In South Africa, our final demand growth remains disappointing, while the marginal rate of return on fixed investment remains too low to encourage robust private business investment.
South African growth for 2015 is also expected to remain mediocre, averaging about 2% to 2.5% for the calendar year. Reasons for this include:
• a challenging labour environment/poor labour productivity;
• extension of credit to the private sector remains weak;
• electricity disruptions continue to hold back the economy; and
• moderate global trade activity.
A strengthening case
If we add to this that our local equity market is valued fairly richly at a trailing price to earnings ratio (P/E) of almost 20, then the case for diversifying offshore starts gathering momentum.
We are seeing the United States continuing to show moderate recovery growth, and the United States equity market is even showing a slightly lower trailing P/E when compared to the South African equity market. With Quantitative Easing (QE) kicking into first gear in the EU and European unemployment moving in the right direction, things are looking a lot more positive for Europe as well.
As always, currency plays a major role for South Africans when investing offshore. If we assume the local currency will depreciate in line with inflation differentials in the long-run, then the South African Rand is currently undervalued against the US Dollar.
It is, however, notoriously difficult to get calls on the Rand right or to come anywhere close to timing the best moment to take Rands offshore.
Where to turn?
Our preference is currently for equities, even though they are generally expensive with regards to historic measures. The dominant theme offshore remains the low interest rate environment which is fundamentally constructive for equities.
European companies are starting to show earnings recovery, and United States earnings growth expectations are expected to pick up, especially in Q4 of 2015. European exporters are also positioned nicely to benefit from the weaker Euro as the European Central Bank (ECB) continues buying up bonds.
Felling lonely Mr Bond?
On the fixed income or bond side, offshore interest rates may go higher in the United States later this year, but only if growth and/or inflation picks up.
Interest rates and bond yields are priced for a gradual move higher by forecasters in United States and the United Kingdom. This would have a negative effect on bond prices. The ECB’s bond buying programme will continue to supress bond yields in Europe. Gilts and US Treasuries remain relatively cheap when compared to their counterparts in Europe, and can provide a safe haven in uncertain markets.
We have a preference for a more balanced allocation to high quality corporates and tactical government bonds in fixed income for the coming months. However as an asset class, we remain underweight offshore bonds. By buying offshore bonds at current yields, one is very susceptible to any future rises in interest rates or inflation.
Property risk
A de-rating for property offshore remains a big risk, so we need to be very cautious of the sector. The segment remains very much fractured with pockets of value being quite widely distributed and fragmented. We remain neutral on offshore property, but the picking of quality will be imperative.
Cash rates remain at historically low levels in the Unites States, the United Kingdom and Europe. We see cash as a temporary vehicle at the moment, and a way to provide optionality. We are underweight cash offshore for the time being.
Investing offshore remains a good idea for most investors. South Africa’s equity and bond markets make up a tiny portion of global equity and bond markets, so investing offshore can give one exposure to investments that you may not be able to access locally. It is also a way to hedge potential currency, political and economic risk.
Get the latest issue of FAnews