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Six domestic uncertainties to rock equity returns in 2008

25 January 2008 Gareth Stokes

On Wednesday, 23 January 2007 we attended a presentation during which Professor Chris Harmse (chief economist at Dynamic Wealth) unpacked whether the local investment market would collapse in 2008. The timing could not be better, and the big market correc

But what investors fail to grasp is the narrowing of the range of returns. In 2004 property performed best with a return of 42.8% while cash was the laggard at 6.5%. In 2007, equities emerged top of the pile with 16.5% while bonds only managed 4.5%.

Since asset managers are invested in various combinations of these four asset classes, it makes sense their expected returns will shrink too. And that means investors will have to moderate their return expectations for 2008 and possible 2009 too.

Plenty of fodder for economic analysts

We don’t envy portfolio managers and economic analysts who are continually badgered to predict levels for various economic indicators up to 12 months in advance. There are always people asking what inflation will do, where interest rates will peak, how far the rand will fall, etc. To take a stab at answering these questions analysts need to guess at the outcome of a number of uncertain events. Harmse summarised these domestic uncertainties under six headings – politics, inflation, Reserve Bank policy, South Africa’s current account deficit, the rand and the looming skills and capacity shortages.

The domestic political situation is of great concern. And unfortunately the ANC Polokwane conference has not addressed this uncertainty. Because Zuma still has to answer a range of criminal charges in court, we can only guess who will replace Mbeki as president of South Africa in 2009. More uncertainty relates to the composition of the new ANC National Executive Committee. Check out today’s Stokes’ Stage to find out more about the worrying developments on that score. Inflation and the Reserve Bank’s response to it are obviously of major concern too. Right now it seems Mboweni is intent on cracking the interest rate whip at the smallest sign of inflationary pressure. And further rate hikes will certainly put the brakes on the country’s growth.

But the real challenge for South Africa in the years leading up to the 2010 Soccer Word Cup, we believe, will come from the last category mentioned. South Africa is currently in the grip of severe skills and capacity shortages. There is no better institution than Eskom to demonstrate the combined impact of these blights. South Africa no longer has the production capacity to keep industry (and ordinary citizens) supplied with electricity. At the same time Eskom is also struggling to recruit suitably skilled staff. Dirk Herman, a spokesperson for Solidarity recently told The Times that “Eskom’s human resources MD, Mpho Letlape, estimates that the group will require at least another 470 engineers, 700 technical staff, 90 quantity surveyors and 600 buyers over the five-years of its R84-billion expansion programme.” With engineers leaving South Africa in their droves, it is difficult to determine where workers with the necessary skills will be recruited.

International uncertainties to hit capital inflows hard

When we zoom in on the current account deficit we quickly notice that international uncertainties also impact the domestic market. As long as South Africa experiences huge capital inflows from yield-seeking offshore investors we will be comfortable with the deficit at its current high levels (around 9% of GDP at the end of 2007).


But we will face serious economic difficulties should uncertainty cause these investors to panic and take flight. Harmse believes there are a number of issues that will impact on the global investment environment in 2008. These include the possibility of a full blow recession in the US on the back of weaker housing prices and the infinitely discussed sub-prime credit issue. Recession in the US will force international investors to act more conservatively and move out of the perceived riskier emerging markets.

Similarly, oil could also be a problem. High oil prices (more than $100 per barrel) could increase inflation and interest rate pressures in the developed world, slowing growth and reducing the capital flow to emerging markets.

A good year – but get used to lower returns

The Dynamic Wealth house view for 2008 (based on September 2007 inputs to their macroeconomic model) predicts a 16.5% return from equities and property in the coming year. Cash at 9.8% (pre-tax) will just beat bonds which are forecast to deliver 8.8%.

The final word seems that markets will still deliver a positive inflation-beating return for 2008. And 2010 is not the ‘line in the sand’ that many analysts believe it to be. Government and private sector have infrastructure projects planned to 2014 and beyond.

Editor’s thoughts:
Global concerns over poor lending practices dominated the first few weeks of 2008 and resulted in a sell-off of shares on both developed and emerging markets. While battling to come to terms with the scale of their New Year stock market losses, South African investors have faced further trials at the hand of state electricity supplier Eskom. If solutions aren’t found quickly growth prospects for the next three years will be severely affected. What do you consider to be the biggest threat to the South African economy in 2008? Add you comment below, or send an email to gareth@fanews.co.za

Comments

Added by AB GELDENHUYS, 28 Jan 2008
ESKOM MUST CHANGE THEIR RECRIUTMENT SKILLS. THERE ARE MANY BRIGHT AND QUALIFIED YOUNG ENGINEERS THAT CAN BE USED BUT BECAUSE OF UNPRACTICAL AND POLITICAL RECRUITMENT RULES THEY MUST FIND WORK ELSEWHERE.MY NEIGHBOUR WORKS AT ESKOM IN A SENOIR POSITION BUT CANNOT FIND A POSITION FOR HIS HIGHLY QUALIFIED SON ( CUM LAUDE IN ENGINEERING ) THE SITUATION IS SERIOUS.CHANGE THE UNPRACTICAL RULES APPLIED!
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