Difficult markets & Investment Environment– Why?
The long-term (15-year) average annual return for the JSE All Share Index, average balanced unit trust and average conservative unit trust is 17.5%, 12.3% and 10.1% respectively. However, over the last three years, these three investments have produced annual average returns of only 5.6%, 3.7% and 5.1% respectively.
This is due to the effects of a sluggish local economy and good offshore returns being negated by a strengthening Rand. This unusual combination has produced a very difficult investment environment.
2018 has not started well with the JSE All Share Index down 7%, led by a 10% decline in Industrials (Naspers down 20%) and a 5% decline in Resources. This is mostly driven by offshore-based companies where valuations have been stretched.
A brighter future for selected investments – Local is becoming lekker
The recent declines are mostly due to offshore companies (such as Naspers) falling from high valuations. Over the next two years, we expect local companies to produce good returns, the Rand to remain firm and offshore returns to be muted as a host of mounting international risks weigh down offshore markets.
SA politics – Moving in a positive direction
Ramaphosa has his hands full as he re-aligns the ANC. This will be a gradual process, but he is making good progress supported by his interim new cabinet appointments. We believe further positive changes should continue.
Important parastatal replacements are taking place (Eskom, SARS, SAA). Government is starting to meaningfully address corruption, such as pursuing the Guptas and Zuma’s day in court now appears imminent.
We believe concerns over land expropriation are overdone and will not take place in a way that will negatively affect the economy.
The world is watching us, and every move in the right direction boosts positive sentiment and much needed investment in the country. This is borne out by the recent offer by German company Aton to buy out Murray & Roberts.
A stronger than expected local economy – to boost the local market
The South African economy has grown an average 0.9% over the last three years. With a change in President urgently addressing misspending and policy reform, business and consumer confidence is rising, which should boost spending. As the economy has stagnated, these positive changes should boost growth more than government forecasts of 1.8% and 2% in 2018 and 2019. This is borne out by rating agency S&P recently forecasting higher growth of 2% for 2018.
We believe that if positive reforms continue, economic growth will far exceed expectations over the next three to five years. Investment markets have taken very little notice of these improved prospects into account.
Interest rates poised for a further decline – good for investments
We believe that local interest rates could decline further despite the negative effects of the increase in VAT on inflation. A firm Rand and curbs to government spending bodes well for a lower inflation outlook. This is all positive for investment growth.
Rating agency – no downgrade this year
We have been firm in our view that it was unlikely that an across-the-board rating agency downgrade was going to occur. A downgrade has now been averted with Moody’s recent review, which actually resulted in an upgrade from a negative to stable outlook.
If Ramaphosa continues with positive changes, confidence will return, which will boost growth and support our debt ratings into the future.
The Rand to remain firm in 2018
The Rand has appreciated 30% against the US Dollar from its high of 16.8 in January 2016. Since then we have consistently forecasted the Rand to strengthen. We believe the fundamental fair value of the Rand / Dollar to be 11.5 based on purchasing power parity. However, as a positive economic outlook materialises, it is likely the Rand will remain firm and could decline further to below 11 over the next year or two.
The local market offers good select investment opportunities
The JSE All Share Index is roughly split 50/50 between offshore companies (Naspers, Richemont, Billiton, etc) and local companies (banks, retailers, industrial, property sectors, etc). Two very different economies (offshore vs local) drive these sets of shares and therefore it is difficult to predict how the overall JSE will perform when offshore and local prospects are different.
With the economy poised to grow quicker than expected, we believe that local equity sectors should provide good returns over the next two years. This is despite strong starts from the bigger local sectors such as Banks and Retailers.
Local companies have been operating in survival mode focusing more on cost cutting than growth. This places them in a positive position to grow earnings strongly when the economy picks up. We believe the market is not pricing in this positive growth, which will drive local related sectors higher over the next three years.
Selected commodities (such as Platinum) also offer good value as they have not yet reaped the benefit of improved global growth.
Offshore markets – Beware!
Offshore markets have had an unprecedented upward trajectory over the last nine years. The US market is at its third all-time high based on valuation and global investors are the most confident in a decade. The gap between cheap and expensive shares are abnormally wide, which is boosted by inflows in passive investing that is not price sensitive.
Although global synchronised growth is taking place and is positive for certain undervalued areas -mostly in emerging markets – developed markets (US, UK, Europe, Japan) have entered an unchartered space. Central bank debt is at an all-time high and interest rates are rising. This, added to many geopolitical uncertainties, a lack of wage growth and an over-confident market, places offshore markets in a dangerous place.
Investonline portfolios are well placed for good growth
We expect moderate risk portfolios to produce double digit returns over the next two years as they reap the benefit of an improved SA economy and renewed, positive international support.
Conservative portfolios should continue to grow steadily at 3% to 4% above inflation with solid capital preservation intact.
Our recommended portfolios continue to benefit from underweight offshore positions. We are in constant discussions with unit trust fund managers and we are monitoring portfolios closely to ensure investments will benefit from the renewed positive local outlook.
Managing risk will remain critical. Investors need to ensure that their tolerance for risk is matched to a portfolio that is properly balanced to provide a reasonable return but can protect against the different market risks.