Optimism Surrounding Rate Cuts

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Economic Outlook After Rate Cuts

The U.S. Federal Reserve's decision to reduce its benchmark interest rate by 0.5% marks the conclusion of one of the most aggressive rate-hiking cycles in recent memory. This shift aims to prevent the U.S. economy from falling into a recession, amid growing concerns about a global slowdown and persistent inflation. In a similar move, the South African Reserve Bank (SARB) reduced the local repo rate by 0.25%, attempting to provide stimulus to an economy grappling with stagnation and high unemployment.

For investors, these rate cuts have brought immediate positive impacts to the stock markets. Following the announcements, both the S&P 500 and South Africa's FTSE/JSE All Share Index surged to record highs. While this reflects improved market sentiment, it’s important to recognise that the long-term effects of these cuts remain uncertain. Much of the optimism hinges on how well companies perform in the coming months.

Meeting Ambitious Earnings Growth Targets

Optimism in stock markets largely rests on whether companies can meet their earnings growth projections. For instance, FactSet forecasts that earnings for S&P 500 companies will grow by 13.7% year-on-year by June 2025, nearly double the historical average growth rate of 7.4% over the past 20 years.

Source: FactSet

South African companies are also expected to show strong earnings growth, with Refinitiv projecting an 18.4% increase for JSE-listed firms over the next 12 months.

However, it’s worth noting that the JSE's expected earnings growth comes from a low base, and its valuations could still be seen as undervalued compared to international markets. This creates a different dynamic for local investors, who may find opportunities in undervalued assets that could provide solid returns if growth expectations are met.

Uncertain Impact of Rate Cuts

Despite the positive sentiment surrounding these interest rate reductions, there is growing recognition that rate cuts may not have as strong a stimulative effect as many hope. In theory, lower interest rates should boost consumer and business spending by making borrowing cheaper. However, recent years have shown that the economy has been relatively resilient to rate hikes, with spending and incomes not slowing down as expected.

This raises the possibility that rate cuts, while encouraging market sentiment, may not result in the same level of economic growth. For South African investors, this calls for caution, as structural challenges like high unemployment and sluggish growth could limit the overall impact of monetary policy changes.

Investment Strategies in Uncertain Times

In this uncertain environment, a more selective approach to investing is recommended. Instead of relying on broad market trends, investors should focus on actively picking stocks, particularly in sectors that offer value. Companies with strong fundamentals but lower market valuations, known as value stocks, could present attractive opportunities, especially in a market where earnings growth expectations are high.

Additionally, local bonds remain an option worth considering. The 10-year South African Government Bond rate (Govi) has fallen by nearly 2% since June, suggesting that most future rate cuts for the next year may already be priced in. However, long-term data shows that the Govi is still above pre-2020 levels. With a current rate of 9%, it continues to be an appealing investment option.

South African 10-year Government Bond Yield Rate (Source: Trading Economics)

Conclusion

While recent rate cuts from both the U.S. Federal Reserve and the SARB have improved investor sentiment, the outlook remains uncertain. Corporate earnings growth is crucial to sustaining market performance, but with high expectations, companies face the challenge of delivering. South African investors should adopt a cautious and strategic approach, focusing on value and defensive investments while remaining mindful of the global economic landscape.