How would you describe the current investment climate – is it hot, cold, tepid, treacherous? Today we share some thoughts on what is shaping our current investment views, debates and thoughts – and what should the long term investor be looking at.
We wish you a wonderful day on Friday 9 August – National Women’s Day
An investment climate with many temperatures
A well known contrarian investor argument states that you should avoid the herd – be fearful when others are greedy and greedy when there is fear. Consensus is often an investor dilemma as this may point to a narrow view and/or sometimes a bubble. Our current investment climate offers many views and perspectives for the investor. It is a difficult time to invest – but it is also starting to look quite interesting – on some issues there is broad consensus, on others not.
Tepid – the economic picture
We don’t invest in a vacuum and our investments often perform as a result of what happens in the economy. If there is economic growth and employment consumers are willing to spend, and save. If times are tough – unemployment is low – confidence sags and economic growth falls.
The current economic picture is tepid. Growth is present – but it is below par. Speaking at last week’s Old Mutual Investment Group’s media briefing, economist Johann Els said that global growth is expected to be 3% this year – and a good figure for global growth is 4%. Within this figure is a wide range of individual country performances – but of the major economies – growth sits in the sub-par classification. US, Europe, China, and here in SA.
Growth is good, slow growth is not a disaster, but it is a more difficult environment in which to find profit and earnings.
South African growth remains a problem – we had that dreadful just below 1% figure for quarter 1 GDP – quarter 2 is expected to be better – but as Els said last week – we need to look at it in conjunction with quarter 1 and average.
We’ve got growth – but not nearly enough. The problems and issues are well documented. It’s not yet a treacherous picture – but it could go there if the very low growth numbers continue. Again from Els – SA growth should ideally be in the 4 – 6% range.
Mild – inflation scenarios
Inflation also has a big effect on country and personal finances. Globally inflation is not an issue, locally it remains in – or just outside the official target range of 3 – 6%. Personal inflation is proving to be a problem and if you are looking to grow wealth and use it for an income that will include purchasing high inflation items like medical expenses, electricity and possibly food (because although food inflation is down food prices are not) you need to take this into account and look for an inflation plus plus return. (and save for longer)
Speaking earlier in the year at the FPI Convention, Investment Solutions’ Chris Hart said we must take everything into account when we invest – and one of the things we must consider is how different assets perform in different kinds of inflation environments.
A look back in history provides an excellent example.
In the 1970s inflation was high and interest rates were high. Sanlam Private Investments’ Alwyn van der Merwe showed on Tuesday that US equity returns for the 1970s were negative 1.6%. Local equities delivered 6.5% after returning 11.9% in the 60s (these are real returns – above inflation). Local bonds returned real negative 4.8% in the 70s.
In the 1990s – when interest rates in SA were high – SA equities had a 5.8% above inflation real return.
The question must be asked – how will my portfolio perform in various inflation scenarios.
Right now you may not think this is a valid question – interest rates are so low that even a rate of 10% seems unrealistic. But as investing sits in the future unknown area – what ifs must always be asked. If you are a long term investor and inflation could be a problem in the long term can your portfolio weather this?
As inflation destroys an investment never forget that it too has a treacherous side.
Hot, warm and cold – very volatile markets
We have had very volatile markets in the short term – 7% corrections as an example (of which we have had two this year) – and this looks set to stay. “Across the world there is an enormous amount of uncertainty,” said Alwyn van der Merwe.
Over the long term – how will assets perform? Where should an investor be positioned for growth?
“The environment is tough for a number of asset classes,” said Old Mutual Investment Group’s Peter Brooke last week. With low interest rates cash remains a no growth area, bonds are problematic and we are coming off a 30 year bond bull market. This leaves equities as “the only game in town,” said Brooke. Van der Merwe referred to them as “the best of a bad bunch.”
Investing is about weighing the alternatives and scenarios and implementing the strategy that meets an individual’s objectives with what is available – if you need growth you have to include assets that will grow.
Speaking at the Sanlam Private Investments media briefing this week, Van der Merwe shared some research on the returns of various asset classes over time. Below we share these ten year returns of select asset classes – they are real, per annum – after inflation numbers
Van der Merwe noted that each decade has a winner and particular type of economic environment. Often that winner is the next decade’s loser – Gold in the 70s for example, the Nikkei in the 80s, the Nasdaq in the 90s.
To forecast what might happen in the future – Van der Merwe looked at a known – the starting price – and found that there is clear correlation between price and performance. A low starting price leads to higher performance in the future. If the price is high “the risk is that you won’t get a decent return over the next ten years.”
Using this – he came up with the following forecast returns for the next ten years: (again these are real per annum returns – after inflation)
SA Cash: 0
SA Bonds: 2.1%
SA Property: 3.2%
SA Equity: 3.8%
US Equity: 3.1%
Does this favour local equity over offshore equity? Van der Merwe was asked this question. While offshore may not look like a fantastic buying opportunity as an entire market – it is much easier to find cheaper shares offshore than it is in SA.
Within the SA Equity market Van der Merwe looked at Industrials, Financials and Resources.
Over ten years he expects SA Industrials to deliver 0.41%, Financials 6.93% and resources 6.2%. But Resources he noted, is the “wild card,” the price might be low – but is it a low for a reason or low that will go higher in the future?
Van der Merwe’s conclusion is that there is not “a single asset class that promises exciting prospective investment performance.” Investors will have to “recalibrate investment return expectations.”
In the words of Peter Brooke – you have to save more.
And you have to select a strategy and plan, and stick to it.
Treacherous – investor behaviour
The returns the market gives are often different from investor to investor – and this is often due to investor behaviour.
Investors are often swayed by short term news and views and short term – the market moves look very volatile.
Van der Merwe said that one of the reasons he believes leads to volatility is the expectation of investors – when we invest we expect returns of xx and want smooth returns: when that doesn’t happen we often react “quite aggressively.”
We also anchor our views in the current reality, Van der Merwe said. This is the ‘JSE is always going to deliver fantastic returns’ danger.
A long term investor needs to take a long term view – and for the active manager and investor – volatility and uncertainty create opportunity.
“Volatility and uncertainty are the friend of the informed investor,” Van der Merwe observed.
A brief word on forecasts
Forecasting is very treacherous – so many unknowns are involved. Van der Merwe shared a study of earnings forecasts in the US that showed an optimism bias – analysts forecasting earnings were generally over-optimistic – only on two occasion in 25 years were analysts pessimistic and returns were above forecasts. This also showed – that our current expectations are anchored in current reality. Reality changes day to day, year to year, decade to decade.
Speaking at the beginning of June, Richard Carter of Allan Gray said that in investments if you are right two thirds of the time you are a top manager. This is why diversification remains important.
Forecasting also involves a number of assumptions and if you are going to look at forecasts and use them you have to know what the assumptions are. Van der Merwe used real earnings growth of 3% and a dividend yield of 3.7% in his forecasting for SA Equities.
The comment and opinion in this newsletter is comment and opinion only and does not constitute personal financial advice. Personal financial advice must be based on each individual’s circumstances, and not general comment and opinion. For all investment and financial decisions please consult a professional financial planner.