Investment Environment November 2012


As 2012 draws to a close it is important to reflect on listed equity markets, their longer term performance and the drivers of current valuations. The two graphs show the equity returns of both the US and Euro-area since the financial crises in 2009. 

The significant outperformance of the US market can largely be attributed to the accommodative monetary policy compared to the austerity policy adopted by the Euro-area. This has been good for US GDP figures which have significantly outperformed the Euro-area. US corporate profits are at record levels but potentially the US national balance sheet will be under pressure in the long run.

The South African listed equity market has also shown very good returns since 2009 on the back of corporate earnings from the financial and industrial companies.  These companies have benefitted from increased consumer spending given real wage increases, historically low interest rates and availability of unsecured debt:

As the world stimulates growth and exits the recessionary environment through accommodative means, this will bode well for listed equities and in turn valuations.  This is probably the most appropriate way to correct the imbalances of the past and “trade out” of the problem.

The question that is “Where to from here?” and in this regard the following is relevant: 

  • Notwithstanding the Euro Zone austerity measures, the Greek bail out has at least stabilised the situation and it would appear that there is sufficient will to deal with Spain in the same way. However, the austerity measures remain concerning as they will prevent the peripheral economies’ from a quick recovery. 
  • The US continues to be hugely accommodating with quantitative easing in full force and arguably well through 3 phases as US$40 billion per month is released into the system. Some refer to this as QE∞! Furthermore the Fed continues to support this by buying mortgage backed securities from the likes of Fannie Mae and Freddie Mac. At the risk of sarcasm, Bernanke might choose to “kick the can down the road” as his term ends in February 2014 and he would leave his successor facing record debt levels and interest rates at an all time low. Obviously this begs the question “Are the problems simply being postponed?” but for now it is an equity supportive scenario. The one problem that cannot be postponed is dealing with the so-called fiscal cliff which has been highly politicised and requires agreement of both the House of Representatives, the Senate and the President of the US. If this is not resolved and the Bush tax relief extended beyond 31 December 2012, it might “kill” the American consumer. It is unlikely US politics will risk this scenario with their own and world economies being so fragile. 
  • China is the key to taking advantage of the above 2 points by providing an engine for world economies. The PMI, the gauge of the manufacturing industry, tilted positively in September and November’s index of 50.6 was the highest in 7 months (readings >50 indicate expansion). With new leadership in place, it can be expected that China will follow the same accommodative approach that has worked well in the US.

In conclusion, with all the negative news flow maybe things are not as bad as they appear. If investors are brave enough to ignore the noise, we believe that it is “risk-on” for the time being and equities will continue to show good returns.

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