Investing in a post-recession environment

Dr Simon Pearse, CEO of Marriott Asset Management, warns that investors may be in for a long haul

With South Africa having technically emerged from a recession, we note that on average, investors have not achieved positive real returns over the past 3 years, particularly when factoring in tax on cash, property and bond income streams. Inflation has averaged 8.4%pa and cash has produced the highest average return at 10.1%pa. Bonds, property and equity have averaged 9.6%pa, 8.8%pa and 6.3%pa respectively. An obvious question is which asset class will produce the best returns over the next three years.

Of concern is inflation remaining above 7% on average, while asset class yields are currently low at 2.2% from equity, 8% from property and 9% from bonds. These factors do not bode well for improved real returns in the years ahead. The key driver to produce positive real returns will be dividend growth, an elusive commodity at this time in the economic/business cycle. The following two paragraphs explain why dividend growth may be difficult to achieve in a post-recession environment:

It has been 17 years since the last recession. South Africa’s extraordinary economic success since 1994 may be attributed to the following:

1. The lifting of sanctions thus facilitating participation in world markets.
2. The steady reduction in borrowing rates from 20% levels in the late 1990’s to currently around 10% thus increasing consumption and consumption taxes.
3. China’s extraordinary economic growth and the resultant commodity boom.

The result of this has been massive consumption expenditure, double digit corporate earnings growth, an unprecedented increase in personal debt, and government budget surpluses. Recession, unknown to a generation of South Africans, means a new experience for so many consumers, asset managers, even leaders of industry. This increases the risk of expected outcomes.

A Reinhart and Rogoff paper (January 2009) showed that the aftermath of a financial crisis and consequent recession sees the following average peak-to-trough market moves:

1. Real house prices decline an average of 35% over 6 years
2. Equity prices decline an average of 55% over 3 to 4 years
3. The unemployment rate rises an average of 7% over 4 to 5 years
4. Output falls by 9% on average over roughly 2 years before recovering
5. The real value of government debt tends to explode, rising on average by 86% and is predominantly attributed to the collapse in tax revenues combined with over ambitious countercyclical fiscal policies aimed at mitigating the downturn.

The past year cost South Africa 870 000 jobs. Tax revenues are down by 10% resulting in a fiscal deficit of R177bn. Government debt has increased to 28% of GDP and is expected to exceed to 40% of GDP by 2013. The Government in its budget review expects corporate earnings to decline in real terms by 4%. Household debt has not declined and consumer spending remains subdued with December retail sales 3% down on last year.

The recovery from recession may take longer than is generally expected and investors should err on the conservative when anticipating levels of return from the various asset classes. Bear in mind that the current dividend yield combined with the expected growth in dividends will be the driver for returns.