Stock-picking, offshore exposure key to investment outperformance

With asset class returns expected to remain muted, investors looking for inflation-beating returns are likely to find that stock-picking and offshore exposure will be key to outperformance.

Commenting in his economic report for the first quarter of 2013, Francois van der Merwe, Head of Macro Research at Novare Investments, said that while many of the risks had diminished, the global economic outlook remained uncertain.

“A string of data over the last few weeks has brought the stronger recovery into question, and renewed fears of a Northern hemisphere economic slowdown during the middle of the year, as experienced over the last two years.

“In the US, the housing market recovery has surprised by its strength and should continue to be a tailwind to the recovery, with consumer spending aided by the wealth effect caused by higher home prices and rising investment values. In addition, household balance sheets are in much better shape after years of deleveraging.

“Ultimately, however, it is the US Fed’s open-ended commitment to keep ultra-accommodative monetary policy in place that will support the economic recovery. Even Japanese authorities have come to the realisation that extra-ordinary measures are needed to stimulate their economy.”

Van der Merwe said the continued slow growth environment and lack of global inflationary pressures would see central banks maintain accommodative monetary policies, keeping their liquidity taps open. This should support asset class rotation with investors moving away from low yielding bonds into equities.

“The recent rally in international equity prices means that valuations are no longer cheap, but they are also not overly expensive, enjoying support from accommodative monetary policy and a progressive improvement in economic conditions. Company earnings growth expectations have discounted weaker conditions and actual earnings have the potential to surprise on the upside. Investors should, however, not expect a repeat of the strong returns equity markets achieved over the last 12 months,” he added.

On a relative basis, equities should outperform global government bonds that are trading near historically low yield levels.

Van der Merwe said that the South African situation was worrying. Poor growth prospects, uncertain labour market conditions, and the wide current account deficit are risk factors, as is a global slump that would dent demand for exports.

“The demand side of the economy looks set to continue losing steam as household consumption is negatively influenced by higher energy costs, stabilising wage growth and falling employment growth. There are also signs that credit providers are beginning to tighten lending standards. Inflation risks will remain and will be dependent on pass-through effects from the weaker currency.”

On domestic equities, van der Merwe said company earnings growth had tumbled despite the equity market’s recent advance, pushing valuation levels into expensive territory. “Consensus earnings expectations for the next 12 months also seem overly optimistic given the weak economic backdrop and pressure on consumer spending.

“Despite having benefitted from foreign interest, we believe current bond valuations are unsustainable given the deteriorated fundamentals. Investors might consider taking an overweight position with regard to international assets to take advantage of potential rand weakness.”