Investment Environment February 2014

27.03.14

Douglas Investments took a cautious view on equity markets at the end of the November 2013. This view was largely due to the macro uncertainty surrounding the US budget deficit and ongoing debt ceiling negotiations as well as the US Federal Reserve’s tapering of its quantitative easing program and the consequences thereof. Furthermore equity markets globally have become expensive justifying a more cautious approach as the risk reward trade-off appeared skewed.

The macro risks identified above have by and large dissipated. Janet Yellen has assumed her position at the FED and, having been one of the architects of quantitative easing, is now responsible for tapering and appears to be achieving the right balance for markets. This, combined with the global recoveryled by the US, is eliciting a positive sentiment for riskier assets. The US is benefiting from consumer spending, improved employment and rising earnings and wealth. Apart from the temporary freeze due to very cold weather, the US economy is expected to grow 2.5% in 2014. Markets have also benefited from the synchronised effect that the Chinese economy, while being expected to slow, will yet achieve a 7.5% growth rate for 2014.

Emerging markets (South Africa included) are expected to show weaker growth with their currencies absorbing the foreign disinvestment as developed markets appear to be more attractive investments. South Africa recently experienced dramatic weakness in the Rand to above ZAR11/USD which was probably overdone! A purchasing power parity (PPP) calculation indicates a rate of approximately ZAR10.50/USD. While this is not the only measure of currency, we have recently seen the Rand moving towards this level. A large portion of the market capitalisation of the JSE is weighted in resource stocks that have underperformed financial and industrials and to a large extent been caught in a value trap. As global economic growth improves together with the demand for commodities coming from China, resource stocks may outperform other sectors.

In conclusion Douglas Investments is more positive on equity markets in general and while we continue to be wary of the risks and valuations s we believe equities will continue to show good gains that are superior to other asset classes that are more sensitive to a changing interest rate environment.

International USD based portfolios should continue to hold a significant equity exposure to large multinationals that do business across the globe. South African portfolios must continue to Rand hedge. This can be achieved by holding South African listed multinationals as well as augmenting this with resource stocks and offshore equity index tracker products listed on the JSE.

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