Why a surprise US rate cut is good news for SA stocks, economic growth – Kevin Lings
Stanlib chief economist Kevin Lings says he now spends at least half his time researching what's happening in the US – that's how important the world's biggest economy is for South African investment markets. In this interview with BizNews editor Alec Hogg, he unpacks why last night's bigger-that-expected US rate cut is excellent news for SA and, together with other recent developments, may help trigger a reverse in the long-term outflow of capital from the country.
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Highlights from the interview
In this interview, Kevin Lings, Chief Economist at Stanlib, discusses the strategic shift in investment portfolios towards smaller companies, particularly in light of interest rate cuts. He explains that smaller companies tend to respond better to rate cuts and offer more attractive valuations. Lings highlights the Russell 2000 index, which tracks 2,000 smaller companies in the US, as a valuable option for investors expecting continued rate cuts.
He draws parallels between this approach in the US and South Africa, suggesting that small and medium-sized domestic companies offer greater value, especially since larger South African companies often have significant offshore operations. While acknowledging that South Africa's economic performance must improve for these smaller stocks to thrive, Lings notes tentative signs of optimism, with improved sentiment from CEOs and better policy implementation.
However, he emphasises that the country's economy remains fragile, relying on hope for better outcomes in sectors like Transnet and water infrastructure. Lings also underscores the importance of foreign investment in boosting South Africa's markets, which have seen consistent foreign divestment. Ultimately, fund managers must take calculated risks, getting ahead of positive economic indicators before they are publicly reported, in order to capitalize on potential growth.
Edited transcript of the interview ___STEADY_PAYWALL___
00:00:05:09 – 00:00:26:20
Alec Hogg:
Kevin Lings is the chief economist at Stanlib, one of the few economists who works very, very closely with the investment team. So I guess you could call him an investment economist. That's why he's the man we want to talk to about the latest big moves in the world, with interest rates starting to come down again.
00:00:26:22 – 00:00:37:20
Alec Hogg:
Is that accurate, Kevin? Are you what we could describe as an investment economist rather than one of those guys who stand up with PowerPoint presentations and kind of bore us to death?
00:00:37:22 – 00:01:03:10
Kevin Lings:
Yeah. So most of the work is focused on what the economics mean for the world of investing. That's the entire emphasis—trying to take whatever develops in terms of economic growth, inflation, and low interest rates, and interpret that to determine what we should do in the markets, which markets we should be in, and which asset classes we should focus on.
00:01:03:12 – 00:01:15:02
Kevin Lings:
I don't generally get involved in particular equity selection—that's not my strength at all. It's much more about asset classes and the world of investing.
00:01:15:04 – 00:01:33:11
Alec Hogg:
We've been following very closely the movements in the United States on the interest rate decision that came out last night. It was bigger than anticipated. But perhaps you can just put it in perspective—why is the rest of the world so interested in something that's happening so faraway from us?
00:01:33:12 – 00:02:01:13
Kevin Lings:
Over time, the world has become very integrated in a range of things, and financial markets are no exception. The world of finance is incredibly linked, and nowadays, I would probably say I spend more than half of my time analyzing the US versus, say, South Africa or Europe. It's that important. Most markets react to whatever develops in the United States—it's not just South Africa.
00:02:01:13 – 00:02:25:23
Kevin Lings:
It's very much a global phenomenon. They have by far the biggest financial markets, the most liquid markets, and they set the tone for most things in terms of currencies, inflation, and growth, among other factors. So what we find, in reality, is that whatever the US does, it sort of filters into the rest of the world.
00:02:26:01 – 00:02:51:04
Kevin Lings:
Obviously, China is growing in terms of its role in global markets. But because their financial markets are nowhere near as developed as those in the US, Europe, or other jurisdictions, they're not playing a key role. They have a bigger role when it comes to global growth, commodity prices, and some of the geopolitical events.
00:02:51:10 – 00:03:21:19
Kevin Lings:
So they are significant, and you need to pay attention to that. But in terms of day-to-day movements, not really. The economic data from China is not well-developed—it's very patchy at best, and it's not reliable. So the markets don't fixate on whatever data China releases. But when you look at the US, it's a huge fixation. Watching Jerome Powell do a press conference is literally a global event nowadays.
00:03:21:19 – 00:03:46:05
Kevin Lings:
Markets react immediately during that conference and afterward, and the bigger markets follow that. For a lot of people, it sounds odd, right? Because you're changing an interest rate in the US—what difference does it make to us? But capital flows are very much impacted by what the US does, and then, as a subset of that, what each country does individually.
