A realistic look at the investment landscape

We often go into denial in the face of bad news as this can protect us from very stressful situations such as the loss of a loved one. But unchecked, it can cause us to ignore critical change in our world and its impact on us. Denial is often the case when dealing with our finances and this probably relates to the stress of our savings and the continual worry whether we have saved enough for the future. We mistakenly presume that good returns we may have enjoyed will continue and we miss signals indicating that we need to make changes.

But what is likely to remain the same? And what might change? What impact might this have on our investments and what can we do about it?

Let’s look at our local experience over the last few years.

Like most countries, South Africa experienced a financial jolt during 2008 as a result of the global credit crisis. Many were affected but since then our economy has continued to grow, spending has continued unabated and our stock and bond markets have reached new heights. Is this good news likely to continue?

A major driver in our economy over the last five years has been the vigorous spending from both the consumer and the government.

As interest rates have declined the cost of debt has reduced, resulting in more available cash for households. Extra cash has also come from continued borrowing especially from overdrafts and short-term loans. The South African government, too, added ten million more recipients of social grants increasing the number of economically active households. But will this set of circumstances continue? Perhaps not.

Interest rates are likely to remain low, not eroding households cash. But there has been a notable slowdown in unsecured lending over the last few months and the government has started to rein in its spending, including that on social grants. This translates into muted growth in expenditure and retail sales statistics have already shown a slowdown in spending. Hence the earnings of companies reliant on domestic spending are unlikely to grow at the pace they have in the past.

What about interest rates? Short term interest rates may stay at low levels for a while longer. But the same may not be said for longer term yields of government bonds. International bond yields have been held artificially low as a result of the intervention in the US by the Federal Reserve. But this may be coming to an end resulting in a rise in bond yields and a decline in bond values. Because listed property behaves in some respects like a bond, this asset class may well be affected by higher yields, leading to a decline in listed property values.

The dynamics in international markets may also change. Emerging markets have produced greater returns than first world markets over the last decade but trends are shifting. The growth in the Chinese economy may slow as it becomes increasingly expensive as a manufacturer and other countries, such as Spain and Mexico, may benefit from changes in outsourced manufacturing patterns. The US and the UK economies are also starting to show signs of growth. A more global approach to international markets may be more appropriate in the future rather than a focus only on specific emerging markets.

So how will these changes impact on our investments and how should we invest our assets in the light of current conditions?

It may be wise for investors in local equities to focus on those companies that will continue to have a steady and growing demand for their goods and services over the next few years. Food, clothing, tobacco and alcohol retailers, medical and general health suppliers, data and telephone providers and large banks and insurance companies may be resilient to the reduction in spending over the next few years and should be able to continue to deliver reliable dividends.

When investing internationally, companies owning universal brands such as Coca Cola, Johnson & Johnson and Unilever should continue to prosper, as they enjoy demand from both the emerging markets as well as the first world.

There are increasing risks to holding bonds and related investments like listed property. While these investments should provide reliable income, there is a risk that capital values will fall.

 

Some investors have been able to draw not only the income produced from these investments but also have drawn from capital profits to supplement their lifestyle. There may not be much by way of capital profits going forward – rather the opposite – so investors may need to review the amount drawn from their investments.

Capital-stable money market instruments currently provide returns of around only 5%. Investors who are not able to live off this should use their capital in a controlled and careful manner. Remember, the more capital that is used today, the less future income will be earned as the investor has literally "cut down the tree” providing future fruit.

Investors should be aware that past performance cannot be expected to continue into the future and that there are changes occurring in our local and global markets. Reduced consumer spending may result in a slowing in the earnings of some South African companies, bond values may decrease and a more global approach to investing may be more prudent.

To minimise the impact of these changes, investors are encouraged to re-align their investments to ensure that there is predictability in their investments’ earnings and risk associated with capital values is minimised. The amount of income drawn from investments should be reviewed to ensure that capital erosion in minimised or, if it is necessary, that it occurs in a controlled manner.