CIARAN RYAN: A shift is taking place in markets. A low interest-rate, high-growth environment has been the general experience for most investors over the past decade. As with all things in life, markets also go through cycles. PSG Wealth has been warning of this shift for some time now, and that shift is now clear for most to see.
At the same time we saw projected growth rates for US stocks increase significantly on the back of that. The cost of capital is obviously also a proxy for the discount rate, so essentially how you value stocks. With that in mind, higher multiples were perfectly justifiable. So you saw that the top 10 of the S&P 500, for example, in the first 10 years were trading at around an 11 PE [price-earnings ratio].
So there’s this dislocation between earnings and valuation, and that means risk has significantly increased. But what that really means is: obviously a higher interest rate puts a damper on the economy, so you would expect to see lower sales volumes come through as consumers feel the squeeze; then also lower profit margins because the financing cost that these firms have to pay to acquire capital to grow is increasing in line with interest rates.
So the question is really: where should that multiple be? If you sit in an environment where interest rates are moving up, there’s a lot of pressure on costs, and generally sentiment is receding, [and] from that obviously we see stock prices adjust. I think it is going to be largely driven by a derating impact through interest rates – which is the core component for everybody to see. I don’t even think that’s obviously big news for everybody.
It always helps to try and illustrate this point by way of example. So, if you look at something like Microsoft, for example, it’s a fantastic company with a good long-term track record. But if we look at what the share price was in the mid-nineties, you could pick up Microsoft stocks for $5/share – unbelievable. Investors obviously recognise that this is a great business. It’s on the right side of where the future’s going in terms of using technology to become more efficient.
It’s good if you can look into the future and say, well, there’s a lot of growth on the cost, but you have to ask yourself, how much growth is currently priced into these businesses, because [if] that growth is already priced in, then there isn’t really an opportunity there.
In fact, bond yields have moved up, which means that bond yields have suffered at the same time that equities have suffered. That brings a very important question into play in terms of what you are going to do to manage risk in your offshore portfolio to offset losses on equities over the short term. That’s a really important question to be able to answer.
CIARAN RYAN: Okay. There is quite a lot of confusion around the rand. A lot of people are saying it’s a one-way bet. What’s your view on that? If South Africa was in that situation our currency would be significantly lower – our debt-to-GDP is now under 70% – and yet the assets are cheap, reflecting complete chaos.