The triple threat to economic recovery
Investors hoping to answer the “Where to make money in 2011?” question will have to consider the impact of at least three threats to global economic recovery. Clyde Russouw, portfolio manager at Investec Asset Management took a candid look at these threats when presenting his latest market view to journalists on 14 April 2011. Russouw manages the group’s successful Investec Opportunity Fund.
On economic threats and uncertainty
The first threat – an ugly monster that raised its head again this week – is that of sovereign debt. Economists have repeatedly warned of the risk of one or more European economies ‘going to the wall’. They even went as far as identifying the group of countries most likely to fail – and creating the PIIGS acronym so we can easily remember the list. Say after me: “The Euro-zone economies most likely to falter are Portugal, Ireland, Italy, Greece and Spain!” Russouw doesn’t share their concerns. He points out that the core of Europe (including Germany and France) should hold. “The core can easily carry the rest,” he said. And it will be in Germany’s best interest to prevent an economic meltdown on its doorstep.
Russouw’s comments were still fresh in mind when the rating agency, Standard & Poors, downgraded its outlook for US sovereign debt from ‘stable’ to ‘negative’ less than a week later. Here’s a problem the world economy certainly cannot deal with! If America fails then every country around the globe is going to be dragged down with it. The mere hint of trouble – a circular distributed by an oft-criticised ratings agency – was enough to send global equity market tumbling. Investors poured their capital into the so-called safe havens of gold and, ironically, the Japanese Yen. And the JSE All Share dropped 800-plus points to close the day 2.6% softer!
Rumblings of discontent on our doorstep
The second threat to economic stability is too close for comfort. Civilian uprisings in the Middle East and North African (MENA) region have had a knock on effect on the rest of the globe. Russouw focused on the impact of this unrest on the price of Brent Crude oil, but there are other threats too. Let’s deal with the oil concerns first... Libya is not a major player among the group of oil producing nations, OPEC. It contributes only 1,347 million barrels of the organisation’s 30,016 million barrel daily haul. The real threat hinges on the Libyan unrest spilling over into Saudi Arabia or one of the other major oil produces…
“We’ve seen this movie before,” observes Russouw. “Oil rushes up to new highs, puts the brakes on the global economy due to its inflationary impact, and suddenly collapses again.” He said local investors who believed oil had charged beyond fair value could make a killing by selling ‘short’ Sasol shares and buying government bonds… But that’s a trade for the bravest of speculators with very deep pockets!
Africa’s economy will suffer if these civilian uprisings (and in Libya’s case civil war) play out over a long period of time. Africa will never live up to its promise as an emerging market growth region if the continent is lumbered with decade-long conflicts. Even Egypt, where majority sentiment held sway, will take years to bring the full weight of its economy on track.
Undone by natural disaster...
Japan has sent shockwaves through the international investment community. Russouw observes that an investor with a global outlook will have to factor the risk from similar events into their future return forecasts. “If Asia is a good source of long-term investment returns it makes sense to consider likely external risks, such as those posed by an earthquake,” he says. Analysts call these risks ‘tail risks’ – events that will happen – but where time, place and magnitude remain uncertain. A portfolio manager has to take steps to protect portfolio returns from such risks.
Navigating these global threats is just one of the portfolio managers’ tasks. The real test is to deliver inflation beating return in an environment where virtually all asset classes appear expensive. As we power through the second quarter of 2011 Russouw observes that JSE listed equities are expensive. Some analysts suggest the JSE All Share index will be hard pressed to beat inflation by 3% per annum over the next five years. “Why take on the risk inherent in equity investing for such a small return,” he asks. The good news for investors is the Investec Opportunity Fund equity portfolio should deliver inflation plus 8% in the coming year.
Editor’s thoughts: Savers rely on inflation-plus (real) investment returns to build up enough capital for a comfortable retirement. And they depend on portfolio managers and other asset managers to generate the required return. But in recent years the “gap” between return and inflation has narrowed. In the past you could ‘earn’ inflation plus 15% in a simple JSE index tracker – today you’re lucky to get inflation plus 5%. Are you concerned with the narrowing of real returns across asset classes in recent years? Please add your comment below, or send it to [email protected]
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