The year ahead will be a tough one for investors looking to achieve inflation-beating returns.
“Asset class returns will be muted, with stock-picking key to outperformance. Diversification will benefit portfolios, and investors will increasingly have to look beyond our borders for opportunities,” said Francois van der Merwe, head of macro research at Novare Investments.
Commenting on his economic report for the fourth quarter of last year, van der Merwe added that, “internationally, ultra-stimulative monetary policy should keep financial markets awash with cash in the absence of any material inflationary pressures. At the same time, the risk of a major fall in global growth seems slightly lower than a year ago.
“But this doesn’t mean we’re out of the woods. The United States still needs to find a final solution to the fiscal cliff and address the looming debt ceiling, the Eurozone will have to stimulate growth in the wake of harsh, but lessening, austerity measures, and the Chinese economic recovery will have to prove its durability.”
He said that US policymakers had only addressed half of the fiscal cliff problem with agreement on further spending cuts needed in February.
“The US cannot live on borrowed prosperity forever. Except for Japan, the US fiscal outlook is the most troubling of all the major advanced economies, and the US will remain in the spotlight of credit rating agencies considering a potential sovereign credit rating downgrade,” Van der Merwe said
In Europe, the most recent indicators show an improvement in the economic situation, but still point to weak, recessionary-like conditions.
The political backdrop remains uncertain and the resolve of countries to stick to austerity measures will be tested in the coming year.
Said van der Merwe: “A modest acceleration in Chinese growth is expected, with longer term reforms aimed at an economic transition from being investment-led to demand-driven. Japan seems to have embarked on aggressive policy reforms, which will re-open currency war debates as the government tries to weaken the yen”.
The backdrop is worrisome with uncertain labour markets and poor growth prospects set to prevail. The wide current account deficit becomes a new macro-economic risk factor to contend with.
“Fiscal policy will be constrained by credit rating risks. the government capital expenditure has taken over some of the slack caused by the slowdown in household spending, but ratings agencies will want to see the budget deficit being brought under control, which will prevent the government from stimulating growth through an overly-expansionary budget,” he said.
The domestic equity market rallied sharply during 2012 at the same time as company earnings growth slowed to single digit levels.
This caused the price-to-earnings ratio of the JSE/FTSE All Share Index to rise to 15, above its long run average. The market’s less-than-attractive valuation, pressure on earnings growth, the weak economic outlook, as well as growing domestic imbalances, support the case for being underweight in this asset class.
Although the domestic bond market benefitted from foreign investors’ appetite for yield, this is unsustainable given the deterioration in domestic fundamentals. “The rand has dislocated from other high yielding currencies, depreciating while they appreciate, and we expect the domestic bond market to follow suit.
“There is a high probability of bonds underperforming cash this year, while international assets look attractive due to potential rand weakness,” said van der Merwe.
