Dinner Dialogue with Pippa Malmgren & Justice Malala

Dinner Dialogue: an engagement with Pippa Malmgren & Justice Malala – the impact of geopolitics on capital markets

Last week we arranged a private dinner engagement in Sandton with Dr Pippa Malmgren, international keynote speaker and strategist, and Justice Malala, one of South Africa’s most respected political commentators, where we discussed the impact of geopolitical events on capital markets and market trends globally, and what it means for investing assets.

We now share some of the highlights of the evening with you.

Indebtedness and the breakdown of the social contract – Pippa Malmgren

Quipped Pippa, indebtedness has become the story of the world economy. Governments everywhere are in such an indebted position that they cannot fulfil their promises, and this holds true for the UK, the US, South Africa, China, Greece…. Pippa calls this the breakdown of the social contract, causing a worldwide despondency.

Says Pippa, there are four possible ways for nations to default on their debt:

• An Argentile-style default where governments simply say “I’ll never pay you back”
• A Greek-style haircut, where they say “I will definitely pay you back, but a little bit later and a little bit less”
• Austerity measures, where governments say to their citizens, “I know I made you promises that you could retire at a certain age, but I can’t afford that anymore. So not only are we no going to deliver on those promises, but we’ll tax you more”
• Or, we can create inflation. This is where Central Banks deliberately brings about inflation to overcome deflation (in the US this was called Quantitative Easing). Unfortunately, people are caught in the rising cost vice as a result. Their cost of living has been pushed up while their income is falling, so they’re feeling the squeeze. But at the same time there is a massive disconnect between the official inflation data and the real cost of living, causing widespread social dissent.

As a result we’re seeing the breaking of the social contract between citizens and their governments as the bad news sets in: you’ll have to work longer and live on less than you expected. This sets in motion many outcomes: social unrest in emerging markets, strikes, lower manufacturing outputs, unemployment, higher food and energy prices.

Says Pippa, something as simple as the rising price, but shrinking size, of a steak (or bag of onions or pork) could propel some nations to deploy drastic action to secure their resources and protect their citizens from rising food, energy and housing prices. Russia now looks set to seize the Baltic countries and is already attempting to increase its foothold in the region, to take advantage of the cheap source of abundant resources in the area… all as a result of these inflationary impulses.

On the other hand, China have initiated their ‘one belt, one road’ strategy, the single most important phenomenon that will affect us geopolitically today, with significant consequences for emerging market asset prices. This is China’s response to Central Banks creating inflation; they’re selling treasuries, gilts and sovereign debt assets in the industrialised world, plus are reaching out to secure additional assets. Rather than circulate their savings into western debt markets, they want to put their savings directly into infrastructure (roads, airports, railways) as a means of exporting their domestic excess capacity, and generating cashflow.

So what’s the outcome?
It’s not all bad news, says Pippa. There are opportunities that arise from the breakdown of the social contract and, with it, endless possibilities. Ultimately, it is growth and innovation that are the keys to success.  We need the impetus of gutsy entrepreneurs with new ideas who are not afraid to risk failure in their attempts to build a more dynamic economy.

Where are the investable opportunities?
Says Pippa, the hard landing in China has already happened. China’s one belt, one road strategy will create significant investment opportunities in special economic zones outside of China itself. Innovation is coming but so is market turbulence. Military tension is growing between China and the US and this will affect the markets. But they will find quiet ways to navigate through it, so don’t be deterred.

Overall, says Pippa, we can expect a relatively stronger US than we’d expected and a relatively weaker China. And in South Africa, we can expect further currency devaluation. Asset classes? Look to equities she adds, because “optimism in innovation is usually expressed in equities, not bonds”.

There is a big disconnect between official inflation data and the actual reality of the ‘man in the street’, and as asset owners, this is the critical gap that we need to manage when making our asset allocation decisions. We must find out how to participate in other, higher-yielding markets to engineer inflation-beating returns in a world that understates its inflation stats. We should therefore look to alternative asset classes in a world of lower returns and rising inflation.

Accountability, integrity and institutions – Justice Malala
In answering the question, “Is South Africa a ‘buy’, a ‘hold’ or a ‘sell’?” Justice responded quizzically, “The truth is that locals never see the upside  – and this is true of us locally”.  Add to this events such as the Nkandla Report and rocketing Public Works Department budgets, and business confidence is at an all-time low. Having said this, we do see hope for South Africa and there are some institutions that give us amazing hope for our country. So the answer to the question would be, “It’s a hold”. And that’s a tragedy. We need to do far more to make it a ‘buy’.

Why? Because in South Africa, there is unbelievable value and certainty in our ‘rule of law’, our institutions of accountability, like the Public Protector. South Africa could well be the gateway to the rest of Africa, simply because people trust in our ‘rule of law’ and they want to get into Africa. There is massive opportunity in that.

Added Justice, for all our foibles, we forged an amazing phenomenon in 1994 in managing to shape a peaceful political dispensation. There’s always an upside for every downside, and we shouldn’t lose sight of the big picture. But it all begins with our institutions of accountability.

What keeps you awake at night?
The unemployment of our youth, who are the future of our country, responds Justice. The reality is that there is a wide disconnect between the official unemployment figures which come out every year and actual reality; the official stats are only 10% of the real picture. People feel inadequate, there is a ‘boiling’ beneath the surface, an insidious anger. People are looking at the past and not to the future and it is permeating the country. And this is part of the reason of why we’re a ‘hold’ and not a ‘buy’. Yet. Watch this space…

Concluding thoughts
Justice and Pippa ended the evening on a unanimous note of optimism about South Africa and its future investment opportunities.

And while they both agree that geopolitical issues have a profound effect on investment portfolio outcomes, geopolitics brings both risks and opportunities onto the investment landscape. The parting questions left were, as managers of capital, how much time and effort can be devoted to this subject? To what extent should geopolitics be included as one of many drivers of the investment strategy?

In the end, the purpose of making an investment is not only to get your money back but also to make the best return possible, given the risks and opportunities involved. Therefore, investors who fail to consider all these factors could be short-changing themselves and the interests of the capital for which they have a fiduciary responsibility.