Tilman Friedrich’s Benchmarks May /June 2014
While the fortunes of local equity markets improved nicely over the past 3 months, within equities there was a major turnaround in fortunes between different sectors and the fortunes of Listed Property from 3 months ago
Comparing various indicators of 3 months ago with the latest indicators over a 3 month period in each case, Listed Property was the worst performing asset class (-10%) while it is now the top performing asset class (15.4%). Top performing asset class previously was Bonds (1.5%), while it is now the worst performing asset class after cash (4.1%). Equities previously returned -0.6% compared to 9.6% for the latest 3 month period.
Within the various economic sectors of equities, Basic Materials was the top performing sector (4.9%) while it is now a ‘middle of the road’ performing sector (7%). Worst performing economic sector previously was Technology (-9.8%). It remained in that position the last 3 months (-6.1%). Top performing economic sector this time is Financials (18.5%), which was previously one of the worst performing sectors (-7.1%).
Within the various equity sectors, Banks (22.4%) and Food and Drug Retailers (19.4%) are the two top performing sectors, while in January 2014 Food and Drug Retailers was the worst performing sector (-16%), Banks occupying third lowest position (11.2%).
As far as global interest rates are concerned, 10 year bonds rates generally reduced marginally over the past 3 months. Over the 3 months to end January 2014, foreign 10 year bond rates had moved up marginally, while the SA rate had moved up noticeably from 7.67% to 8.79%.
Looking at foreign equities, in US$, developed market equities as measured by the MSCI returned 0.2% while emerging market equities as measured by the MSCI returned -9.2% for the 3 month period to 31 January 2014. For the 3 months ended 30 April 2014, developed market equities returned 6.4% compared to 6.9% of emerging market equities.
So while the fortunes of local equity markets improved nicely over the past 3 months, within equities there was a major turnaround in fortunes between different sectors and the fortunes of Listed Property from 3 months ago.
From 3 months ago where the Rand depreciated by 10.9% over 3 months, it has appreciated by 5.5% over the past 3 months. This was largely the result of foreigners moving back into local investment markets – the SA trade balance not having changed much over these two 3 month periods producing a negative trade balance of around R 30 billion over both periods. Over the past 3 months foreign portfolio flows into equities and bonds amounted to R 42.5 billion compared to an outflow of R 61.7 billion over the 3 months to end of January 2014.
As we commented in the previous newsletter, the uncertainty in global investment markets as a consequence of the policy of the US Federal Reserve has subsided and it is now ‘back to business’ for the global investor community. The result of the turnaround in investor sentiment has evidently also resulted in the turnaround of fortunes of the various portfolio managers as depicted in the 3 month performance ranking graph.
The question now is whether the past 3 months are an indicator of what to expect over the next 12 to 36 months? Will we see the Rand strengthening further and interest rates declining as the result of foreign investment flows, inflation declining and equities continuing to steam ahead?
At this stage, signs are that the US economy is ever so slowly starting to improve, while Europe and China still show little signs of an improvement in their economies. Capital is still pumped into the financial system, less so by the US Fed, but more so by the ECB and the Bank of Japan. The outcome of this colossal first time experiment in monetary policy intervention is difficult to foresee.
The more risk averse investor will remain cautious given the distortion prevailing in global investment markets, while the less risk averse investor will believe that the outcome of the monetary policy intervention will be positive and will invest aggressively in equities.
Our view is that financial markets will have to normalize. What investor in his right mind will accept a negative real interest rate on his fixed interest investment other than under duress? So what is forcing investors to accept negative real interest rates? This is largely the result of the ‘save haven’ notion of investing in the US, for one, occasioned by its economic and military power but also because of the fact that global trade is mostly denominated in US Dollar.
This status of the US will not change soon although nature dictates that those on the receiving end of continuous pressure will not rest until they have found a way to evade and to overcome the pressure. In the mean time, one will have to work with the realities. These are that interest rates will remain very low to negative for some time, as the result of which investment capital will continue to flow into other asset classes and into developing countries, in search for yield.
At current debt levels an increase in interest levels by 1%, would require the US economy to grow at 4% per annum over 8 years or at 3% per annum over 11 years, for the US government to absorb the interest rate increase without it impacting negatively on its fiscal position. An increase in inflation will of course also achieve the result of the economy growing, if at nominal values only. This should give a fair indication of the time frame over which and the pace at which interest rates in real terms, may drift upwards in the US.
Accepting that the US will ‘call the shots’ we are thus also likely to see low real interest rates locally for some time to come. This will support the Rand and equities.
An analysis of the S&P 500 versus the JSE Allshare indices in our previous newsletter concluded that SA and US company earnings are 8% and 50%, respectively, above their 26 year trend line. Despite high earnings, South African and US equities are priced at 30% and 8%, respectively, above their 26 year trend line.
On that basis, both the South African and the US equity markets are in risky territory. The likelihood of profits and valuations declining to normal levels is substantial, more so in the US than in SA though. These markets are clearly powered by monetary policy measures of central banks and this will be the case for some time.
In the light of the above analysis, equities remain the asset class to be overweight globally. Offshore diversification spreads investment risk and the current exchange rate offers the opportunity to do so. As consumer demand in the developed world starts to gain traction slowly, we should see consumers in developed economies starting to borrow to spend again. In developed markets offshore this should benefit the consumer sectors, and the financial sectors. Locally, the consumer sectors had a terrific run over the past couple of years. We believe there is not much room for these sectors to move higher and favour the financial and the industrial sectors relative to the consumer goods and services and basic materials sectors.
Download the complete Benchtest fund investment overview for March 2014 at http://www.rfsol.com.na/benchmark