Novare bearish on the outlook for domestic equities

Equity market investment returns over the past year have been strong, but the outlook for the coming 12 months is for much more muted returns and investors will struggle to outperform inflation.

“Investors should continue to take the opportunity to invest money offshore where equity market valuations look more attractive, to improve diversification and to take advantage of potential currency weakness,” said Francois van der Merwe, Head of Macro Research, commenting on Novare Investments’ economic report for the third quarter of 2013.

“The FTSE/JSE All Share Index is expensive from a price-to-earnings valuation perspective. The margin of safety within the equity market is very slim and it has ignored the risks from weak economic fundamentals.”

Van der Merwe said that five years into the global economic recovery conditions remain fragile. Growth has been built on low interest rates and unprecedented central bank stimulus. Uncertainty over when quantitative easing will be removed and what impact rising rates will have on asset prices will cause volatility in markets. Policy decisions will be the key market drivers over coming months.

Through its recent inaction on monthly asset purchases, the Fed signalled that it would support the US economy and market prices a while longer. The government shutdown during the first part of the fourth quarter would have detracted from economic growth and might also delay the start of tapering.

“There are more signs that point to synchronised global growth. Manufacturing and non-manufacturing leading economic indicators have turned up and risks to the global economy have abated. The worst of fiscal austerity is over for the US and Europe and Chinese GDP growth seems to have bottomed. The Japanese economy is on a stronger footing.

“The improvement in global economic conditions, waning risks and low interest rates should support equity prices. But equity valuations have rerated sharply over the last year and need to be supported by company earnings growth that will be more dependent on economic growth. Profit margins will be under pressure, with earnings dependent on revenue growth. We expect muted returns from global equities over the next twelve months but they should comfortably exceed returns from global sovereign bonds,” van der Merwe said.

Bond yields were likely to continue rising over coming years as ultra-accommodative monetary policy is unwound.

Van der Merwe said Novare Investments was concerned about the outlook for the domestic economy and markets. Fundamentals pale in comparison to other emerging economies, while the South African equity market valuation is the most expensive within the emerging market universe.

On bonds van der Merwe said: “We remain very cautious on the outlook for the domestic bond market. We view higher global bond yields, upward inflationary pressures, the domestic twin deficits as well as currency weakness as risks to the bond market.”