Investment Environment May 2017

06.09.17

Equity markets have been a little lacklustre of late but in the US we are holding onto most of the Trump gains and recently we have been impressed by the opportunities that have arisen in Europe where confidence is on the up and there is more value in equities because they have not had the same run as the US where valuation criteria have been extended.

The reasons to invest in Europe are further underpinned with the recent strength of the Euro, meaning that one can depart from the USD as forecasts are that the Euro will hold its value relative to the USD and thereby not neutralise any equity gains. This improved Euro outlook was catalysed at the time of the French elections. For a USD based portfolio this is a suitable diversification for up to 20% of the portfolio.

It doesn’t make sense to give up on the US as there is no doubt the market likes Trump economics as shown in the graphs.

It is evident that equity ownership is supportive of Trump economics as when this is threatened, or Trump himself is badly portrayed in the media, the US equities react negatively. Basically, the US is full of confidence and underpinned by full employment. However, politics causes some uncertainty as to when the FED will raise interest rates and the yield curve is less aggressive and low risk-free yields are good for equities but also send a signal of uncertainty.

Global economics is supported by improvements in China.

The question that needs to be answered is “Why is the JSE weak?”, and the answer is reflected in the Rand which is arguably unusually strong. The JSE has a natural Rand hedge bias of  >60% by market capitalisation. A stronger Rand converts JSE stock prices and their earnings into lesser amounts.

The real question is not about the JSE but rather why is the Rand so resilient against a backdrop of high unemployment (official figures Q2 2017 : 27.7%) and government debt as a percentage of GDP forecast to be >50% providing no potential for fiscal support of the economy, which is now in recession following two quarters of GDP contraction. The situation is exacerbated with both the consumer confidence and business confidence at a low ebb.

Kevin Lings - Chief Economist at Stanlib (whose view we respect) - believes that unless confidence can be restored an economic revival is somewhat doubtful. The only explanation for the Rand strength is the lack of yield available in the first world economic regions (eg USD, EUR etc) and therefore investors disregard the economic and political threats to take advantage of Rand interest rates, either directly or by way of the carry trade.

It is deliberate that we have limited our comment regarding the current SA political climate as this is currently driven by daily events and revelations which swing the pendulum both ways. On one side, a SA controlled by a Zuma faction, and on the other, the attractive alternative of a new start without these Zuma Camps’ manipulative and corrupt politics. If Zuma prevails the prospect of a failed state cannot be ruled out and the Rand will not survive this scenario!

In conclusion, Douglas Investments continues to believe there are better opportunities internationally in a USD denominated portfolio which can now take on some Euro exposure. In SA portfolios we continue (maybe stubbornly) to invest with a Rand hedge bias. Even though equity markets have been lacklustre, it never pays to quit as shown in the 40 year S&P500 graph.

While recent events are always top of mind, grey haired portfolio managers talk of the crash of 19 October 1987 when US equity markets declined by >20% on that day. Looking back, it hardly seems worth worrying about!

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