Firstly, why is inflation important?
Inflation is the enemy of cash holdings.
Let’s say you’ve decided to sit in cash. Maybe you’re concerned about the value of financial markets. We are in the middle of a pandemic after all. Companies are going to suffer. You’ve taken the safe and prudent option to protect your money by opting to reduce your risk. Basically, you’re sitting on your hands until markets come down a bit.
Your money is safe in the bank, right?
Inflation is the silent thief which slowly steals your money, every hour of every day, every month, every year.
It is a measure of how much the price of goods and services will rise. The R100 in your bank account used to buy:
• A round of drinks, a candle lit dinner and two movie tickets,
• Then suddenly it could only buy the dinner for two, and
• Today, you’re lucky if you can get a single Steers burger.
Tomorrow perhaps only a can of tuna?
But the good news is, the value of your cash is protected by the interest rate.
If you’re getting +7% on your cash, and inflation is 6%, well you’re getting a real return of around +1%.
Again, you’re not seeing the whole picture.
You then need to reduce your return by your tax rate.
So, if you’re paying 45% tax (ignoring exemptions to keep it simple) your cash return is only +3.85% after-tax.
This means your real return is -2.15%.
So, in a normal situation, you’re really losing -2.15% of your money ever year as you sit in cash.
That’s not too bad right?
Inflation is low, so I’m safer now right?
Now, we started the discussion by saying inflation had fallen to a record low and we’ve covered the basics of how inflation works, now let’s look at what yesterday’s number means for you.
Traditional thought says low and stable inflation is good because the value of your cash is not eroding as quickly and money functions efficiently because stable prices lead to certainty in transactions.
It’s one of the reasons Central Banks like the South African Reserve Bank adopted an inflation targeting framework.
They currently aim to keep inflation between 3% and 6%.
Inflation at 2.1% means they’re below their current target.
It also means something has gone horribly wrong.
So, what’s the issue?
Without getting into the difference between cost-push and demand-pull inflation, you need to know this.
The current collapse in CPI is based on a collapse in the demand for goods. As Covid-19 and lockdowns forced business to shut (and jobs to disappear) people stop spending.
When people stop spending, businesses make less money. So, then more businesses close, and more jobs are lost. The cycle continues. And it is going to get unbelievably bad.
Without demand, business inventory is sold at a discount. The general price level starts to drop as we’re seeing now.
The next step is for the South African Reserve Bank (SARB) to use the only tool it has available: Cutting interest rates.
In response to the predicted collapse in demand the SARB has already cut interest rates by -2.75%. The SARB is predicted to cut another -0.75% off the repo rate.
(The 7% you were getting in cash... Well, that’s going to likely be +1.92% once you’ve paid the government the tax.)
Suddenly cash is starting to look like a dismal option.
But that’s not all.
Another way to think about the interest rates is as the compensation you receive for holding onto rand.
At 7% you might be happy to take on the risk of a weakening rand because you’re getting paid a decent interest rate.
At a horrible +1.92% return will you still feel sufficiently compensated?
Right now, since the SARB has been comparatively slow to cut rates in the global context, our interest rate looks extremely attractive to foreigners.
It’s what is helping to prop up the local currency.
As I write this, the USDZAR rate is R16.60.
In relative terms this is REALLY strong.
But, if SARB cuts deeply next week, you can expect this to weaken.
I would say now is the prime time to convert ZAR cash balances to hard currency. Or better yet. Get out of currency all together and look at moving into real assets.
The Rand Swiss Global Portfolio has returned +14.83% over the last 12 months in USD or +33.4% in rand. This is more than double the S&P500 over the same period. You can see a full track record in the chart below:
So why would I suggest getting out of both rand and cash altogether?
Another factor you need to be aware of is that CPI is measured by taking into account the “average” basket of goods in South Africa. Let me tell you, this shopping basket almost certainly looks nothing like the goods you’re used to buying in the store.
If you have a tendency to shop for products manufactured overseas. Well, you’re going to get smashed. Inflation on imported goods, is going to be much higher than the basic non-vatable food items present in the CPI basket.
Don’t expect a new flatscreen TV to match the conservative 2.1% CPI growth number. It’s going to get a lot more expensive a lot more quickly.
One of the major components of the basket is transport costs including fuel. Over the past year fuel prices have dropped -25%. This again artificially skews the inflation number lower. And if oil prices start to rise (which is already happening) inflation is going to come back in a big way.
But as CPI roars back, and interest rates remain low, you’re going to be driven into a situation where real returns on cash and the resulting increase in currency risk leave you significantly poorer than you are today.
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So, what should you be doing?
Right now, you have an exceedingly difficult decision to make. And you don’t have much time to make it.
You’ve got to decide, given the currency is expected to weaken from here and that interest rates are expected to drop further, to get invested.
You need to take action!
The portfolio I showed you above is only one of the various options available to you.
Everyone’s situation is different and as such I would highly recommend you speak to one of our financial advisors. Rand Swiss is currently ranked the best advice-based broker in the country and you can contact us on email@example.com
The financial landscape in South Africa is deteriorating rapidly. Delay at your peril. You have been warned.
Rand Swiss, an authorised financial services provider, and currently ranked South Africa's #1 Stockbroker, Best Advice Broker and People's Choice Award Winner by the Intellidex/Financial Mail Top Stockbrokers Survey.
Rand Swiss, Wealth Manager