South African investors’ biggest enemy

The biggest enemy for South African investors is inflation, with the consistent increase in prices impacting purchasing power and emphasising the need to earn higher returns. 

Data shows that the best way to beat inflation over the long term is by investing in and holding equities for a substantial period of time. 

This is feedback from Old Mutual Investment Group (OMIG) portfolio manager John Orford, who analysed the impact of inflation on purchasing power and investment returns in the asset manager’s Long-Term Perspectives report. 

Orford explained that many investors suffer from ‘inflation illusion’, as they do not notice how it erodes spending power over time. 

Unless you grow your investments at least in line with inflation, you will face a declining standard of living in the future. 

Orford said that what matters is not whether your salary or investments are increasing in value, but whether they are outpacing inflation over time. 

Inflation is the rate at which the prices of goods and services increase over time. It may seem innocuous at rates of 3%, but compound interest applies to it as much as it does to investments. 

This rate has averaged 5.4% a year in South Africa since 1911, which is significantly higher than the 3.3% average in the United States, for example. 

This means that income and spending power have eroded at a faster rate in South Africa over the past 115 years.

As a result, investors have a higher threshold to meet to generate real returns in the country, discouraging investment. 

This also results in yields on fixed-income investments, such as government bonds, being higher to attract capital. 

In turn, the government and companies pay a higher interest rate to service their debt, limiting the capital they can reinvest in future. 

The same effects impact individual investors through home loans, car loans, and personal loans. It also means that investors must earn a higher rate of return to retire comfortably. 

The impact of inflation on retirement income is illustrated in the graph below, which shows the eroding effect of different inflation rates on R10,000. 

Inflation in South Africa

South Africa’s inflation has largely followed global trends since 1911, with a significant gap emerging between it and the United States over the past forty years. 

Inflation in South Africa has averaged 5.4% per year since 1911, compared to the average of 3.3% in the United States. 

Orford explained that before 1980, inflation in South Africa was coupled to inflation in the United States, with the country averaging an annual rate of 3.6% compared to America’s 3.4%. 

The decoupling began in the 1970s, with successive oil price shocks pushing inflation higher in both South Africa and the United States. 

Only after decisive action by US Federal Reserve Chairman Paul Volcker in the early 1980s did inflation in the United States begin a sustained decline. 

At the same time, expansionary domestic policies, rapid wage growth, and economic isolation resulted in South Africa’s headline inflation remaining high throughout the 1980s. 

Only extremely high interest rates and a recession saw inflation begin to moderate in the early 1990s. 

The adoption of inflation targeting in 2000 led to lower inflation, with the average rate averaging 5.5% from 2000 onwards, compared to a 12.3% annual average in the two decades preceding 2000. 

Globally, the battle against inflation appeared to have been won in the two decades leading into the Covid-19 pandemic. Globalisation and China’s entry into the global economy anchored inflation at low levels. 

Following the 2008 Global Financial Crisis, central banks in Europe, Japan and the US were more concerned about inflation being too low than too high, Orford said. 

However, the pandemic saw inflation skyrocket around the world. In the US, consumer prices rose by an average of 5% in 2021 and by a multidecade high of 8% in 2022. 

This prompted an aggressive, if belated, response from central bankers, with the US Federal Reserve leading the charge to higher interest rates. 

Several factors, including ageing populations, the retreat from globalisation and the high cost of the green transition, mean that inflation is likely to remain higher, on average, over the next decade than it did in the period since the 2008 financial crisis. 

Donald Trump’s ascendancy to power in the US has also increased the risk of higher-for-longer inflation. 

There is significant uncertainty about how much of Trump’s policy package will be implemented. However, core elements of his agenda – such as fiscal stimulus, tariff hikes and immigration clampdown – are expected to be inflationary. 

The lesson from the era of high inflation in the 1970s, which was echoed in 2022, is that the economy is better off taking the pain of higher interest rates and lower growth in the short term than tolerating persistently rising inflation. 

The Reserve Bank has stood out as a bastion of orthodoxy among global central banks, remaining committed to forward-looking inflation targeting, which is the best guard against inflation and its corrosive impact on living standards, Orford said. 

The graph below compares South Africa’s historical inflation to that of the United States.