2010 in a nutshell

With the end of the global recession in sight, corporate earnings showing signs of recovery and inflation well contained, the state of health of the global economy has shown a steady improvement.

Low and declining interest rates have been a prime driver behind the expansion of price earnings multiples and the equity rally that took place during 2009, when markets recorded their sharpest yearly rise since 2003. With that impetus likely to reverse in time (although this is some way off), earnings growth will increasingly be relied upon to preserve momentum.

Current ratings are such, however, that much of this appears to be discounted in current price levels and global equity performance should be substantially lower than that experienced in 2009. We nevertheless still expect global equities to outperform global bond and money markets in 2010.

On the local front, earnings growth is also expected to re-bound off a low base, but this notwithstanding, relatively low forward dividend yields and high risk free (long bond) rates suggest that the local equity market is a little on the expensive side.

Our economy is in reasonable shape, with inflation anticipated to average 5.4% in 2010 from 7.2% in 2009. Interest rates are expected to stay at current levels (a repo rate of 7% and a prime lending rate of 10.5%) throughout 2010 and to rise by some 250 basis points by the end of 2011. The effect of interest rate cuts and the Soccer World Cup should boost GDP growth to some 3.0% in 2010 (from a negative 1.8% in 2009) and to 4% in 2011 before slowing again to some 3.6% in 2012. The rand is expected to be around R/$7.70 by 2010 year end and around R/$8.20 by the end of 2011. The current account deficit as a percentage of GDP will weaken a little from around 4.2% in 2009 to some 4.5% in 2010 and to 4.8% in 2011.

Globally, we expect growth in the developed world to be constrained by private sector lending and borrowing restraint. De-leveraging, it seems, is still at an early stage. Fiscal stimulus also has a limited lifespan, especially with government debt at very high levels. There has to be payback at some point and any withdrawal of stimulus will cap economic growth.

The global economy is expected to grow by some 4% in 2010, following a negative performance in 2009. The bulk of the contribution to this growth will come from emerging economies, led by China, India and Brazil.

Looking at specific asset categories, equity ratings on a forward basis are now regarded as full. While we remain of the view that the equity markets offer good long term value, we would not be surprised to see consolidation or even some weakness after the recent strong run-up. We would continue to adopt an accumulation stance in local equities on a specific stock selection basis, as and when we see value.

Bonds remain an important asset class and the 10 year government bond currently yields some 9.3%. Corporate bonds offering rates above 10% are regarded as being relatively attractive given that short term (1 year) interest rates are currently around 8.1%.

The forward yields on listed property are around 9.3%. Notwithstanding slowing economic growth, average distribution growth of some 7% per annum over the next 12 months should be anticipated from the better quality listed counters. There is no longer a yield premium available over government bonds, but we regard listed property as fair value and this asset category will continue to deliver a high and growing income stream.

The current and forward yield on the preference share portfolio is some 8.5%. This compares to an after tax yield on 12-month money of some 4.9%. The yield benefits on preference shares are clear and they are regarded as an attractive income generator.

Offshore investment remains attractive from a diversification perspective. The South African rand tends to suffer when there is a rise in risk aversion. Offshore