Offshore equities trump local stocks on a five year view
Five years have passed since the December 2007 sub-prime collapse triggered global financial market contagion. And it is three years since global equity markets “bottomed” in March 2009. Since its 21 March 2009 low of 18121 points the JSE All Share index
Stock markets are largely driven by investor sentiment. When investors and asset managers feel positive about global economic prospects, they buy shares. When they feel negative, they sit on the sidelines, with their assets tucked away in so-called “safe haven” fixed income opportunities. As we near the halfway point of 2012 the news flows from the developed world remain mixed. Each bit of good news is immediately countered by something bad! This explains why the JSE All Share has traded sideways since January this year. We cannot break through 34500 points on the up side, while strong buying action has set a “floor” at around 33400. The major obstacle to reaching new market highs is the sorry state of the world’s developed economies.
Obstacles to an equity market party
There are numerous reasons for equity prices being stuck in the doldrums despite offering fair value. The first of these is the negative news coverage the markets are getting. Not a day goes buy without some speculation over the future of the Euro-zone and its constituent economies. We have dealt with sovereign debt concerns, country defaults, radical austerity measures, political change and renewed popular resistance to the very measures designed to resolve the region’s problems. Although some economists argue that Germany can carry the entire region on its own, they have no way of predicting the impact of Greece existing the Euro-zone block. And Klopper observed that Greece’s exit could happen sooner rather than later.
“The impact [of the global financial contagion] on Greece has gone beyond financial,” he said. “Industrial production in that country has declined by 30% over the past three years – and now politicians are asking the people to tighten their belts further!” It will also be difficult for many of the smaller European economies to power out of this “new” recession. Spain – for example – is sitting with an overall unemployment rate nearing 25% and youth unemployment around 55%. It is difficult to introduce the austerity measures required to repair a country’s finances without removing social benefits – and it is near impossible to cut these benefits without triggering some form of social uprising.
The upheaval throughout Europe will push the region into a second round of recession. In fact most of the economies are already in the red, with economists waiting for GDP growth statistics to confirm the regression. There is little doubt that European markets – and markets worldwide – are pricing in this negative outlook. Another stumbling block to positive economic sentiment is the ongoing threat posed by Iran and its desire to develop a nuclear weapons capacity. Oil prices reached post-recession highs of some $125/barrel recently as fears over fresh Middle East disruption multiplied. South Africans know the affect of higher oil all too well, with the price of petrol breaching R12/litre for certain grades recently. There are hopes the oil price could slip back by around $20/dollar per barrel as tensions abate.
Reasons to be thankful...
Given the shocking situation in Europe one might expect global markets to be in freefall. The good news is there are many factors underpinning equities in both the developed and emerging markets. Global equities received massive support thanks to the record amounts of liquidity injected into financial markets by governments worldwide. The US led the way with two massive rounds of Quantitative Easing. Poor yields on government bonds (1.8% in the US and 1.6% in Germany) have also forced investors into higher-yielding asset classes.
“Corporate profit is growing strongly as companies convert their post-recession balance sheet strength (thanks to aggressive cost cutting) into bottom line profit on the back of higher turnovers,” said Klopper. He said that while the macroeconomic outlook remained bleak there was plenty of unreported “good news” to drive global markets forward. Top of mind is the reversion of US employment numbers to pre-crisis levels. Although the 8.1% unemployment is not historically low, those in employment are more confident today than five years ago. “People are prepared to spend again – feeling less threatened about losing their jobs – and more confident to splurge on expensive durable goods,” he said. Low interest rates – in the US and South Africa – will ensure that consumers remain upbeat.
Another positive is the weak Euro. “The Euro is quite week and thus supporting European corporations that export to the rest of the world,” said Klopper. He referred to the impressive achievements by German-based multination, Volkswagen. The car manufacturer, with 94 plants worldwide, posted an impressive 14.7% increase in production through 2011. Sales performances from divisions such as VW passenger cars (+13%), Audi (+19%), Bentley (+36%), Lamborghini (+26%) and commercial vehicles (+21%) are largely attributed to growing demand from emerging markets. Despite the woes in its home market Volkswagen managed a 26% improvement in turnover, 93% surge in profit before tax and 11% increase in vehicles delivered in the three months to 31 March 2012. At €128/share and a price-to-earnings ratio of just 6.5 times, Klopper believes the company offers excellent value.
SA Inc turns to Australia for guidance
South Africa is stuck in a “muddle through” economic cycle at present, with GDP growth forecast in the low-3% range this year. Interest rates remain at 30-year lows but there is little chance of another rate cut due to inflation “fixing” above 6%. Most economists expect interest rates to remain at current levels into 2013. (They have been pushing out their estimates for the date of the next hike for some time). Klopper said the rand could follow the Australian dollar and trade weaker over the short-term. He also warned that poor PMI numbers from Australia were a leading indicator of softer economic growth in that region – a development that could impact on domestic growth too. Both South Africa and Australia rely heavily on commodity prices as underpins for their respective economies.
“Although commodity prices appeared “cheap” at the beginning of the year, they have fallen significantly since,” said Klopper. He expects the prices of larger locally-listed commodity companies such as BHP Billiton and Anglo American to recover soon, though the timing of this recovery is difficult to predict. Overall South African equities represent fair value at current levels. Local investors can look forward to 14% annual compound growth from offshore equities, 10% from local equities, 9% from bonds and 6% from offshore bonds over the next five years. It seems fund managers will give a “yes” to local equities and a “definite yes” to offshore equities when finalising their asset allocation strategies.
Editor’s thoughts: South African investors find it difficult to move their investment capital offshore. Those who entered the US market a decade ago – based on the S&P 500 performance since – have lost around 24% (in rand terms) of their capital. Are you confident in asset manager and economist predictions of strong returns from offshore investments over the next five to 10 years? Add your comment below, or send it to gareth@fanews.co.za
Comments