. This may prove even more important because the US Federal Reserve will be reducing its asset purchases, effectively pulling the plug on the significant rise in liquidity that has occurred in financial markets over the past 18 months.

Second, in a challenging economic environment, the companies that can deliver superior rates of earnings growth and return on capital may command a higher premium, despite the impressive performance we have seen from value stocks over the recent past.

Either way, investors will do well to heed the dark clouds that history is showing us hovering over the horizon.