Global economy is greatest threat to domestic economic growth

As the South African economy slowly recovers from the worst recession in decades, the prospects for strong domestic growth remains tempered by continuing uncertainty in the global environment. Consequently, local investors are advised to ensure that their portfolios are appropriately diversified in terms of both geographical spread and asset class.

Madelet Sessions, investment analyst at BoE Private Clients, says that the major challenges facing the domestic economy include the evolution of sovereign risk and the default probability of the EU periphery, together with the potential for inflation in the US and the consequences of these factors on emerging market currency and debt.

She points out that, whereas advanced economies achieved growth estimated at 3.5% during the first half of 2010, emerging economies achieved robust growth of about 8% during the same period. Although the South African economy, for its part, suffered during the recession from high short-term interest rates, conditions are now favourable for growth.

“I am comfortable that the worst of the crisis is behind us.In SA, significant interest rate cuts by the Reserve Bank, much lower inflation than market expectations over the last 6 months, an easy fiscal policy and cheap and readily available global capital all support the recovery in the domestic market,” she says.

“However, SA relies on foreign savings to fund its fiscal deficit and private sector investment expenditure. Should foreigners no longer be interested, the Rand would weaken. This would most likely re-introduce inflationary pressure and short-term interest rate hikes. Furthermore, as foreign savings fall away, domestic long-term interest rates would rise. The higher domestic savings requirement would result in significant excess capacity in the economy and much slower growth.”

However, with Quantitative Easing still being used in the US, Sessions says that the Rand, along with other emerging market currencies, is likely to benefit, barring any domestic policy errors.

“Low interest rates and slow growth in the US and in developed markets more generally, make for a solid investment case for emerging markets. However, we would caution that one needs to see some recovery in the US. A double dip recession and a much-weaker-than-expected US economy would not be good for global asset values,” she says.

For South African investors, Sessions says that the most important principle is to remain focussed on the long-term, rather than to get swept up in the mood of the moment, and to ensure appropriate diversification.

“If you are investing for the long-term, it is appropriate to take equity risk – which in the long run should be rewarded. As it is very difficult to accurately predict market timing, however, it’s appropriate to invest continuously in a diversified portfolio. By not trying to time the market, investors buy exposure to different assets at different times at different valuations. Over the long run this makes for the highest risk reward investment profile.

“The prospects for the global economy remain unusually uncertain and diversification at this time - when no-one really knows what the future will look like - is invaluable,” she concludes.