In this week's episode of the financial podcast, Warren Ingram discusses the complexities of the nation's fiscal situation with Chris Eddy, Head of Multi-Asset funds at 10x Investments. They analyze the implications of high debt levels and the use of foreign exchange reserve profits, highlighting the transition from stability to vulnerability. Amid economic challenges, opportunities for investors are explored, with Chris promoting strategic risk-taking, particularly among the youth, for potential personal growth.
Questions/Topics:
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Have a question for Warren? Don't forget to voice note your questions through our WhatsApp chat on (+27)79 807 8162 and you could be featured in one of our episodes. Follow us on Twitter, LinkedIn and subscribe to our YouTube channel for more Financial Freedom content: @HonestMoneyPod
In this week's episode of the financial podcast, Warren Ingram discusses the complexities of the nation's fiscal situation with Chris Eddy, Head of Multi-Asset funds at 10x Investments. They analyze the implications of high debt levels and the use of foreign exchange reserve profits, highlighting the transition from stability to vulnerability. Amid economic challenges, opportunities for investors are explored, with Chris promoting strategic risk-taking, particularly among the youth, for potential personal growth.
Questions/Topics:
For more valuable insights from the 10x team, click here.
Have a question for Warren? Don't forget to voice note your questions through our WhatsApp chat on (+27)79 807 8162 and you could be featured in one of our episodes. Follow us on Twitter, LinkedIn and subscribe to our YouTube channel for more Financial Freedom content: @HonestMoneyPod
Welcome to another episode of Honest Money. We're doing kind of a still a little bit around South Africa's financial position following the budget, which was kind of an important one for us this time round, and so I thought to kick off the conversation. I'm very glad to have Chris Eddy he's head of multi-asset funds at 10x. Chris, thanks so much for joining us.
Speaker 2:Hi Warren, thanks for having me on.
Speaker 1:So, chris, if we look at the budget, I love the kind of media like machine it always builds up before and kind of hypes it up and everyone wants to get their kind of thoughts out seven seconds after the budget is published and I always think it's often not that meaningful to be quick. I think it's more meaningful to take time and kind of understand it and I mean we don't need to do a rehash of all the fine print of the budget because both you and I and everyone else will fall asleep by then. But maybe just to kind of say you know where are we now as a country? This was our kind of personal finances. You know what are we looking at now that our budgets are out there?
Speaker 2:Yeah, warren, I mean I completely agree with you. I mean, the details are important on a year to year basis, but I think what is important for us and for listeners is to really step back and zoom out and look at the longer term trend as well, because what we've been seeing year in and year out from a budget perspective is consistency around the picture and that, unfortunately, that picture isn't that great. I mean. What it basically boils down to is almost for the last decade, the government has been spending more than it's earning and it's had to effectively balance the books by borrowing more money year in and year out. That's the high level overview of the trend, and we can certainly kind of unpack some of the reasons behind that and some of the implications of that as well.
Speaker 1:So you know, the one probably new thing for most people was around this foreign exchange profits and again, you know it's been explained to death. But my sort of simplistic view on this was we this was kind of like a savings pot that the country had that wasn't really ever considered before by anybody. You know it wasn't like it was something that had been well used in the past and I think you know Treasury was scrambling around like crazy people trying to find some form of savings and it feels to me it's almost like our last little bit of money under the mattress that we found and we're feeling lucky about it and it's just enough money to pay down some personal loans and overdrafts and credit cards and all that stuff. But it's not like this was a very positive choice. It was a good thing to do because we're in a bad situation, but the reality is our country's in a bad situation.
Speaker 2:Yeah, I mean that's completely right. I mean before we talk about, like the impact of using the profits on those currency reserves, I mean if we just take a step back and we look and really over the last, pretty much the last decade, every year, year in, year out, on average the government has been spending about four and a half percent of GDP more than it's been earning in terms of tax revenue. So that's been the whole that we've had to fill year in and year out. And if you look at that, that spending from government has been running ahead of inflation and ahead of tax revenue. So if you think about it, you can almost picture these jaws widening where spending continuously gets larger than the revenue that ultimately the government's bringing in, and that's that bit that needs to be financed.
Speaker 2:If you look back over the last 15 years kind of around 2007, 2008, our debt to GDP was about 25 percent. That has consistently grown, to kind of call it roughly between 70 and 75 percent now. So you've seen that that ultimately the amount of debt that South African government has has grown dramatically and the concern isn't purely around the amount of debt but it's the cost of that debt as well and the combination because, if you look at, like many global developed markets, 75 to 80 percent debt to GDP isn't an issue. It's not unheard of. Like in Japan, you're running a 250 percent of debt to GDP, but their financing costs are pretty much zero. When you have a 12 percent financing cost, it's that debt service cost, or the amount that you have to pay on a monthly basis, that really becomes the issue.
