Global market sailing in calmer waters
Global investment markets have not changed significantly since last month’s newsletter as the result of the economic environment having remained stable. The WTI oil price declined only marginally from US$ 49.80 to US$ 48.9.
In Rand terms it increased slightly from R 581 to R 593. The Rand weakened slightly from US$ 11.68 to US$ 12.14, while global interest rates remained unchanged. Is this the calm before the storm and is there any need for the investor to adjust his investment strategy?
As the result of the strengthening of the US$ against most global currencies, the expansion of the US economy has lost some steam, expanding at only 2.2% over the third quarter of 2014, as opposed to 5% over the 3rd quarter. Graph 1 depicts this trend.
Conversely, the weakening of the Euro has aided the European economy, growing at 0.9% in 2014, compared to 0.5% in 2013, despite the negative impact of sanctions imposed on Russia in the earlier part of 2014.
US inflation, another key economic indicator for the determination of the US repo rate, besides the state of the economy, shows no clear trend despite an upturn since the beginning of the year as depicted by Graph 2.
Based on these parameters, it seems that the US economy is not ‘ripe’ yet for an increase in the repo rate, there being neither a clear indication of a sustainable expansion of the economy nor of clear upward trend of inflation. Following the weekly utterance of the various US reserve bank governors, their views consistently alternate between an increase in the repo rate and maintaining the status quo. Foreign investors seem to believe in an increase in the repo rate in the not too distant future, having withdrawn R6 billion from the SA equity market and R 7 billion from the SA fixed interest market over the 12 months to end of March 2015.
The fact that any government would want its economy to expand is evident, as it should lead to an improvement in the employment rate and an improvement in the tax base that funds government. Inflation, typically not perceived as positive by the consumer, does present the benefit to the government of improving the net wealth through the appreciation of asset values while debt remains unchanged, and it raises the income levels of consumers and hence the tax revenue for the government. The US government does have a debt problem following the quantitative easing program that was aimed at getting the US economy back onto the growth path after the financial crisis in 2008.
An effective means of growing the economy is a weak exchange rate. As pointed out above, however, the US Dollar has actually strengthened gradually against most currencies of its main trading partners, which no doubt has put a damper on the economy as depicted in graph 6.1. Whereas the repo rate is typically employed by monetary authorities to manipulate the currency, as low as the US repo rate currently is, it cannot serve this purpose anymore
So where to from here for the US under these circumstances? It would seem that the only alternative is to weather the period of quantitative easing currently being employed in the Eurozone and Japan. This means that we will see no major changes in monetary policy probably until early to middle of 2016. To ease over –indebted developed countries out of their debt problem, any evolving economic growth is likely to be retarded by a simultaneous increase in interest rates. This scenario would mean that we will move into a cycle of increasing interest rates and slow economic growth and gradually increasing inflation. As a result equity markets are likely to experience only pedestrian performance for years to come.
On this basis we do not expect any major swings in investment market for the next 2 years plus, given no political upheavals impacting investment markets.
Our investment view remains unchanged
In this phase of economic adjustment the local investor should invest in equity and property in preference to fixed interest assets, talking only about conventional asset classes. Stock picking should prove to make the difference in returns and will be a prerequisite for out-performance of a portfolio. Investors should forget about double digit annual return and focus on investing to out-perform inflation. With an inflation rate in the region of 4%, the investor should be comfortable with a return of between 45 and 10% p.a. over the next few years.
With the expected upswing in consumer sentiment over the next year or two, one should see the demand for consumer goods and hence commodities increasing again. A weakening Rand and a depressed local economy suggest that the investor should continue to diversify offshore.
An investment in depressed foreign economies and bourses should be biased towards the consumer while any investment in stocks on bourses already at high levels should focus on finding value rather than on any particular sector.
On the basis of fundamentals, local sectors and shares driven by foreign investors over the past few years, such as consumer goods and consumer services should now be switched for those shunned by them, primarily basic materials, financials and industrials. From a macro economic perspective the weakening Rand should advantage Rand hedge shares, exporters and manufacturers locally.