Investing: Banks will be winners, and retailers will lose as interest rates climb

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Banks will likely make more money than retailers as central banks start hiking interest rates.
Banks will likely make more money than retailers as central banks start hiking interest rates.
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  • More interest hikes are probably on the cards this year, which will affect consumer spending.
  • Old Mutual Investment Group expects three more 25-basis-point hikes.
  • As rates rise, banks will collect more interest income leaving little disposable income to spend at retailers.

Banks will likely make more money than retailers in the coming year, as central banks start hiking interest rates. Mining companies are at the mercy of the movement of commodity prices. 

Old Mutual Investment Group (OMIG), which took the crown as SA's largest investment manager in 2020, is buying banking and telecommunication shares, and holding on to mining companies and retailers that have proven over the years that they can produce sustainable earnings even in tough times.

OMIG is expecting more interest rate hikes this year. Chief economist Johann Els believes there will be another 75 basis points increases over three monetary policy committee meetings this year.

"Two of those would probably be in the first half, front-loading," said Els.

But he still expects the hike cycle to end before the interest rates reach the levels they were before the Covid-19 crisis.

Why banks over retailers?

OMIG portfolio manager Urvesh Desai said the interest rate expectations - coupled with other macroeconomic factors that drive companies' earnings growth - make certain industries stand out. He said financial and industrial companies tend to outperform in this "overheating" phase.

"When we think of rate rising rates, it is likely that banks will do much better in this environment than retailers, especially when you combine it with other consumer pressures," said Desai.

Although Els said consumers are starting to be slightly more optimistic about their household finances, Desai said consumers' buying power is eroded by the rising electricity and other municipal charges and rising unemployment - over and above the interest rates. Even though the R350 Covid-19 grant extension will help consumer spending, Desai still doesn't see a rosy picture on that front.

So, OMIG is maintaining a large holding in banks. FirstRand makes up the biggest single stock holding in Old Mutual Balance SA Equity Fund, followed by Naspers/Prosus, MTN, Standard Bank and Anglo American. Generally, the investment house expects SA equities to do well.

So, even in retail, a sector that it expects to come under pressure, OMIG still owns a few clothing retailers.

"We own The Foschini Group. There's a turnaround story we see there. We see value in that story. We own Pepkor as well. We see it as a potential winner in this environment … We also own Shoprite on the food retail side," he said.

Desai added that Shoprite has proved itself as a noteworthy longer-term holding because it can grow earnings sustainably.

Wary of property stocks

One area that the company doesn't seem convinced about is SA property stocks. The Old Mutual Moderate and Stable Growth Funds even invest more money into cash than in local property.

Even though many SA property stocks have lost a lot of value, Desai said the company is staying away because there are still negatives to avoid.

"The environment is negative. And the bad environment is the high vacancy rate," he said.

Desai said even though the sector performed better than expected in 2021, it's better to go for companies with more exposure to defensive properties such as warehousing and storage.

He said while the office sector has been affected the most in terms of rising vacancies, if SA doesn't deliver high growth rates quick enough, even retail property will be in some trouble. As it stands, footfall coming to the malls has not recovered to pre-pandemic levels.

It is also not enthusiastic about global propert. It was invested in global property stocks in the past, but as interest rates go up, it is concerned about the earnings of global property companies

"As interest rates go up, the rate at which you discount the future earnings of property companies, that's going to be negatively impacted. In fact, if you look at negative themes of rental growth and work from home and the decentralisation of CBDs, that's even more pronounced in the developed world," Desai said.

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