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Speaking at the Sanlam Investments Institutional Insights conference in Johannesburg last week, Dr Phillipa Malmgren said there is an intriguing stand-off taking place between the US Federal Reserve and emerging markets, with the likes of China and Russia accusing the world’s largest economy of inflating its way out of debt.

She observed that unchecked global inflation was not only contributing to market uncertainty but could be fuelling geopolitical risk. There is a big disconnect between the real cost of living and official inflation statistics released by national governments, and consumers are treating official inflation data with suspicion as it no longer reflects their real world experiences.

This divergence has profound implications for the investment strategies of pension fund administrators.

Malmgren, President of Principalis Asset Management and a former White House economic adviser, pointed to several critical flashpoints that all money managers should be wary of before allocating capital. Inflationary spikes in seemingly arbitrary commodities -- such as the price of pork in China, onions in India, fish in Russia, wheat in the Middle East and beef in the United States -- put great pressure on the spending power of consumers in different parts of the world.

Inflating a Dangerous Bubble

The US has attempted to manage its high (and unpayable) debt by providing cheap money to boost its stock markets and property prices -- meant as a vote-winning “feel-good” stimulus, but in fact inflating a dangerous bubble. Such policies, and their inflationary effects, have an immediate knock-on impact on emerging markets.

“The common wisdom among central bankers is that deflation is the biggest threat to the global economy, which explains such extremely low interest rates,” said Malmgren. “It is in fact the rising cost of living that should be top of mind.”

China Retaliates

Events in China have in recent months scared the global investment community. The country is now in the process of a massive disinvestment from low-yielding US sovereign debt instruments. Given this, investors should focus on what the Chinese government does next. Opportunities abound for savvy investors wanting to offset inflation by following high-growth, Chinese-related assets that will come to define the next decade.

The Grab for Assets

Perhaps the most ambitious Chinese initiative of all is its grand “one belt, one road” plan to develop an economic corridor spanning the entire width of Asia to the gates of Istanbul and Cairo. Unprecedented expenditure on infrastructure, including roads, ports and power will ultimately put China on the doorsteps of Europe and Africa.

Russia too is making an unprecedented grab for assets in the Ukraine, Baltic and Arctic. They are vying for large parts of the Arctic, where oil, gas, minerals and proteins (fish) are in abundant supply. This will have the effect of pushing up the value of the assets in those regions.

The implications for South Africa as an emerging market are potentially enormous. Malmgren said South Africa was very much on the radar of international investors, particularly since the country is perceived to have a stronger rule of law than, for example, Nigeria.

“South Africa should be the gateway towards strengthening capital flows to the whole of Africa,” she said.

The Impact on Asset Allocation

Faced with these facts about “hidden” cost pressures, Malmgren said the least attractive global asset class at the moment was bonds, the value of which was being eroded by underlying inflation. Instead, she suggested the next wave of “growth, innovation and entrepreneurship” would be driven by people who put capital to work by being risk-takers. Such investment opportunities could only be found in equities and alternative markets.

“Negative interest rates and rising inflation are tilted against traditional saving methods. The geopolitical environment at the moment compels you to be a speculator in equities and alternative asset classes,” said Malmgren.

Asset managers and financial advisers need a deep understanding of the world economic outlook when assessing investment opportunities whether in South Africa or abroad. They must consider how markets, prices and risk will change in response to developing trends such as inflation, market uncertainty and geopolitical risk.

Investment decision makers will have to think long and hard about the assets they purchase and pay close attention to how much of the asset price is a function of management and how much is a function of artificial inflation.

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