Investment Environment May 2014


Douglas Investments has reverted to being cautious when focusing on the JSE. This is a difficult stance to take as the major indices hit new highs virtually every day, but more so as there seems little prospect of generating reasonable returns in other asset classes. The possibility of interest rates rising will be negative for fixed interest and property investments. Cash is a safe haven but after tax generates negative real returns so it needs to be accumulated with the intention of using it as a “war chest” if markets correct.

The basic concern relating to the JSE is demonstrated by 2 fundamentals shown in the graphs.

The government debt to GDP ratio has expanded to nearly 50% having been optimally positioned in 2008/9 at 27%. More importantly the take on of debt at this rapid pace and ahead of GDP expansion, has been largely to fund the government’s salary bill and grants. Infrastructure build has been sacrificed for consumption and a populous approach! The creation of an engine for future GDP growth has not taken place and will now be muted because of the extent of debt. Against this backdrop, if one compares the current ALSI P/E of 17, this is an expensive entry point that might only provide an annualised forward return of 10% as shown in the graph above. Obviously, if one buys the market on a cheaper rating there is a better chance of showing more substantial returns. One also needs to appreciate against the tight economic backdrop that it would be difficult for SA companies to expand their earnings at a rapid pace.

It is not all bad news as it appears that the US is starting to show some decent growth as demonstrated in the graph showing the increase in house prices. As more economic indicators come in, forecasters are becoming more confident that a US GDP of 3% might be achieved for 2014. This would be some achievement after the extremely low growth of the first quarter due to adverse weather conditions.

The graphs show the recently released Chinese manufacturing Purchasing Managers’ Index (PMI) which is hopefully signalling some stability in that economy. It is expected that the Chinese fiscus will reduce reserve requirements for some banks and accelerate budget spend in an attempt to meet the targeted GDP of 7.5% for 2014. If the 2 largest economies in the world can produce a synchronised growth of 3% for the US and 7.5% for China this must be positive for equities.

So while South Africa, like most emerging markets, has probably missed their opportunity, the developed markets and in particular the US are proving to be more attractive. If South African interest rates rise (even if led by international markets) this will further pressure the local economy and probably serve no purpose in protecting the ZAR. Fortunately however, there are many JSE listed companies that have a significant portion of their business external to South Africa and these must be favoured in any portfolio. If the ZAR continues to weaken there remains an opportunity in resource stocks but again we would focus on those with an international bias as the South African mining industry continues to suffer from labour issues and remains caught in a value trap.

In conclusion Douglas Investments will continue to bias SA portfolios to listed equities with a significant international component. Developed markets (the US and Germany) are starting to show some reasonable growth that will be supportive of those equities. Interest sensitive counters have to be avoided as the cycle is changing and interest rates will start moving up.

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