Global equities likely to deliver solid returns over the next year

Francois van der Merwe, Head of Macro Research at Novare.

But South African stock market valuations look expensive.

The recent correction in global financial markets has left developed market equities about 10% cheaper and emerging market equities 25% cheaper, removing a lot of the valuation froth that was evident.

Commenting in Novare Investments’ economic report for the third quarter of 2015, Francois van der Merwe, Head of Macro Research, said: “We expect global equities to be supported by continued accommodative monetary policies, soft inflation and a moderate global economic recovery.

“Global equities should deliver solid returns over the next 12 months, but the pullback in the domestic equity market has not been big enough to unwind excessive valuation levels.

“Going into the final quarter of the year, the FTSE/JSE All Share Index had already recovered most of its losses and was again in expensive territory with a price-to-earnings ratio of 19, which is close to historical peaks.

“Expensive valuations aside, the weak economic backdrop and concern over companies’ earnings expectations do not augur well for South African equities.”

Where the sluggish South African economy is concerned, van der Merwe said there were no catalysts on the horizon to prompt stronger growth. Instead, recessionary risks for next year have risen and the continued lacklustre performance will prevent employment, consumption and private sector investment spending from recovering.

However, the moderation in economic activity will limit the extent of interest rate hikes and the Reserve Bank will probably come under pressure to ease monetary policy towards the end of 2016.

The rand is expected to remain on the back foot given the weak economy, low real interest rates, large fiscal and current account deficits and the risk of a sovereign credit rating downgrade.

Van der Merwe added: “Financial markets have entered a period of increasing volatility and we expect this to continue as global growth remains uneven. Under these circumstances, it is important to maintain allocations to offshore assets to benefit from diversification and currency movements.”

He added that, until four months ago, the liquidity glut from global central banks pushed asset values higher and kept volatility at extraordinarily low levels.

“Investors have been spooked by the pace and magnitude of market turmoil, but we view this as a mid-cycle correction that was necessary to extend the duration of the current business cycle. The turmoil left financial markets overly bearish with weak economic growth already priced in.

“A stabilisation in Chinese economic growth over the coming months will probably be the key factor in helping to sustain global expansion.”

He noted that, since the US Fed’s September meeting, interest rate hike expectations have moved out, although US economic conditions still provide the Fed with the right backdrop to increase rates before the end of the year.

“It will be important for the Fed to lift rates from zero as soon as possible as this will remove lingering uncertainty about when rates will rise. The US economy is expanding strongly due to rising household consumption following the windfall from lower energy prices. The recent slowdown in employment data should not be the start of a sustained deterioration in the labour market.

“The euro area economies are stronger and more durable than investors currently appreciate. The region is strengthening and showing signs of a broad-based expansion,” van der Merwe said.