00:03:46:07 – 00:04:14:13
Alec Hogg:
David Bacher and I on BizNews Briefing last night were talking about the commentary from our partners at Bloomberg, who said, "It's going to happen at 2:00 this afternoon, but we'll be crossing live from 1:30." It's a little bit like a preview to a rugby match—this FOMC meeting. And just to maybe unpack for us, most commentators felt that the interest rates would fall.
00:04:14:13 – 00:04:28:23
Alec Hogg:
That was known. But the extent of the fall, at 50 basis points—or half a percent in layman's terms—rather than a quarter percent, or 25 basis points, did seem to be higher than anticipated.
00:04:29:00 – 00:04:54:20
Kevin Lings:
If you look at what the Fed did, you'd say that the expectation from economists was for a 25 basis point cut. Bloomberg surveys about 100 economists ahead of time, and pretty much 90% of their 200 expected only a 25 basis point cut. The fact that the Fed did 50 then obviously raises questions, and it does have an effect on the markets.
00:04:54:20 – 00:05:19:21
Kevin Lings:
Immediately, you want to understand why they did so much, and what that means for the future interest rate outlook. In terms of why they cut 50, it seems clear that on reflection, what they're saying is they probably should have cut in July. Yeah, if we look at the data that was around, particularly the labor market data, they claim they didn't have it at the time.
00:05:19:21 – 00:05:40:22
Kevin Lings:
It came out essentially the next day. And they're arguing that if they'd had that data, they probably would have cut in July. So I think you've got to see the 50 basis points as partly just to catch up. They should have started the rate-cutting cycle earlier. They've realized that the economy has weakened appreciably since July.
00:05:41:00 – 00:06:00:13
Kevin Lings:
The labor market in particular has softened. The unemployment rate has moved up, and inflation has remained under control. So, when they look at it, they're saying to themselves, "We're a bit behind now." They don't want to admit it—no central bank wants to stand up and say, "We are effectively behind the curve. We've made a mistake, and we need to catch up."
00:06:00:13 – 00:06:26:23
Kevin Lings:
That's not great politics. So, what they've tried to say is, "It's appropriate to cut 50, and we're still in very good shape." In essence, what they're messaging is that it's a catch-up. Going forward, they are signaling ongoing interest rate cuts. But the key takeaway here is not to expect them to keep cutting by 50 basis points, or half a percent, every time.
00:06:27:01 – 00:06:51:00
Kevin Lings:
They have tried to communicate that, yes, they started with half a percent, but going forward, it's more realistic to expect a cut of a quarter percent, and that they will be cutting regularly during the course of next year and the year after that. At this stage, you would be looking at the US taking the interest rate down to more or less 3% by the end of next year.
00:06:51:02 – 00:07:18:08
Kevin Lings:
So, if you think about it, they were sitting at 5.5% before this cut. They've taken it down by half a percent, so they've already started. Over the next two years, their plan at this stage would be to reduce that rate to 3%. Clearly, if the economy weakens substantially in the interim and surprises on the downside, they'll just accelerate the interest rate cuts, and you'll get to that 3% a lot quicker.
00:07:18:10 – 00:07:41:21
Kevin Lings:
Equally, if inflation starts to become a problem again, they'll slow down. But that's the general plan, and it's important because it signals to other central banks around the world what they intend to do. Most central banks will look at their own interest rate in relation to the US and try not to be radically out of line.
00:07:41:21 – 00:08:05:21
Kevin Lings:
It doesn't mean they're going to follow whatever the US does exactly. That's not the case. But they want to be mindful of where the US is going. They know that if they deviate too much from the US trajectory, they're going to face risks, and those risks generally show up in the currency. Right now, the rand has done very well.
00:08:05:21 – 00:08:32:12
Kevin Lings:
And one reason for this is sentiment. Since the election, things have been better. But South Africa has also been very conservative on interest rates, and we're effectively reaping the rewards of that conservatism. Clearly, the Reserve Bank is also in an interest rate-cutting cycle, so that positive effect will start to dissipate during the course of next year.
00:08:32:13 – 00:08:57:08
Kevin Lings:
When central banks make decisions, they have to consider the gap between their interest rate and the US's, and what that means for the currency. It's become a complicated set of parameters to evaluate—you can't just look at South Africa-specific factors.
