Macroeconomic factors and the equity market
The equity market is a complex ecosystem influenced by various macroeconomic factors, and the South African equity market is no exception. Macroeconomic factors such as economic growth, interest rates, and inflation, significantly impact the equity market. Understanding these factors and their impact on equities is crucial for investors who want to make informed decisions about their investments.
Economic growth
When an economy is growing, companies tend to perform better and often exhibit an increase in profitability. Higher underlying profitability will see higher values being attached to companies and an increase in demand for their stock. The combination of higher valuations and higher demand for companies shares usually result in higher equity prices. In contrast, when the economy is in a recession or is stagnant, companies tend to struggle, and profitability suffers. Lower profitability leads to lower valuations and suppresses demand for their stock, usually resulting in a fall in equity prices.
In South Africa, the economy has experienced low levels of growth for some time, with an average real growth rate of only 0.6% over the past five years, or 5.8% in nominal terms (including inflation). This has had a significant impact on the equity market, with many companies struggling to generate growth and losing appeal to both local and international investors.
As a result, investors need to be selective when investing in South African equities, as economic growth remains a critical factor in determining their performance. The JSE All Share Index has comfortably outperformed nominal GDP on a total return basis over the last 10 years (9.9% average versus 6.3% average) but this is in large part due to several major international companies being listed on the local exchange. If one considers pure “SA Inc“ exposure like financials and retailers, the former has outperformed by a smaller margin (7.6% average) and the latter has underperformed the index (2.0% average).
Interest Rates
Interest rates also have an impact on the equity market and for a variety of reasons.
In South Africa, interest rates have remained relatively stable over the past few years, with only increases in the interest rates recently to tame inflation. Overall, the low interest rate environment has been a positive factor for the equity market, as low interest rates have encouraged companies to invest and expand their businesses.
As an aside - there are certain industries that benefit from higher interest rates - notably the banks.
Inflation
When inflation is high, companies tend to struggle as the cost of production increases resulting in a decrease in profitability. In contrast, when inflation is low, companies tend to perform better as the cost of production decreases or only increases at a slow rate. Inflation also determines the movement of interest rates - high inflation usually results in higher interest rates, and vice versa.
Some companies can perform reasonably well during periods of high inflation - notably food retailers who tend to have the commensurate buying and pricing power to squeeze food producer's margins and pass on additional costs to consumers.
In South Africa, inflation has remained relatively stable over the past few years, with only a recent rise in inflation. Overall, this has had a positive impact on the equity market, as low inflation has allowed companies to keep their costs under control, leading to improved profitability.
Applying macroeconomic factors to your investment strategy
Investors can look to macroeconomic factors to inform their investment decisions by monitoring macroeconomic data to determine trends and select entry points and potential industries to invest in.
Because of the volatility associated with macroeconomic factors, how they impact different industries, and how they differ across geographies, it becomes very important to diversify your portfolio appropriately and to tilt your portfolio to where macroeconomic support exists. Having investments across multiple industries and geographies will limit your exposure to any one specific macroeconomic factor.
Investing for the long-term is another proven strategy for mitigating the impact of short-term changes in macroeconomic factors. By holding onto your investments for a longer period, you can ride out any short-term dips in the equity market caused by macroeconomic factors. This can help you achieve higher returns on your investments in the long run.
Finally, it is important to stay up to date with current events. News about political events, economic policy changes, and other developments can have a significant impact on the performance of the equity market. Investors can keep up with current events by following news sources and reputable financial publications. Reading market reports, analyst opinions, and industry research can also provide valuable insights into the market's performance and how macro factors may impact individual companies or industries.
