Investment Environment May 2011


Change is difficult - Market Stress

The unfolding economic slowdown, which appears to be almost exactly the same situation as a year ago, puts markets under stress. Just like people (who drive markets), when things change markets find it difficult to adjust. It would appear that economic indicators have a reached a top and this, combined with the concerns of a removal of monetary stimulus and a possible central bank rate tightening, is expected to cause severe economic slowdown. Prophets of doom are again talking of a severe double dip recession. The situation is compounded with sovereign debt problems that generally seem to focus on Europe but the US is far from immune, and this questions whether economic recovery is sustainable. However, taking a reasonably long term view (>12 months) that economic expansion is occurring, abundant liquidity is in the system and reasonable valuations exist, then equities are an attractive asset.

May was not a good month for markets in general with most indices giving up at least half their gains for the year to date. However, without sounding over-optimistic, we believe there is an opportunity to build equity portfolios.









The above two graphs show, based on a history going back to 1988, the value demonstrated by a forward PE multiple of the MSCI (Morgan Stanley Capital International) indices for developed and emerging markets. Furthermore, if one compares the earnings yield (the inverse of PE) vs bond yields, these measures are indicating a widening gap (barring extremes). Both graphs pictorally show the value of equities compared historically and on a yield basis. What is important to note is the PE’s are on a forward basis and therefore should take into account the economic uncertainties referred to above. Equity yields in developed markets are even more compelling when one realises it is possible to buy some large cap equities that have a dividend yield significantly superior to cash (or bonds). Earnings yields are also the only return likely to outperform inflation in most countries.

Turning to South Africa, the GDP growth trends shown below reinforce the equity opportunity that exists in emerging markets generally.










The SA GDP growth rate continues to grow at a seaonally adjusted annual rate of 4.5 – 5% q-o-q. The graph also shows that the recssion of 2008/9 appears to be well behind us and that the trend of actual GDP value (shown in the red line) is very much intact. This key economic indicator is the all encompassing environment in which South African companies (equities) have to perform and it would appear to bode well for the future. Furthermore the potential of a weakening Rand, subdued interest rate environment for longer than is expected and strong demand for commodities should continue to support South African businesses. Implicit in this is JSE equities should be capable of continuing to grow their earnings and as the market is resource based, the Rand hedge and commodity underpin will also be positive.

Download Full Investment Environment Article (PDF, 114KB)