00:08:57:08 – 00:09:22:19
Kevin Lings:
It's not that simple. In fact, it goes even further. When the Reserve Bank sets its monetary policy meeting dates, they only finalize them after knowing when the Federal Reserve will meet. They get that information first and then plan their meetings afterward. They do this on purpose, as do many other central banks, to ensure they're working with the latest information from the US before making their own decisions. It's become that integrated.
00:09:22:21 – 00:10:11:06
Alec Hogg:
Yeah, and that's important. Today, we've got updates from South Africa and from the UK, for instance, one day after Jerome Powell, the Fed chairman, gave the US direction. On a broader level, what is it likely to mean when interest rates fall—for the value of equities on one side, or share prices, and also for the currency on the other side?
00:10:11:08 – 00:10:14:06
Alec Hogg:
It would be very interesting if you could unpack that for us.
00:10:14:08 – 00:10:41:21
Kevin Lings:
So, obviously, when the Fed cuts interest rates, what it tends to do is weaken the US dollar because it's not as attractive to keep your money in the United States as it was before. As a result, money will move, looking for another jurisdiction. It also increases the likelihood that other countries will start cutting interest rates as well.
00:10:41:21 – 00:11:20:22
Kevin Lings:
And so, you look for opportunities elsewhere in the world. We call that "risk on," where investors are now looking for jurisdictions that might be considered a bit riskier, such as South Africa, where they are cutting interest rates. Because they're cutting rates, there are some potential growth opportunities elsewhere in the world, so money moves around opportunistically. In this instance, an interest rate cut in the US will tend to weaken the dollar and encourage money to move into emerging markets, which is exactly what happened.
00:11:21:00 – 00:11:42:18
Kevin Lings:
So, the rand strengthened against the US dollar. But we're not alone—many other emerging markets also strengthened. We were one of the better performers. If you look on the day, there were emerging markets that didn't gain. I think we performed better because of improved sentiment in South Africa post-election and the fact that we've kept our interest rates reasonably elevated. So, as a currency, we're doing well. Obviously, that will change if we extend our interest rate cuts more aggressively.
00:11:42:18 – 00:12:11:09
Kevin Lings:
If we start our interest rate cuts and, at some point, decide to accelerate them, then presumably our currency would also come under pressure as money looks for an alternative destination. So, interest rates make a big difference to the currency and the perception around the flow of money. In terms of other markets, generally, when you're cutting interest rates, bond markets tend to do well. That would be your expectation, and as countries start to anticipate rate cuts, bond markets tend to outperform.
00:12:11:11 – 00:12:38:19
Kevin Lings:
If you look at the South African bond market, it's done well recently. Part of that is the fact that we've started our rate cut cycle, and the currency has been reasonably strong, which obviously helps the inflation rate. When it comes to equities, it depends on whether you think the interest rate cut is going to boost economic growth, and whether that boost is already captured in the equity market. Markets move well ahead of time; they anticipate a lot of this.
00:12:38:19 – 00:13:04:02
Kevin Lings:
So, it's not a foregone conclusion that once you actually start cutting rates, equity markets will automatically outperform. It's entirely possible that they've already discounted that. If you look at last night, for example, the S&P 500 actually declined, even though they cut rates more than expected. Part of that reason is that it was already priced in. So, equity markets try to move ahead and don't necessarily just react to the policy decision.
00:13:04:04 – 00:13:30:11
Alec Hogg:
So, as far as investors are concerned, generally, this is anticipated. All of the information is already in the marketplace. Don't go buying or selling or doing anything different—just stick with the strategy you already have, because there's no big surprise here, even though the interest rate cut was significantly higher than expected.
00:13:30:13 – 00:13:52:01
Kevin Lings:
Yeah, I think that's right. We certainly wouldn't be changing our investment profile because of the Fed cutting by 50 basis points instead of 25. What we would do instead is look at the path of interest rates that the Fed is laying out. As I said earlier, they expect to get to 3% by the end of next year.
00:13:52:03 – 00:14:15:13
Kevin Lings:
Is that path of interest rates radically different from what we had previously anticipated? The answer is no, not really. Yes, they've started a little faster than expected, but the general trend is still more or less in line. The US economy is expected to grow at a slightly slower pace next year, but not fall into a recession.