Speaker 2:So, as this kind of relates to using the broader foreign currency profits from those reserves, there's really about 150 billion that they're going to use over three years to ultimately try to bring down our total outstanding debt. But what that doesn't do is it doesn't impact the jaws that we've been talking about, so governments, year on year spending patterns and it also doesn't impact the cost of debt. So, like you say, it's kind of this temporary plaster that helps our current positioning, but it doesn't change the longer term trend and, like you rightfully point out, this is the first time we're using those profits that I really have come about as a result of ran depreciation over the last 20 years. So those are profits that have accumulated over 20 years. We're using them. Now there's a little bit left in the pot. We're not using all of it. But, like you say, whether those will continue to be there, going forward and continue to be a source ultimately to plug the deficit hole remains to be a big question.
Speaker 1:I mean it's just funny because I actually remember. I mean it makes me feel old now, but I remember the early 2000s when the country's economy was growing well, we were reducing unemployment year after year after year, and we were getting hammered in international markets, especially by rating agencies etc. Because the RAND was so volatile, and one of the reasons was we owned no foreign exchange reserves, and so I remember that pressure and the treasury then started accumulating and putting it into the reserve bank's vault whatever you want to call it metaphoric vault and so it was interesting because it was a kind of a theme for a while. Then it disappeared, then somehow it wasn't an issue anymore, and what makes me smile now is it had no impact on the volatility of the RAND. The RAND stayed volatile no matter what. No matter what we did, we were impacted.
Speaker 1:So it might have helped a little bit, but I think it's one of those things where, if we're going forward, the only real solution to this problem is the economy needs to grow, we need to generate a lot more revenue, not spend more money, and then hopefully, unemployment starts to reduce, the financial position starts to reduce, but when we're getting excited about the economy being the adjustment for the economy's growth, going from 0.8 to 1.8,. Just to understand, the economy needs to grow at 5 or 6% a year at the least, I think, to start absorbing some of the unemployed people and to start solving this problem. And ideally, a dream growth rate would be 7, but I feel like 5 is the number.
Speaker 2:Yeah, no, that's completely right, I mean. So that's why you always hear people talking about structural reforms that are needed in the economy to really open up that really private sector growth engine, to create employment and broaden up the tax base, as you mentioned, because only growing our tax revenues is the only way to change the broader trajectory. I mean, every year in your out-of-budget time, national treasury always talks about debt stabilization. At what point is the government going to stop accumulating debt? And it's always two, three years out, and every year it's two, three years out, and that always gets pushed out. And so until we, I think, see material changes in policy that are kind of aligned to kind of pro-growth, we sit in the same position. But talking to your point in terms of that growth and revenue, tax revenues the only way out. If you look at those debt service costs we're now spending, this year we're going to spend more than 20% of tax revenue on just servicing debt. So you can think about 20 cents out of every ran raised from tax revenue is going to go just to paying down the interest on debt. Do you think about that? Like if our debt service costs were half of what they were last year, we would have had another 150 billion for government to spend on things like the social relief of distress grant or effectively potentially lowering taxes, because they don't have to raise so much Debt service costs and the high level of interest really crowds out government's ability to invest for growth.
Speaker 2:But equally, government's high cost of debt also crowds out private sector growth Because if you think about it from a business perspective, really your cost of capital as a South African business is tied to South African government interest rates and if those interest rates are really high, you're not going to borrow money to invest in your business. You might as well just take any money you haven't invested in government bonds because they're paying 12%. So there's this very strange dynamic where low growth has led to higher interest rates from a government perspective, but now higher interest rates in turn actually inhibit broader economic growth in South Africa as well.
Speaker 1:So it's something you're explaining that I may be understanding properly for the first time. I mean, I understand it on a personal level. If I've got debt, I'm not going to be buying stuff and I'm not going to be in, shouldn't necessarily be investing. I should be paying off my debt, especially when interest rates are high. But at a company level, even if the company doesn't have a lot of debt, the rational thing to do is to say well, if my company is only growing at 10% a year, why don't I take my cash and put it into something which is guaranteed to give me 12% a year and just not grow, Just stay stable?
Speaker 2:Exactly, exactly. And also, if I am borrowing money, let's just say, use round numbers at 12%, but I'm only going to earn 10% of my business, I'm not going to borrow that money and invest for growth because I'm not going to make enough money to pay the cost of my debt. So you actually have businesses that now are not looking at. How can I grow my business, how can I employ more people, how can I invest in more factories? How can I borrow money and go invest for growth? They're saying well, let's batten down the hatches. How can I try see through this period, which almost feeds on itself, from a growth perspective, which is quite interesting If we look at it from an investment and we move from an economic growth to an investment market perspective?
