Slow growth puts defensive shares back in the picture
Expectations for the South African economy through 2010 vary depending who you talk to. Economists predict around 2% GDP growth next year while finance minister Pravin Gordhan is pencilling in a more modest 1.5%. Whichever estimate you prefer, it’s clear the economy won’t shoot the lights out next year! How do you position your portfolio for slower economic growth? To find out we attended a presentation by Chris Freund, portfolio manager at Investec Asset Management, at the group’s Sandton head office.
A bounce is not a full-blown recovery
Before tackling the domestic economy Freund unpacked recent developments on the global economic stage. He notes that economists in the developed world expect manufacturing production to stabilise and recover, but off a very low base. US corporate earnings will improve in a similar fashion in the first half of 2010.
A long term US economic recovery is hampered due to a large slice of activity hinging on the strength of its domestic consumer. They’ve walked a difficult road of late. Average household net worth (expressed as a percentage of income) has been in decline since mid-2006 due to massive downward revaluations in house and equity prices. Although this trend has reversed in recent months – improvements are being unseated by the US unemployment rate that has now crawled up to 10%. One in 10 ‘official’ US jobseekers is out of work.
Western economies are facing massive budget deficits too. The International Monetary Fund (IMF) estimates deficits for 2009 in the United States (-12.5%), the UK (-11.5%) and Japan (-10.25%). These deficits have grown astronomically as governments stepped in to take up the slack from private spending. Freund observes this overhang will “take some fixing!” Against this backdrop the best we can expect from the developed world is a slow drawn-out recovery. Why? “The traditional powerhouse – tasked with leading the rest of the world out of recession – is still very battered and bruised,” said Freund.
Mixed signals on the world stage
The recovery is being further hindered by a significant change in US economic statistics. According to Freund “economic data has started to come in ‘mixed’…” After months of consistently exceeding analyst expectations, house price and payroll data has taken a turn for the worse. The result: “All of a sudden there’s some doubt about whether we’re really out of the woods!” The picture is slightly better in the so-called emerging markets. “The economic bounce has happened in a lot of countries outside of the US, UK and rest of Europe,” said Freund, pointing to the impressive performances in China and Australia as examples.
Ignore the gold bulls?
Investors tend to stream to gold when the world economy is in trouble. But Freund believes gold’s recent price movements are largely overdone. He says gold is only good in three scenarios. The first is rampant global inflation. He observes the developed world (and some emerging market superpowers) will be more concerned with deflation in coming periods. The second is the so-called “coming of the end” doomsday event. Far from it, the world is growing apace. Experts expect GDP growth of around 2.5% in developed economies up to 8% in emerging markets next year. And the third is a much weaker dollar. There are simply too many people against the dollar right now to expect it to devalue much further. The cases for gold are thus easily dismissed.
Meanwhile in South Africa
The buzzword for the South African economic recovery is SLOW! “The thing that’s going to hold back our economic recovery versus other emerging economies is the extent of the job losses in the domestic economy,” said Freund. The last time South Africa experienced this level of job losses was in the 12 months to 30 September 2001! Rising unemployment is not good for consumer-based economies. Without improved consumption demand the manufacturing, retail and services sectors of the economy will experience weaker recoveries over the coming year – dragging GDP down.
There is some good news. Investec Asset Management is extremely bullish on the inflation outlook for 2010. They expect inflation to remain firmly below the Reserve Bank’s 6% upper target even if Eskom hikes electricity prices by 45%. This bullish scenario hinges on the rand retaining its current strength against the US dollar and other developed market currencies. With inflation under control we won’t see further interest rate cuts. Investec says the interest rate cycle has definitely bottomed and the next move, probably in Q3 2010 will be higher.
Corporate South Africa will begin a slow recovery too. The expectation is for listed company earnings to recover through 2010. But Freund warns that once earnings recover share prices tend to go sideways – with volatility – for extended periods of time. His advice to investors is to start reducing the pro-growth cyclical shares like BHP Billiton, Anglo American and Old Mutual with defensive opportunities. Defensive shares include the foods and drugs manufacturers (think Tiger Brands and Aspen Pharmacare) and something like British American Tobacco.
Editor’s thoughts: Political risk aside the real challenge to South Africa is rising unemployment. If more South African citizens were gainfully employed many of the country’s socio-economic problems could be addressed. How do we combat rising unemployment? Add your comments below, or send them to [email protected]
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