00:14:15:15 – 00:14:39:02
Kevin Lings:
Inflation is expected to be under control, which will allow them to cut interest rates. That becomes the more important factor when it comes to investment decisions. So, we would still be optimistic about global equities, particularly US equities. Where we would be changing, though, is switching into smaller companies rather than large-cap stocks.
00:14:39:04 – 00:15:05:08
Kevin Lings:
Large-cap stocks have generally outperformed—some of the IT stocks have outperformed—and that's understandable in an environment where interest rates are elevated. Smaller companies tend to struggle more with higher rates. Now that rates are being cut, it tends to benefit smaller companies more, as they typically have more debt.
00:16:00:00 – 00:16:47:05
Kevin Lings:
They tend to respond better when you cut interest rates. And so they are considered a better valuation. They are, relatively speaking, in terms of a P/E ratio, more palatable. And so what we've been doing is changing our portfolio and switching away from the top, being the large companies, into a broader range of smaller companies. If you want to follow that, you would follow the Russell 2000, which is 2,000 companies. That would include a huge amount of smaller companies where we think there is probably more value right now if you expect that these interest rate cuts will continue, which is our expectation.
00:16:47:07 – 00:17:09:00
Alec Hogg:
In South Africa, at our BizNews conference last week, we heard from Piet Viljoen and Cy Jacobs that they're both looking at small and medium companies in South Africa, which Piet says have been massively oversold and are at the lowest level in many, many years. Would your strategy in the US also work here?
00:17:09:02 – 00:17:36:19
Kevin Lings:
Yes. So we would have the same general view—that's where the value resides in South Africa, in more domestic stocks. And almost by definition, those stocks tend to be smaller or mid-sized companies. The big companies tend to have, almost by definition, a large offshore part of their business. So yes, we see more value in domestic stocks, and some of those are small-cap.
00:17:36:19 – 00:17:59:14
Kevin Lings:
Obviously, a lot of that will depend on each fund manager as to the size of the portfolio and how big the company is, and whether they can actually fit it into the portfolio. Some of the smaller boutique asset managers have a benefit because they can buy more easily into the smaller caps, and that can make a significant difference to their portfolio.
00:17:59:16 – 00:18:34:12
Kevin Lings:
Nevertheless, that's been our exact same trend in terms of how we've positioned equity exposure. And obviously, we need two things to happen. The important one is we do need the South African economy to perform better. This buy-in into cheaper South African stocks is a good strategy if the economy does better, if earnings grow, and it all washes down to the bottom line. It would make a hell of a lot of good sense.
00:18:34:12 – 00:19:11:07
Kevin Lings:
I think there's good value there. The second thing that would help us enormously is if we start to see foreigners coming back into our market. Foreigners have been net sellers of South African equities every month. I can't remember how many months they've been doing that. They don't like the South African story at all, no matter which segment you're looking at. What we need, and what would help us enormously, is if some of this better sentiment in South Africa—let's assume it translates into better growth—starts to attract foreign investment into the South African market.
00:19:11:07 – 00:19:43:07
Kevin Lings:
That would give us a very nice uplift. So that's our general positioning. As we grow in confidence around the idea that South Africa can do better, that positioning will become more aggressive. At this stage, you would have to say we've got tentative signs of improvement. We've got a bit of sentiment. A lot of CEOs we chat with are expressing better optimism and sentiment.
00:19:43:09 – 00:20:10:01
Kevin Lings:
We think we've got better policy in place generally, but we've got a long way to go in terms of implementing some of these to make a meaningful difference to the actual economy. It's fragile. It's not 100% guaranteed that South Africa is going to be in better shape this time next year. Obviously, there are issues, like the electricity situation—that's improved—but apart from that, it's still a lot of hope.
00:20:10:01 – 00:20:37:01
Kevin Lings:
We hope Transnet gets better. We hope that the water system gets more actively investigated. We hope that the government of national unity sticks and holds as an entity. We need more conviction around that. As we gain that conviction, I think there's a lot of value in South African assets.
00:20:37:02 – 00:20:59:01
Kevin Lings:
I think our assets are viewed as cheap, but they're only cheap if you can grow the top line or grow the economy. That's the part you have to be a bit hesitant about now. Fund managers want to get ahead of all of this, right? They don't want to wait for the newspaper to tell them that South Africa is growing faster. They want to anticipate it and get into the market ahead of that. That's where the risk lies.
00:21:05:03 – 00:21:10:13
Alec Hogg:
Kevin Lings is the Chief Economist at Stanlib, and I'm Alec Hogg from BizNews.com.
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