Speaker 2:The easiest way and I take that this market is quite esoteric the credit market in South Africa, where companies come and they come to capital markets and they want to borrow money to invest for growth.
Speaker 2:Because the growth picture has been so poor, very few companies have actually been coming to borrow money in the credit market, so there's been very little corporate credit issuance.
Speaker 2:But we know that there are lots of income funds, there are lots of bond funds, there are lots of multi-asset funds that invest in credit as an asset cost.
Speaker 2:So you have a lot of this money chasing very little corporate credit issuance and what that has meant is that the spread of this corporate debt has become very, very compressed. Now, just to break that down, let's say government interest rates are 12%. For companies to borrow, that's more risky because they can default, so they generally have to borrow at a higher rate compared to government. So let's say government's at 12% and corporate should be borrowing at 13% or 14% or 15%. So that difference between the rate that the corporate can borrow at and government is called the spread and that's really additional compensation that investors receive for the risk of that company going bankrupt and not being able to return the debt. And the dynamic that we've seen is all of this money from kind of investment funds chasing very little corporate credit issuance has meant that those spreads have completely compressed where actually you're investing in companies that have a risk of default but you're not really being compensated for it because of this very strange dynamic around how growth is being crowded out in South Africa.
Speaker 1:Again something that's key and probably something that a lot of us don't really appreciate. The impact of high rates is multifaceted and, I think, maybe a little bit subtle, but actually pervasive. I didn't really pay much attention to something. I know you guys did a lot of research on the correlation between the stock market and the bond market. People like me go. Asset class diversification is a good thing because when shares are going up, bonds are probably going down and the other way around and you get diversification because things don't perform at the same time and for the same reasons. But one thing I'm noticing now and especially 2022 hit us all is that these asset classes are starting to look a little bit the same. I'm hoping it's not a new long-term trend. I'm hoping it's a short-tail thing, but it feels to me like when you're buying shares, your alternate is not Look at bonds for diversification. It's actually look at bonds because I might get a better return and the things are performing roughly in the same pattern.
Speaker 2:If we zoom out and we don't look at it from a pure South African lens. If we look at global markets and we look at South African bonds, we know we rated sub-investment grade or junk equivalent, so high yield. High yield bonds are effectively a growth asset class and often they are thought of as substitutes for equity in a global perspective. Now, generally, growth assets tend to move together, so they sell off together and they're rallied together and that's what we've been seeing in South Africa. Actually, going back over a long-term, south African bonds have typically been roughly, relatively correlated with South African equity. So, like you say, selling off and rallying together. But there's been a material step change since 2020, when our fiscal picture changed dramatically. That correlation is much more elevated today, moving together a lot more, like you say, in terms of building a multi-acid portfolio and a diversified portfolio. That sometimes presents challenges in terms of how do you incorporate diversification when the two tools that historically one would always rely on bonds diversifying equities that that paradigm isn't what we're currently experiencing. I definitely agree with you there. There has been a big change, but there's been quite a negative conversation, I think, up until this point, talking about the challenges around the South African economy and really the broader fiscal trajectory. But, like we've been saying, south African bonds are almost like a growth asset class. Now there are some silver linings for investors the challenges from growing your business and from the economy.
Speaker 2:But from an investor perspective, you can invest in South African government bonds that are yielding 12% and if over the next 10 years, inflation comes in at 6%, you're earning a 6% real yield, which, if you look back over the last 10 years, south African equities only delivered inflation plus 3.5%.
Speaker 2:So through that lens, south African bonds are exceptionally attractive. There is obviously the risk around inflation not being 6% over the next 10 years. Let's say inflation is 10%, then you would only realize a 2% real return, which is a lot closer to long-term bond returns that we've seen in the past. But you can control for that inflation risk because we have inflation link bonds which are yielding close to 5% and you can actually hedge out some of that inflation risk and lock in inflation plus 5% over the next 10 years. And through that lens, the role of bonds and the role that bonds should be playing in a portfolio targeting inflation plus 5%, targeting inflation plus 6%, has certainly changed compared to where we were 10 years ago and it certainly is a different way to think about this asset class, I think, from the traditional through then how investors would traditionally think about bonds.
Speaker 1:I hope you know about histories that it won't exactly repeat in the next 10 years. But if we are in an environment where the South African economy just stays low, growth stays stagnant, it's very unlikely to translate to great stock market returns. And so if you do end up banking inflation plus 4 from the stock market but you're getting inflation plus 5 or 6 from bonds, with your only real risk being the South African government, you're right, it is something to consider and a lot of us wouldn't have thought of it. We would I mean someone like me would always say equities is your growth asset, especially broad diversification. Attract the index, don't worry too much about choosing a share and don't worry too much about bonds other than as a diversify. It might be that we're seeing balanced fund managers saying actually the rational thing is to overweight our exposure to bond sorry and to weight our exposure to South African shares to give you 10 or 11 or 12% growth a year at a reasonably low risk other than SA government.
