With commodity prices bearing the brunt of China’s slowing growth and a struggling South African economy putting SA companies’ profits under pressure, the sources of returns we’ve seen over recent years in the SA market, have all but dried up.
This is according to Old Mutual Investment Group’s fourth quarterly investment update for 2015, where its presenters highlighted that, given the current global environment, developed markets, in particular European equities, will offer the best source of returns in 2016, and that investors should expect lower returns considering the high returns seen over the past few years.
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.”
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 Bank of Japan are likely to continue providing stimulus in the form of Quantitative Easing (QE) to their economies,” he says. “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.
Considering SA’s weak growth environment, Orford pointed out that profits for SA companies, particularly those exposed to commodities and to the local economy, are likely to be under pressure. “SA companies with successful global growth drivers and that are underpinned by reasonable valuations such as financials are where the opportunity lies,” he says. “ “While we expect 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 SA 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.”
Looking at the local economy, Rian le Roux, Old Mutual Investment Group Chief Economist, says that growth is currently at a crawl, but a technical recession in SA has been avoided, despite GDP forecasts for 2015 and 2016 being slashed further.
“Inflation remains well contained, considering the weaker rand, with the SA Reserve Bank’s raising of the repo rate showing it views inflation risk as skewed to the upside,” continued Le Roux. “Fiscal date is looking reasonable so far this year, but concerns are mounting over 2016 data and beyond. The rand has further weakened, based on global and SA-specific concerns, and remains vulnerable to local and global developments, and the latest trade data highlights the difficulty of narrowing the Current Account deficit in an environment of falling commodity prices.”
On the whole Le Roux says that South Africa is facing a difficult and uncertain year ahead for 2016. “The global macro-economic environment isn’t very supportive for SA growth, and local policy tightening and structural headwinds remain in place.
“As such, we could be seeing significantly more political and social noise regarding policy reforms in 2016, as the pressure for growth-enhancing reforms is mounting relentlessly. The rand too remains in the firing line, considering the large Current Account deficit, commodity price risks, a difficult environment and risks to SA’s ratings,” he said.
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