Equities to benefit as developed markets lead the recovery in global growth

Global equities are likely to benefit most as the theme of resynchronised global growth continues playing out over the coming year, with developed economies accelerating gradually and emerging markets bottoming out.

Commenting on Novare Investments’ economic report for the first quarter of 2014, Francois van der Merwe, Head of Macro Research at Novare, said global macro-economic risks were mainly in the emerging world, but a deflationary environment, especially for the Eurozone, could not be ruled out.

“Within emerging markets, there will be greater differentiation between economies with healthy fundamentals and those that have failed to implement the necessary reforms. In the US, the economic recovery is broadening and we believe that 3% or stronger GDP growth this year is not an unreasonable expectation.”

Van der Merwe said the US job market recovery remains intact and, together with improved confidence levels and rising wealth, should lead to more robust consumer spending. Absent from the recovery has been business capital expenditure, but this also looks set to reverse given record profit margins and historically low borrowing costs.

Interest rates in the US are likely to remain low to avoid putting the recovery at risk and jeopardising the efforts of the last few years.

While the Eurozone remains fragile, indicators are moving in the right direction, real economic activity is following and confidence is rising. The main threat is a Japanese-type deflationary environment.

Chinese economic growth seems to be bottoming and the government has noted the importance of targeted growth of 7.5% in combating unemployment.

“Global growth is likely to improve at a rate below potential with muted inflation risks and ample room for central bank policies to stay accommodative. Developed market fiscal consolidation is slowing and should stop subtracting from growth. As the recovery strengthens, it will remain uneven amongst emerging economies where governments need to implement reforms to reduce structural imbalances,” said van der Merwe.

Despite slightly lofty valuation levels, Novare believes the environment will benefit global equities over bonds as improving growth leads to a re-acceleration in corporate earnings.

According to van der Merwe: “Technical corrections in the equity market cannot be ruled out, but the bull run looks set to continue for a while. We remain underweight global bonds and prefer absolute return orientated fixed interest strategies.”

On the local economy he added that that the Reserve Bank was likely to raise interest rates in May, either by 0.25% or by 0.5%, depending on the weighting given to the impact on growth in the decision-making process.

“It is concerning that despite historically low interest rates, the economy is performing below potential and households continue to be highly leveraged. Furthermore, power supply problems put a cap on potential growth.

“Higher interest rates, rising inflation, a slowdown in bank lending and a squeeze on real disposable income growth will impact consumer spending. With the demand side of the economy slowing down, one would have hoped that the supply side would take up the slack, but mining continues to be compromised by industrial action while manufacturing production loses out on competitiveness. Manufacturing should, however, be helped by the weak rand and rising global demand,” said van der Merwe.

The current account deficit will stay under pressure due to weak manufacturing and mining activity, even though a slowdown in consumer demand will reduce import growth. The economy will be reliant on volatile foreign portfolio inflows to fund the current account deficit.

Novare Investments does not expect South Africa’s foreign credit rating level to improve given its socio-economic challenges.