Global equities a better option than the still expensive JSE

Francois van der Merwe, Head of Macro Research.

The recent correction in global equity markets removed a lot of the froth evident in valuation levels a few months ago and, looking ahead, global equities are likely to be supported by continued accommodative monetary policies and low bond yields.

Commenting on Novare Investments’ economic report for the third quarter of 2014, Francois van der Merwe, Head of Macro Research said: “Equity prices should grind higher over the next 12 months, despite increased levels of volatility.

“Global bonds offer poor value. The normalisation of yields will take longer than expected, with low yields offering little compensation for the risk taken to invest in bonds. In the global fixed interest environment, we prefer absolute return orientated fixed interest strategies”.

He added that the domestic economic outlook remains bleak, and newly appointed Reserve Bank Governor Kganyago is likely to adopt a tightening monetary policy bias.

While consumer inflation will benefit from lower petrol prices, given the risks associated with a persistently large current account deficit and the effect of volatile foreign portfolio flows on the rand, inflation should remain close to the upper limit of the bank’s targeted inflation band.

With government expenditure constrained and the focus on lifting revenue, higher taxes look likely. Consumers will continue to feel the effects of slowing real disposable incomes.

“Although the sharp drop in South African share prices reduced some of their over-valuation, the FTSE/JSE All Share Index’s price-to-earnings ratio of close to 17 is still above the long run average. The domestic equity market is not only expensive compared to its history, but also when compared to other developed and emerging markets.

“Expectations for company earnings growth are optimistic, although companies with offshore earnings exposure could benefit from the weaker currency. We remain underweight domestic equities, but have reduced the underweight position after the recent fall in share prices” said Mr van der Merwe.

He said the domestic bond market continues to be overvalued. While the threat of a sovereign credit rating downgrade has been pushed out by Finance Minister Nene’s pragmatic budget, the government has a poor track record of sticking to its targets.

“The credit rating agencies are bound to react negatively if there are any signs of fiscal slippage. And there is also the key risk of foreign portfolio outflows should sentiment towards global bonds change.

“We are underweight domestic bonds and continue to advocate an overweight position in offshore investments that will improve diversification and take advantage of potential currency weakness.”