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Grindrod Asset Management comments on economic situation

19 September 2014 Paul Stewart, Grindrod Asset Management
Paul Stewart, head: fund management at Grindrod Asset Management.

Paul Stewart, head: fund management at Grindrod Asset Management.

The current deficit has widened more than expected, and South Africa has narrowly missed slipping a recession. Paul Stewart, head: fund management at Grindrod Asset Management, has commented on the economic situation as follows:

1. Is South Africa really on the brink of a recession? What is the likelihood of SA growth improving in the third and fourth quarter?

It is likely that SA’s growth rate will remain positive, but very weak for the remaining part of 2014 and into 2015. GDP for 2014 is likely to be around 1.6% and will only accelerate marginally to around 1.8% in 2015 according to Bloomberg consensus forecasts. While a technical recession will be avoided in 2014, the conditions in South Africa’s economy will continue to display all the hallmarks of a recession, including low aggregate demand, weak labour market conditions, and sluggish business and consumer confidence.

2. Is this economic ‘decline’ being experienced by other emerging markets?

Unexciting growth is being experienced in most economies across the globe. A nascent recovery in the US is being hamstrung by slowing growth across the Eurozone. Most emerging markets, while not in recession, are seeing growth well below their long-term trend levels. Recent data releases from New Zealand, Thailand, Russia (which has its own unique challenges), China and India paint a picture of generally sluggish conditions.

3. A report last week stated that “The shortfall on the services, income and current transfer account widened to R121bn from R86bn due to "higher net income payments to non-resident investors." Does this pertain to foreign investors? If so, what message does this send?

These payments are made to foreign entities that own SA assets like equities, bonds and listed property and pay dividends or interest payments and remitted across the borders. These higher offshore income payments reflect the increasing demand by global investor for high quality income streams provided by many SA assets and the demand for these assets by foreign investors has been substantial in 2014.

4. What is a good investment strategy in light of this backdrop?

In light of weak growth and not outsized inflation risk, the SARB is likely to be reluctant to hike SA short rates too substantially in the cycle. So the interest rate risk to investors is not of great concern at this stage. Despite all the economic challenges, many SA companies and listed property securities are still likely to show dividend growth in excess of 10% per annum over the next 3 years. These assets are still likely to produce returns well in excess of inflation and cash, and we would remain over-exposed to these types of securities in the future. We call these securities Payers and Growers. We would, however, avoid any shares that trade on excessively high P/E ratios and low or zero dividend yields, as these assets may pose some capital risks in the cycle.

5. Should one stay invested in SA stocks as offshore investments start to look more attractive? What are the risks of staying / going offshore?

One of the major risks of investing offshore at present is that it appears unlikely that foreign assets will produce nominal returns in excess of SA inflation. The reason for this is that economic growth rates are low and the entire Eurozone is in strife. Equity, property, bond and cash yield are also very low, and equity valuations are in premium territory in most parts of the developed world. This implies that overall returns will be lower looking forward. For South African investors with money offshore, they may need to have substantial rand currency depreciation to achieve the same returns that SA Payers and Growers assets are likely to deliver. While the currency depreciation may occur, it is just as likely to move the opposite direction in a world hungry for yield and relative growth that is available in quality emerging markets. Therefore be wary to bet heavily against quality emerging markets assets and currencies over the next few years.

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