Uncertainty continues to dominate global markets – think Trump as US president, the Brexit process gaining momentum and potentially high-stakes elections in Europe. On the local front, the ANC leadership succession battle is starting to heat up. Investors may be forgiven for feeling jittery going into 2017. While I do believe our nerves will continue to be sorely tested, I’m more optimistic about investment prospects for the year ahead compared to those of 2016 – especially looking beyond the daily ‘noise’ at the crucial considerations of price, perspective and pattern.
Investors faced with unpredictable events or negative news flow are always tempted to consider changes in asset allocation. In our view, however, it’s more important to look at prices or valuations across asset classes, interpret the macro-economic environment or perspective, and ultimately formulate an opinion of the current price patterns across asset classes. With this approach in mind, I believe we should see better nominal overall investment performance in the year ahead.
At the start of 2016, we witnessed a considerable amount of negative sentiment as investors grappled with the fallout from Nenegate. This shock event, the reverberations of which were felt throughout the market, resulted in the mispricing of certain assets, including our own fragile currency. Over the past year, the rand has strengthened considerably against most currencies, including the US dollar – albeit off a low base –and has started 2017 on a much firmer footing.
From a macro-economic perspective, we expect the global economic recovery to continue this year. Most economists have revised their global growth outlook upwards over the last quarter, and in response, analysts have started to revisit their expectations of company profitability and growth.
My optimism for the year ahead stems mainly from a valuation perspective, however – to my mind, the price of local equities is looking much more attractive than a year ago. Over the past three years, our equity market has moved largely sideways and delivered lacklustre returns – the total return for the market last year was 2.6%. Prices now look far more interesting – there are real opportunities to buy attractively priced assets and sell expensive ones.
In terms of global equities, I’m less optimistic about US equities from a price perspective. Although we’ve witnessed a decent recovery in US equity prices, we’ve yet to see a recovery in earnings. We need to see positive earnings surprises in the US to justify the current overall valuation of US listed shares. The US market has overemphasised the potential positives of the Trump presidency, including his proposed relaxation of fiscal policy – which will stimulate economic growth and therefore also boost company earnings – as well as tax cuts and infrastructure spend.
The quid pro quo is, of course, the cost to the global economy. His isolationist trade policies and protectionist views remain a cause for concern. If Trump does implement policies reflecting his harshest protectionist rhetoric, it could present global macro-economic headwinds. However, the markets have until now decided to ignore this possibility, and may continue to do so over the short term.
My concern is that if market hopes of economic growth as a result of Trump’s election and concomitant increased company earnings don’t materialise, we may well find later in the year that markets will start to focus on high valuations and that cheap prices will come under pressure. In our portfolios, we therefore currently hold an underweight position in US equities, preferring cheaper – albeit somewhat unpopular – options such as emerging markets and European equities, as well as the financial sector in general.
Outlook for bonds
Looking at global bonds, it’s important to understand that after the financial crisis of 2008 and 2009, we had a lengthy period during which interest rates were abnormally low. In December last year we saw the first hike in interest rates in the US, and long-dated government bonds kicked up significantly in response. To my mind, real yields remain unattractive. Although our call last year that the global bond market looks vulnerable didn’t play out over the first nine months, our view was certainly vindicated in the last three months of 2016, and the trend is continuing. So we’ll continue to exercise extreme caution as far as global bonds are concerned – it’s hard to see inspiring returns from this asset class internationally.
The local bond market on the other hand continues to show value. This was also our view at the start of 2016, and indeed it was the best-performing asset class for the year – the ALBI Index returned 15%. This trend is likely to continue during 2017 despite the well-documented risks for the asset class.
On the property front
Property is not currently an exciting asset class. From an operational perspective, I believe in the current economic environment it’ll be tough for local property companies to grow distribution by more than 7 or 8% this year, and vacancy rates remain high. Also, several locally listed property companies have significant exposure in the UK, and as the Brexit process gets under way, investor sentiment may well turn against UK property.
In a nutshell
In conclusion, our earlier misgivings in terms of local equities have given way to cautious optimism, and we’re likely to increase exposure to this asset class in our balanced portfolios. We continue to have a decent allocation of the bond market locally, but not offshore. A stronger currency would encourage us to reconsider offshore investment more favourably – up to the 25% limit on international assets set by Regulation 28 of the Pension Funds Act.
It’s important to remember that asset allocation is longer term in nature – and this is what our philosophy at SPW dictates. Macro-uncertainties, especially political uncertainties in South Africa, will continue to impact investor sentiment over the short term, which will in turn have an effect on price. Over time, the market will always correct itself and patient investors and clients will reap the rewards of a longer-term investment approach.