Cautious optimism rises as local equities perform well
We are well into the second quarter of the year, and investors have largely avoided the volatility that was expected to be the prevailing theme of the year. This was largely due to favourable oil prices and the benefits that it provided to the country to reclaim some ground lost through savings.
There was also significant recovery made in local and international equity markets which many investment companies believe will gain in strength during the year. However, Prince Al-Waleed bin Talal, dubbed the Saudi Warren Buffet, has sounded a stern warning in the international market by saying that we cannot be complacent and we have to act cautiously while there is still risk in the market.
Investing without fear
Shaun Ruiters, Head of Retail Strategy and Solutions at Sanlam Investments, points out that the relatively low levels of the South African Volatility Index (SAVI) suggests that investors have been continually forecasting low equity market risk. This implies a general preference for this higher yielding asset class and a risk-on market sentiment.
“Historically, persistently low levels of forecasted equity market risk have been a good indication of possible market corrections. That indicates that, when market sentiment reflects perfect equity market conditions only, with no indication of capital loss possibilities, investors should rather practise caution and opt for capital protection,” says Ruiters.
This is clearly visible over multiple years associated with equity market downturns, including 1997 leading to 1998 and most recently 2007 to 2008.
International interest
Ruiters adds that foreign investors have also shown an appetite for emerging markets over the past few years, with South Africa being a good destination. This has once again been the case during the first quarter of 2015, with foreign flows to South African equities exceeding R10 billion for the quarter.
The question we need to ask here is if this interest has an expiry date. The interest in South African equities will depend on international demand for commodities such as platinum and coal which are exported to high end markets in Asia. This however depends on a steady and reliable supply. Eskom’s challenge to meet electricity demands has had an impact on the South African economy which is dependent on mining.
This needs to improve before investors get skittish and change their confidence in South African economies. Putting most of your eggs in a market which is dependent on a struggling power supply company that has a monopoly on the market, is never a good idea, and it will not be long before investors realise this.
Where to from here?
While there is a lot of risk in the market, the outlook is far from being overly negative. There are opportunities for investors to achieve decent returns, if they proceed with caution.
Ruiters says that when looking at current South African equity valuations, we see that on a price-to-earnings (PE) basis, the local equity market is currently trading at a PE of 17.5, well above its long-term mean of 12.1. Based purely on valuation, the Sanlam Investment Management House View remains underweight South African equities.
In addition we’ve already seen an increase in volatility within equity returns, with four of the last 12 months’ performance being negative and a 9% swing from highs to lows over a two-month basis.
“Tactically, a lower allocation to equities would be a prudent decision right now, but this should still be viewed in the context of one’s investment objective or goal. It is our view that over a three to five-year period, real returns are definitely achievable through equities, but given current risks to the risk-on party, exercising caution around your longer-term investment strategy would be a wise decision,” says Ruiters.
A number of investment specialists from Franklin Templeton Investments, Sarasin and BlackRock feel that international equities are lucrative investment options and that bonds from Europe and Asia will provide pockets of excellence for investors to look towards.
Editor’s Thoughts:
On the positive side, there will always be a demand for South African equities. Whether the inherent risk in the market will be short-term or long-term will largely depend on Eskom’s ability to keep the lights on. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts [email protected].
