Investment Environment August 2014

22.09.14

As stated at the end of May, we were concerned about equity valuations and a possible asset bubble developing. This has proved wrong as the South African market in the last quarter continued to rally and hit new highs as shown in the graph.

We continue to remain cautious on South African equities and find it difficult to apply new money at these levels.  We do however feel it appropriate to maintain our equity exposure and lighten on a selective basis where we feel valuations have become stretched or are fully priced.

The international picture looks a little different.  US GDP grew 4.2% in Qtr2 this year and corporate America is growing earnings in the mid teens and is in good shape.  European GDP stagnated in Qtr2 and corporate Europe grew earnings but at a slower pace than their US counterparts.  US equity valuations remain high relative to historic norms and European equities are less expensive offering more value.  We remain concerned that an “asset bubble” has developed which may correct when US interest rates start to rise – expected to be sometime in 2015. Our cautious forward looking view is supported by:

  • The rise in equity risk premiums  as investors demand more safety for holding such assets;
  • Draghi is embarking on the Eurozone’s own form of quantitative easing to stimulate growth and avoid deflation. The banking system is already flooded with almost €1 trillion in excess liquidity and the ECB’s regular money market operations allow banks to borrow an unlimited amount of further funds at zero interest rates. In simple terms it would appear the ECB is "pushing on string!"; and
  • Rising geopolitical tensions, which appear to be beyond any government’s control.  Despite the US’ valiant efforts to "degrade and destroy" ISIS and curb Putin's march on the Ukraine these international threats persist. There is no telling what economic effect such threats could cause, but in the long run they cannot be good as war is expensive and unproductive. Although peaceful, the Scottish quest for independence also brings its own uncertainties to both Sterling and the Euro.

Uncertainty is never good for markets!

As of 6 August, South Africa has had its own specific problems as the unsecured lender African Bank (ABIL) approached shareholders for a further R8.5 billion bail out (this is subsequent to a R6 billion bail out earlier this year). Fortunately the Reserve Bank’s quick and decisive action prevented the systemic risk but many equity and debt investors have felt the consequence of the consumer vulnerability that was exhibited in the ABIL collapse. 

A good measure of consumer indebtedness and their ability to service debt (capital and interest) is the ratio of household debt to disposal income.  When viewed against Prime over the past 10 years it provides for an interesting picture - see graph.  

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