What surprises are in store in 2011?

The famous US baseball player “Yogi” Berra once said, “It’s tough making predictions, especially about the future.” Hopefully we can all identify with Yogi’s somewhat contorted logic.

Forecasts on very short-term outcomes such as, ‘I will be alive to see this article’s completion in an hour’s time’ are usually high-probability forecasts. Being in good health and safely in my peaceful Durbanville office, I would guess there is a reasonably high probability that I will live for the next 60 minutes.

Conversely, predicting what the rand/US dollar exchange rate, CPI or the JSE index level will be by 31 December 2011 are less certain forecasts of a much lower quality. This is so because as the time period and number of variables affecting a forecast increase, there is a greater quantum of hidden interrelationships and uncertainty.

As such, even an ex-ante prediction that turns out to be absolutely correct must be recognised as having a large element of luck attached to it. The corollary is obviously also true.

Why is it then that most of us start every January thinking and agonising about what investment opportunities and challenges the great unknown may cast our way during the next 12 months? Our clients want us to stick out our necks and make our best guess of what we will see occurring in various key economic indicators and asset classes. I suppose trying to pre-empt the future is part of human nature.

So, after thinking about what I believe are the most probable outcomes for the year, without further ado here is my 2011 outlook for your entertainment. These views need to be digested with all the scorn, health warnings and obvious disclaimers that should accompany such views.

1. Inflation – After a period of deflation followed by subdued inflation from 2008 to 2010, I believe 2011 and further into 2012 will be a period of early inflationary and later significant pressures beginning to build throughout the world. This inflation will be seen in rising industrial commodity, oil and food prices largely created by the massive monetary and fiscal stimulus observed in the developed world in the last two years.

The other consequence of central bank actions will be weaker developed-market currencies (US dollar, euro and British pound) relative to commodity-based currencies (Canadian dollar, Australian dollar, Brazilian real, SA rand). This means that the developed world will be importing some inflation into their local economies for the first time in many years.

To summarise, I expect global inflation rates to rise above current consensus, although only marginally at this stage.

2. Interest rates – The low short-term interest rate policies adopted in the developed world will remain in place for the year as central banks remain highly accommodative in the face of weak growth, uninspiring domestic demand, high debt to disposable income levels and fragile residential and commercial property markets.

Emerging markets and Tier 2 developed economies like Australia and Canada that avoided the excesses of the credit crisis will likely see the end of their lows in the interest rate cycle and may even see smallish increase in rates towards the latter part of the year and their economies moving closer to trend potential. Indeed India, Brazil, China and Israel have already experienced meaningful increases in their short rates and this trend will continue.

3. Commodities – In the face of an unofficial but obvious weaker US dollar policy in the US, coupled with the risk to the Eurozone and the euro as a result, commodities like precious metals, oil, certain industrial commodities, agricultural land and gem-quality diamonds will continue to appreciate on a relative basis, not necessarily for their utility but also their value-storing properties.

4. Currencies – For the reasons stated in 1, 2 and 3 above, I continue to prefer Canadian dollar, Australian dollar, Singapore dollar, Swiss franc, Brazilian real and SA rand to US dollar, euro, Japanese yen and British pound. I think the rand will continue to confound people and perhaps even strengthen off these heady levels relative to the US dollar, euro and British pound.

Of the two major currencies that South African investors usually look at, I would prefer the US dollar over the euro as it has the additional benefit of being the world’s reserve currency in the event of any black swans paying us an unheralded visit.

5. Bonds – SA bonds may experience small capital losses as yields drift outward marginally, but will still offer attractive yields relative to global bonds, especially if the global investor thinks the South African rand will remain roughly stable in 2011. It should be an unexciting but positive real return year for SA bonds.

Global developed-market bonds look risky and susceptible to rising yields, especially in the Eurozone periphery. Best-quality corporate bonds and mid-duration government bonds in the US, Germany and UK are probably the safest bets. Emerging-market bonds with less onerous funding requirements, better national balance sheets and growth prospects remain the preferred global bond holdings.

6. Property – SA listed property will mimic the SA bond market to a large extent. Rental growth for the next year will moderate and vacancy levels will probably not increase markedly, meaning that distribution growth will remain similar to that of 2010. At the same time capitalisation rates may move out a bit with bond yields causing small capital losses. Accordingly we would expect small positive real returns in the region of 3% to 4% from this asset class.

7. Equities – As a general comment, equities at an overall index level, in almost all markets are not cheap. They have traded at above-average historical earnings multiples since the bottom of the credit crisis and the strong recovery in corporate earnings has lifted prices simultaneously, meaning valuations have not improved perceptibly.

Dividend yields are well below long-term averages. In addition, the 2010 run has left the market overbought after some strong momentum. Not exactly compelling stuff if you are an equity investor. But that is not to say there aren’t some companies looking very well priced. Given very low cash yields and low to negative real cash yields, money will find its way into equities.

In South Africa financials offer better relative value than industrials, while in the global context some of the big global brands like BP, Johnson and Johnson and IBM look attractive. I would expect equity volatility to increase from the low levels observed in 2010 and low single-digit positive real returns from equities but with some capital risk in the short run.

So there you have it. Obviously, if unforeseen circumstances arise which have the potential to change the lie of the land in a significant way, these forecasts will be even more meaningless than they already are.

Yogi was also famous for saying, “If you don't know where you are going, you will wind up somewhere else.” So I hope this brief roadmap of my investment opinions will help to take you to where you want to be in 2011. Enjoy the year and happy investing.