Investment Environment February 2018

08.03.18

The year 2017 turned out to be great for equities. As shown in the table*, all markets finished 2017 with good returns (see 2017% change). The US equity markets performed extremely well with the NASDAQ (technology) leading the way with a +28.2% return. The UK lagged most markets, with the FTSE 100 providing only a +7.6% return. The JSE All Share managed a return of 17.5% in spite of the Steinhoff debacle. The JSE Resources lagged but have shown a strong start to 2018.

This momentum continued into 2018 but Investors got increasingly nervous about equity valuations with a general feeling that these have been over extended (as an example see the PE ratios in the table above). In February Investors found a reason to correct markets on the basis of the January US labour data which reported unemployment remaining at 4.1% but wage inflation popped up to 2.9%. This also fed through and the US CPI increased to 2.1% which, while being bang on target for the FED, increased Investors’ concerns that through the year the FED would have to increase interest rates more than expected in an effort to catch up. Simultaneously, 10 year Treasury yields spiked to 2.9% and as a consequence equity markets corrected as shown by the S&P500 Index*.

The question is, were markets looking for an excuse to correct or are equities really overvalued, and the following should be considered:

  • The synchronised economic growth (see Graph 2* and 3*) around the world remains intact and this should support equity earnings;
  • The US equity bull market or business cycle, if it lasts to Q2 2019, will exceed all bull markets since World War 2. While this would be a record some Investors are sceptical.
  • Corporate reports at the end of 2017 and into 2018 have surprised on the up side, supporting these higher valuations. Furthermore, the “Trump Tax Bill” will allow corporates to show stronger earnings net of lower tax going forward.
  • The balancing factor against the bull market points above is: are interest rates going to rise faster than expected and provide Investors with a safe haven and a reasonable yield? Since the Global Financial Crisis of 2008 the world entered an extraordinary period of ultra low interest rates and it would appear this situation is normalising with the FED having forecast 3 interest rate increases in 2018, but if interest rates rise faster than this expectation equity markets will remain jittery.

On 27 February 2018 the new FED Chair, Jerome Powell, passed positive comment on the US economic strength, but also was hawkish and indicated the possibility of 4 interest rate hikes. 10 year treasuries spiked back to 2.9% and the S&P came off as expected.

South Africa

As shown in the graph* above, the ZAR has proven to be a leading indicator of the positive political change that has occurred in a matter of 2 months. This has been supported by Ramaphosa’s State of the Nation Address (SONA), which he presented 24 hours after becoming President, outlining a twelve point plan to rescue South Africa from the Zuma era. However, the question of land redistribution without compensation as one of the twelve points has created a political football that causes uncertainty and will have to be resolved. SONA was followed by a budget that was probably as business friendly as possible with the sins of the past being paid for by all in the form of VAT. Ramaphosa has been tactically clever requiring Gigaba (as a Zuma supporter) to deliver this bad news, essentially placing the necessary tax catch up at the door of Zuma. The current political momentum is building confidence which hopefully can be translated into better economic growth and most importantly business confidence to release the funding from the private corporate balance sheets into the economy. If this continues the “Cyril Spring” could bring about an economic Summer. There is much to do but so far so good. The difficulty is with the Rand reflecting the positive sentiment and the JSE being Rand hedge biased, equities will have a head wind but this has got to be worthwhile!

Douglas Investments remains positive on equities internationally but recognises that 2017 will not be repeated and an exposure to Europe, which seems to be following the US, is appropriate. Locally, current circumstances provide for the most positive time post Mandela and, if this is believed, it must be good for SA equities.

 *Graphs, Images and Tables all available on the Full PDF Version

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