Large allocation to offshore investments warranted, says Novare

The main risk for global financial markets over the next few years is how ultra-accommodative monetary policy, unprecedented in size, is unwound.

Commenting in his economic report for the second quarter of 2013, Francois van der Merwe, Head of Macro Research at Novare Investments, commented: “Not only did financial markets receive their first reality check that accommodative monetary policy will not last forever, but the US Fed’s announcement signalled a diversion in policy amongst global central banks. While the Fed wanted to scale back on stimulus measures, central banks from Japan, Europe and England gave their commitment to keep current policy in place and even provide further easing if warranted.”

Van der Merwe said that risks for the US economy had diminished and its recovery should progress at a soft, albeit bumpy, pace. In addition, this year should mark the peak in austerity as the US government has made strides in reducing the fiscal deficit.

The US consumer is in an improved position to aid the recovery. Most consumer deleveraging has been completed, households have benefitted from rising home and asset prices and consumer confidence has risen to levels last seen four years ago.

The Eurozone should be past the worst of its austerity measures and this will ease the economic headwinds. While the path towards positive economic growth will be long and bumpy, it is expected that the region will emerge from recession by the end of this year.

On China, he commented that, “The newly elected leadership has taken a tough stance on economic reform, which should result in some short-term pain for longer term sustainable economic gain. Although growth for this year will be softer than previously anticipated, China should still be able to reach its growth target of 7.5% and avoid a hard landing.”

The low inflation environment and with low interest rates should continue to support equity prices, but Novare is concerned that most of the rerating in this asset class has already taken place and that valuation levels are no longer cheap. As a result, the group expects that equity returns over the next 12 months will be more aligned with company earnings growth, and that this will be in the mid-single digits.

Said van der Merwe: “The tail winds to earnings growth from lower costs and interest expenses have faded and profits will be more reliant on revenue growth, which will depend on the pace of economic activity. Progressive improvement in economic conditions should help global equities outperform developed market fixed interest investments.”

In South Africa, Novare Investments expects higher inflation and lower disposable income growth to weigh on consumer spending, with business spending constrained by poor confidence. Government spending will be constrained by lower revenue growth, but exporters should benefit from the modest improvement in the global economy and recent rand depreciation.

“It will be a difficult environment to achieve inflation beating returns over the next 12 months. Cash will continue to yield a negative real rate and we are concerned over equity market valuations. The JSE is expensive from a price-to-earnings valuation perspective and company earnings growth will remain under pressure given the weak economic backdrop.

“Bonds will struggle against the twin deficits (current account and fiscal), continued pressure on the rand to depreciate and rising global bond yields. We believe that a large allocation to offshore investments is warranted to take advantage of potential further rand weakness and for diversification benefits,” said Van der Merwe.