Investment Environment February 2013

20.03.13

2012 ended spectacularly for risk assets, which basically means equities. As we close off the South African financial year ending February 2013, questions are raised as to whether the 2012 performance can be maintained and if the recent highs, reached by various indices, will not be challenged by some correction?

Market commentators are finding it difficult to reconcile equity performance when it generally appears that economies are vulnerable. This was recently apparent where US political brinkmanship resulted in the Sequestration deadline passing and automatic spending cuts of US$85 billion being invoked before September this year. In Europe the Italian election political impasse has questioned economic policy. Furthermore, we have had an unprecedented event in Cyprus with the proposed “taxing” of bank deposits.

Ironically, these two political events either side of the Atlantic Ocean are contradictory. The US sequestration is a form of austerity and the Italian election is a setback for the proponents of austerity measures which Europe has self-imposed since the economic crisis took hold. While being contradictory, maybe it is the best for each of these regions in that some caution in the US might temper the approach of “just buy our way out of the problem”. While the ongoing monetary policy in the US has been good for markets, it can’t go on forever. On the other hand, Europe needs to relax austerity and a quantitative easing program similar to the US will help those equity markets. The question is will Germany allow such recklessness, particularly with the current events taking place in Cyprus. The real danger of allowing the Cypriot government to tax deposits is a contagion effect on peripheral Europe which could cause a “run on the banks”. Such circumstances would require massive ECB support.

Notwithstanding this, on balance we remain positive with regard to equities but are conscious we have come a long way since the middle of 2012 and maybe a general “risk on” approach will not work. It is maybe more appropriate to be picking equities that are in sectors that represent good value and applying some sector rotation. In this regard retailers and consumer stocks in general are probably extended and, in spite of the fragility surrounding the resources sector, there is deep value in those stocks. This is shown graphically below where equities have outperformed (shown by the S&P500 Index and Nikkei Index) commodities (represented by the CS commodity benchmark). If the world economic recovery holds and continues to be led by China, resource stocks will provide the bull run or the recovery in markets (depending on what you prefer for believe) with a second leg.

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