Speaker 2:Yeah, and I think the thing that certainly for portfolios that are for retirement savings, a regulation 28 type portfolios, the liberalization of the offshore limits two years ago has also meant that you don't have to rely on primarily South African equities as your equity driver in your growth engine. You can actually allocate to broader diversification, global equities, 3,000, 7,000 individual shares all around the world, different markets, different indices, so when it becomes less reliant on the South African equity market. But one is quite interesting the one conversation we've been having with many people around the South African equity market is that if you just look at long-term valuations of the South African equity market where we are today and compare that back to history, south African equity markets only really been this attractive over the last 20 years at about three points. One was the COVID lows in 2020. The other was around the GFC 2008, 2009, and then also early 2000s, which was the period that you're talking about at the start of the podcast, and all of those periods turned out to be really attractive buying opportunities for equities because you had strong returns from that point.
Speaker 2:But if you effectively take the equity evaluation and you adjust it for the level of government interest rates, what's quite interesting is that the 2003 period was still a great time to buy South African equities.
Speaker 2:The 2008 period was still a great time to buy South African equities 2020, not as good as the two previous periods but still quite attractive.
Speaker 2:But given the high level of real interest rates in South Africa now, south African equities are actually fair value to slightly expensive when you consider the elevated government real interest rates. So what that really means is, if you believe in longer term, mean reversion over five to 10 year holding periods that you want to buy cheap assets because historically over long term time periods they have typically delivered strong returns, current South African equity valuations at these levels of interest rates actually aren't attractive and really to realise the same sort of returns that one would have seen from the lows of 2020 or 2008 or 2003,. It's predicated on materially lower government bond yields. If government bond yields stay where they are actually, south African equities, while they appear cheap, are much more close to the fair value and that's kind of a way of trying to control, for value traps things that are cheap and remain cheap for a long, extended period of time because the reality on the ground has changed.
Speaker 1:Chris, we're rapidly running out of time and I've got to ask you my favourite question for new guests. I'm going to give you a bit of time while I talk, but that question you can think about it is if you were to meet your 18 or 21 year old self now, with the benefit of some life experience, what would be the one lesson you'd love to teach yourself now? It can be about money, it can be about life, Just while you're thinking. I must say I think the South African economy and the JSE as a whole I mean I take Chris's point 100% I think they're valid because it's based on rational thinking and not on a few kind of esoteric forecasts. And so if we're expecting good equity returns from here, it's because we get a positive surprise. We get a positive shock.
Speaker 1:So much of the bad news about South Africa is incredibly well published in our media and the like. So we need to see kind of no load shedding from 2025. We need to see transit working incredibly well and the port's going very well and business really helping governments to just do their job, and if that happens, maybe we do get a positive shock and then maybe we see economic growth kicking off. And if we're muddling along, then I think that those kind of discussions that we've just had are probably accurate. Don't be excited about the JSE and current valuations, just expect normal returns. So, Chris, to kind of end there with my favorite question, what would be the one thing that you'd love to teach yourself?
Speaker 2:So I think this applies to both investing and personal life. But at 18, at 19, your ability to take risk is much higher than at any other time in your life. So if you think about it just from like an investment perspective, well, you know what your cumulative savings are pretty low, like you've got a long time until you need your money. You might as well invest as riskily as possible in kind of equities. You don't necessarily need that much cash other than sort of for an emergency reserve so that you can maximize your long-term returns and kind of the shorter-term volatility in your 20s really it's going to be meaningless over the course of your investing life.
Speaker 2:But equally, from like a personal perspective, as you grow older and as you potentially start a family or as you take on a lot more responsibility, your ability to take risk in your personal life think about, like trying to start a new business or taking opportunities to expose yourself to things that may be considered a slightly off the beaten track path to achieving at your objective. The time when you're 18 or 19 is really the best time to kind of take those risks of trying to potentially find a different way to get to where you want to, which becomes a lot harder as you kind of start settling down into a life with a family and responsibilities. So I would encourage everyone to take obviously rational forms of risk at an early age and potentially not be too conservative, not be too kind of closed-minded in terms of how one approaches life as well.
Speaker 1:I often think the biggest asset that someone at the start of their career has is the future value of the time. They've got now to work and to generate capital and growth on that, and the best thing they can do is invest in themselves to be able to earn more and generate more later, and whether that's life experience or education or just general broad, wide work experience, it's a valuable thing to appreciate. Chris Eddy from TenX, thanks so much for joining us. I really enjoyed that. I think we went way over time, but I was enjoying it and I'm sure our listeners will too. I really appreciate you being on the show.
Speaker 2:Thanks, warren, it was lovely to spend some time chatting to you. Thank you.