The current investment environment is characterised by economic uncertainty and in many instances fundamentally expensive asset classes, probably more so than before. The local investment landscape is complicated further by a choice of over 1,000 unit trusts. Faced with these circumstances, trying to make informed investment decisions is difficult.
In the face of weak fundamentals and demanding valuations, risky assets performed well in 2012 but the outlook remains uncertain
Despite low income yields and relatively subdued income growth, 2012 proved to be a year where investment risk was rewarded. In the face of weak investment fundamentals and demanding valuations, the JSE All Share Index (ALSI) ended the year above 39,000, producing a total return of 26.7% for the year.
Domestically, widespread industrial action during the latter parts of 2012 has worsened growth prospects and has damaged South Africa’s international reputation. The economic outlook is further clouded by the possibility of rising inflation and a volatile exchange rate. All asset classes in South Africa are fundamentally expensive and, again, investors need to be careful in their investment decisions.
Across the globe, governments continue to be faced with economic challenges that could have a profound impact on markets in the years ahead. Although the US recovery is on track, the “fiscal cliff” has only been partially resolved in so far as a decision on spending cuts has yet to be reached. In the UK, economic growth is stalling, while inflation is rising. The Eurozone has unresolved problems and, despite recent policy actions, a possible break-up of certain parts of the monetary union still remains. Economic growth in the developed world is largely dependent on printing money (quantitative easing) and maintaining artificially-low interest rates. This is not a positive outlook and investors need to be astute when investing their capital.
With such uncertainty, an investment strategy based on macroeconomic forecasts is unlikely to produce predictable results
Factors that will impact on 2013 asset class performance include quantitative easing, austerity measures, artificially-low interest rates and the “fiscal cliff”, along with numerous other macro-economic variables, all of which are currently difficult to forecast with any degree of certainty. An investment strategy based on predicting when and how macro-economic variables will unfold is unlikely to be useful and the outcome will be arbitrary.
Investors looking for stable, growing returns should look to international equity markets and global real estate
Given the economic environment that we have outlined, investors will be hard pressed to find adequate returns and yields. We believe that their best options lie with large, defensive first world equities and international real estate which are offering good potential returns and are currently well priced.
SA Money Market
Despite mounting inflationary pressures, the South African Reserve Bank is expected to maintain low interest rates as economic growth prospects remain subdued. This policy has serious consequences for investors, notably it encourages them to adopt more risk than is appropriate, in pursuit of additional return.
SA Bonds and Listed Property
SA fixed interest bonds and listed property yields remain at unreasonably low levels with the current low interest rate policy of central banks providing support for these asset classes. Factoring in a reasonable expectation of long-term inflation and using current yields, it is highly unlikely that these asset classes will provide investors with an acceptable real return over the longer term.
SA Listed Equity
The key drivers for equity valuations are growth in both earnings and dividends. In recent years, despite tough economic conditions, earnings growth from South African companies has been impressive as a result of a combination of:
Historically low interest rates,
A significant uptake of unsecured credit, and
Wage increases well ahead of inflation.
These drivers (especially the latter two) are, however, unlikely to be sustainable over the longer term. Consequently, we believe investors should expect below-average earnings growth from local equities in the years ahead. Current yields of approximately 3%, combined with low growth prospects, makes South African equities expensive in our opinion.
International Real Estate
International Real Estate has recovered robustly since 2008/9 with the strongest players recapitalising their balance sheets and restoring dividends payments. Currently, this asset class is offering investors fair yields with secure income growth prospects.
International Fixed Interest Bonds
Based on current valuations, we believe that international fixed interest bonds should be excluded from an investor’s personal portfolio. Not only would this asset class reduce the prospect of income and capital growth but would also reduce the portfolio’s income yield.
International First World Large Cap Equities
First world equities continue to offer good value to investors. Based on current valuations it is possible to invest in a portfolio of some of the largest and most recognisable companies in the world on a yield well in excess of the current yield of the JSE ALSI.
As 2013 unfolds, investors continue to face economic and investment uncertainty, probably more so than before
Marriott believes that an investment strategy that is likely to produce a predictable outcome is one based on a bottom-up selection of securities or companies that can produce reliable income streams and will be resilient to unexpected events. Emphasis should be given to offshore equities due to attractive valuations.
