International lifelines as local equities nosedive
South Africa has had a very tough year economically. Not only is it coming to terms with an increasing public wage bill, it also had to deal with the fact that the rest of the world (with the exception of Greece and Brazil) are recovering nicely from their economic slumps. This has meant bad news for the Rand as it continues it’s nose-dive towards depreciation.
What does this mean for fund managers? Well, besides being named the next Springbok coach, fund managers arguably have the hardest jobs around in the current economic environment with alpha being very difficult to come by.
The Chinese linchpin
For many years, China was the pin that was passed through the end of the axle to keep the South African economic wheel in position. While China was pushing ahead with its infrastructure build programme, South Africa was a happy supplier of commodities to necessitate this.
But all good things must come to an end. China is now looking at life beyond its infrastructure build programme and wants to become a consumer based economy.
Old Mutual Conservative Fund Manager, John Orford, believes that the ongoing transition in China from investment-led fast growth to slower consumption-led growth will have ongoing implications for investors well into next year.
“We remain cautious on the outlook for commodities and emerging markets as a result, and in our view exposure to the Chinese consumer is preferable to commodity-linked exposure to China,” he explains. “For example, Naspers, via its holding in Tencent offers investors exposure to the rapidly growing internet services in China and remains a core holding in our portfolios.”
The developed market march
Things seem to be looking up in developed markets. The Fed in the US is looking to increase its rates; which is an indication that the US economy is gaining traction. There is a similar outlook for the British economy.
Turning to developed markets, Orford explained his global growth and inflation outlook and what this will mean for monetary policy, currencies and investments.
“While the Federal Reserve Bank is likely to gradually increase interest rates over the next year, the European Central Bank and Band of Japan are likely to continue providing stimulus in the form of Quantitative Easing (QE) to their economies,”
“Therefore, overall global monetary policy will remain very easy and, provided the world economy does not experience a growth shock, this should provide a reasonable backdrop for global equities. In this context global equities remain our preferred asset class on a risk-adjusted basis, with developed markets more attractive than emerging markets. However, he emphasised that diverging macro trends would continue to drive divergence in returns between and within different asset classes in 2016.”
Local troubles
Considering South Africa’s weak growth environment, Orford pointed out that profits for South African companies, particularly those exposed to commodities and to the local economy, are likely to be under pressure.
“Local companies with successful global growth drivers which are underpinned by reasonable valuations such as financials are where the opportunity lies,” he says.
He adds that while Old Mutual Investments expects most asset classes to deliver lower than historic real returns, South African government bonds currently trade on relatively high real yields compared to their long run average real yield.
“Bond yields should be supported by a weak growth outlook and the South African Reserve Bank, which has demonstrated its commitment to inflation targeting. However, the threat of a ratings downgrade, should Treasury fail to deliver fiscal prudence, is a risk overshadowing the asset class.”
The great balancing act
What does this all mean for the South African public? For starters, it means that the budget is going to be more of a fine balancing act than ever.
It also means that the current account deficit will widen, which will lead to a ratings downgrade by rating agencies. We are teetering on the brink of junk status, and we could well see ourselves downgraded to that territory by Easter next year.
To overcome this, wasteful expenditure by government needs to be contained. In a separate - but not unrelated – issue, the public wage bill is getting close to unsustainable. In a briefing to the public, Dawie Roodt, Chief Economist: Efficient Group, pointed out that Finance Minister Nhlanhla Nene has already tapped into cash reserves which are meant to fund public wage increases in 2017 and 2018 to resolve the current impasse.
Editor’s Thoughts:
It seems as if the stormy seas that economists have been warning about over the past few years have finally arrived. With a certain portion of investments required to be held locally, where will fund managers turn to find local alpha? Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts [email protected].
