Feels like Hamilton vs Verstappen again

Much debate has been had about the controversial decision by then race director Michael Masi to allow only the cars between Lewis Hamilton and Max Verstappen to unlap themselves before restarting the race in the Formula One Abu Dhabi Grand Prix last November.

The decision, later called a human error by world motor racing authority FIA, gave Verstappen a clear sight to Hamilton, who had dominated the race, but now with worn tyres, and allowed Verstappen to clinch victory in the final lap to become the world champion.

Putting this aside, a close friend of mine highlighted a strategy error from Hamilton’s Mercedes team of trying to replicate Verstappen’s Red Bull strategy, and then struggling to implement it consistently. Mercedes had the faster car and the better driver on the day, and had they implemented their own strategy, Hamilton most likely would have won the race.

There is an element of hindsight bias, but there are lessons we can carry over to the world of finance and investment.

With most central banks increasing interest rates, it feels like Hamilton versus Verstappen all over again. The Reserve Bank’s monetary policy committee (MPC) has all but shadowed the US Federal Reserve’s (Fed) interest rate moves during the course of the year, and with the Fed having recently hiked rates by 75 basis points (bps), one wonders whether this is the next move from the MPC.

The MPC was initially more proactive in its interest rate normalisation as the economy recovered from the Covid pandemic, hiking interest rates twice by 25bps each time, even before the Fed touched rates. One would expect a cushion from the more aggressive policy normalisation in the US.

However, this has not been the case as the MPC has mimicked every rate hike by the Fed. Furthermore, criticism has been levelled against it as inflation in SA has only recently been moderately above the 6% upper-bound target and is largely driven by supply-side shortages rather than demandside factors, unlike the US where inflation is broad-based and above the Fed’s 2% target.

In addition, we should consider whether the local economy can handle aggressive interest rate hikes. Unlike the US economy, SA’s is characterised by high levels of unemployment, low confidence and low spending levels from consumers and businesses, and, despite the positive surprise in the firstquarter real GDP print, anaemic economic activity expectations.

DIFFERENCES

However, there are a couple of differences from the Hamilton/Verstappen consideration.

Although the MPC may have better drivers, given its proactive decisions even before inflation became a problem, it does not have the better car, much like Hamilton this season. Maintaining real rate differentials with our developed market counters has therefore remained a crucial consideration to avoid currency-induced inflation.

The rand is among the most liquidly traded emerging market currencies, which benefits from flows in risk-on sentiment and suffers during risk-off sentiment, whereas the dollar is seen as a safe-haven currency.

When concerns about global inflation and recessions are elevated, the rand tends to weaken against the dollar, making our imports more expensive. We have seen this effect playing out when the Fed became more hawkish on interest rates; the rand weakened to above 16/$ from 14.50/$, and moderated lower again, oscillating from 15.50/$ to 16/$, once the MPC responded in kind and showed its commitment to containing inflation locally.

Though inflation in the US is higher than here, US inflation is expected to moderate faster due to structural differences. Moreover, the concerns about high levels of unemployment and low consumer disposable income and spending form part of the MPC’s justification of taking a hard line at containing inflation — it sees inflation as a destroyer of wealth and purchasing power in real terms that disproportionately affects the poor. On supply-side shocks, it has said that it is responding to second-round effects as they spread to other parts of the economy.

Though markets may not like the short- to medium-term consequences of policy normalisation, there is strong long-term justification for it. From an investment strategy perspective, it is crucial to consider all risks including market crashes and recessions, and maintain diversified portfolios while seeking positive market participation.

Resource stocks have done well due to elevated commodity prices. We continue to like them, but are monitoring commodity prices as we believe they are stretched at current levels. The finance sector has similarly done well due to the unwinding of impairment and mortality reserves from the height of the pandemic, but earnings have normalised. Some headwinds include a tough economic environment and floods in KwaZulu-Natal, but we believe local banks and insurers are well capitalised to absorb these pressures.

Mr Price has also done well in our portfolios with strategic acquisitions that have continued to boost earnings growth. We recently added Mediclinic, before the rejected Remgro offer, due to attractive valuations, the expected increase in elective procedures and good revenue diversification across SA, the Middle East and Europe.