The current business cycle and its impact on our asset allocation calls
A six year bull market run following the 2008 global financial crisis has created uncertainty about whether you should still be investing your clients’ funds in local equities.
To answer this question, STANLIB uses an investment framework based on three primary pillars: the business cycle, intrinsic value and thematic overlays.
Our centralised research team – the largest in the country – uses this framework to inform our tactical asset allocation calls. We work with our specialist investment Franchises to understand how the issues of the day influence global markets and what effect this could have on your clients’ investments. In understanding the world, we are better able to unlock investment opportunities.
In this article, I look at how the current business cycle is shaping our investment outlook.
Business cycle trends
• Quantitative easing : The macro-economic environment remains challenging. While the US economy is recovering, growth in the rest of the world is slowing down. The US has stopped its quantitative easing programme, while Europe introduced their own version - but it is expected to have a limited impact given the Eurozone’s challenges.
• The price of oil : The oil price’s rapid fall (albeit modest recovery) is deflationary. This may be problematic in the short term for economies with low levels of inflation. But we believe a sustained low oil price will stimulate consumer demand and, in turn, inflation over time. However, the market is ignoring these positives at the moment.
• US interest rates : The market is closely monitoring when the US Federal Reserve will hike rates. We are concerned that a small hike in rates could affect the markets. Our research into the impact of even a small hike shows two possible scenarios. In the first scenario, there will be little impact on the market due to interest rate hikes.
The second scenario, in which we envisage volatile and weaker markets in response to a rate hike, is a bit more alarming. This could see bonds overvalued and equity markets fully valued, while capital would be more expensive, which would negatively affect asset classes.
• Weakening SA economy and limited growth : In the medium term, we expect SA’s economic growth outlook to remain muted. This is due to a combination of factors including increasing taxes, limited government spending as a result of constrained finances, increased borrowing costs as interest rates rise, and depressed capital investment from the public and private sector.
When this is combined with a challenging global environment, we expect companies to struggle with growth so stock market returns will be lower.
Our bond market is largely driven by offshore flows, which are being diverted to developed countries as they start to look more attractive to international investors. This is aggravated by the weakening rand. Listed property is highly correlated with the fate of the bond market, while macroeconomic headwinds are likely to negatively affect rental income growth.
• Outlook on equities : In these tough conditions, it is difficult to see any of the domestic asset classes “shoot the lights out”. We have been advocating caution when it comes to the local equity market for over a year.
The local equity, bond and property markets are not attractive in our view, given the global local risks we face, coupled with no valuation support in these three asset classes to offset our negative view.
Cash is therefore our default holding in South Africa, as we await a better entry point into the local asset classes.
However, we believe all investors should have some equity exposure in their portfolio, and a Balanced/Multi-Asset Fund is an ideal way to provide them with exposure to multiple asset classes within a single fund.
An Absolute Plus portfolio is also a valid alternative for clients in this type of market environment. It exposes them to the market – the managers asset allocate between various asset classes, including equities – while protecting them against the downside.
