South African investors exposed to foreign markets have earned very good returns over the past five years, and the average returns over the past year have been even stronger than the five-year average.
Investment managers say they continue to favour foreign markets, because there are more opportunities there than in South African markets.
The Morgan Stanley Capital World Index returned 29.44 percent over the year and 19.81 percent a year over the past five years to the end of June. On average, rand-denominated global equity funds returned 27.14 percent over the past 12 months, according to ProfileData.
Herman van Papendorp, the head of macro research and asset allocation and the co-portfolio manager of balanced funds at Momentum Asset Management, says the valuations – share prices relative to earnings – of some equity markets are above their longer-term averages, and this is likely to constrain future returns from these markets. A good example is the United States.
The valuations of share markets in Europe and the United Kingdom have increased, but these markets are not yet expensive, he says.
The equity markets in Japan and emerging economies are still downright cheap, he says.
But does the equity markets’ good run mean that the risks are high and that investors might have to look elsewhere for opportunities? There is no consensus on this.
In recent months, both the Standard & Poor’s 500 Index in the US and the FTSE 100 in the UK have reached all-time highs. At the same time, economic growth data in the US has been disappointing.
Allan Gray’s offshore sister company, Orbis, notes in its June 2014 commentary that, “whatever has been driving the US stock market to a series of record highs in the first half of 2014, we can be sure of one thing: it is not the economy”.
The commentary goes on to observe that, on the very day in May when the US reported that its gross domestic product (GDP) in the first quarter of 2014 had shrunk by an annualised rate of one percent, the S&P 500 – the index of the top 500 shares on the US equity market – notched up another all-time high. The index closed higher still a month later, when GDP growth was revised down to minus 2.9 percent.
The ongoing rise in equity markets has been attributed to the effects of quantitative easing – the monetary policy of central banks that includes buying bonds and keeping interest rates low. Near-zero interest rates in developed countries have been the catalyst for large-scale flows of money into equity markets around the world.
GDP and returns disconnect
Paul Hansen, the director of retail investing at Stanlib, says that 40 percent of the earnings of companies listed on the S&P 500 are from outside the US. This explains some of the disconnect between low economic growth in the US and the rise in share markets there.
Elaine Garzarelli, the founder of top-rated quantitative analysis firm Garzarelli Inc, whose views are frequently published by Stanlib in its Weekly Focus newsletter, says the fair value of shares in the S&P 500 is 21 percent higher than its current level, based on her forecast for 2015. Garzarelli predicted the 1987 crash and that the market would bottom in 2009 after the 2008 crash.
Garzarelli says the earnings growth of shares in the S&P 500, which is expected to be seven percent for 2014, may well be higher, as they continue to recover from the “bad weather” of early this year.
She believes that better employment prospects, improvements in the housing market and increased consumer confidence will be the main drivers of US economic growth. She expects US companies’ earnings growth to be good throughout next year.
A recently published report by professors Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School (produced in association with Credit Suisse) supports the view that financial markets do not always follow good economic growth.
The professors show that between 1900 and 2013 there was a negative correlation (minus 0.29 percent) between real equity returns and per capita GDP growth. Over this period, for example, South Africa experienced the best long-term equity returns of 21 countries (including the US, UK and Japan) of 7.39 percent, but its per capita GDP growth was just 1.1 percent, whereas Ireland had per capita growth of 2.8 percent and real equity returns of only 4.1 percent.
A shorter-term analysis of China showed that, although the country has had multi-year economic growth of over seven percent a year and it is regarded as an engine for the global economy, economic growth has not translated into superior investment returns. Between 2000 and 2013, the annualised real (after-inflation) return from equities was 2.6 percent.
The report notes that, contrary to many people’s intuition, investing in countries that have recently experienced the lowest economic growth leads to the highest returns – an annualised return of 28 percent over this period, compared with just under 14 percent for countries with the highest GDP growth.
The London Business School report concludes that a growing population is better for equity returns than a richer one, and that investors who are willing to take the extra risk of investing in uncertain markets are rewarded more than those who invest in safer economies.
Globalisation ensures that many investors can have the best of both worlds. They can invest in companies listed in the US that are exposed to the growing populations of emerging countries.
Looking for opportunities anywhere
In the current environment, some fund managers are ignoring geographical regions and are looking for the best investment opportunities wherever they may be.
Greg Hopkins, the chief investment officer of PSG Asset Management, says that PSG is seeking opportunities locally and offshore, but, on balance, it is finding more opportunities offshore.
PSG has identified some opportunities in the US financial sector, which is undergoing a period of healing following the fall-out from the great recession of 2008, he says.
The banking sector, in particular, is suffering from negative publicity and is out of favour, and consequently there are some opportunities, Hopkins says.
Allan Gray says that China, South Korea, Brazil and Russia appear to be better priced to deliver higher returns than the broader market. Orbis’s exposure to regions outside of North America, Japan and Europe has risen from 21 percent 12 months ago to about 35 percent at the end of June.
Quinton Ivan, a portfolio manager at Coronation Asset Managers, says that Coronation prefers equity markets in emerging countries to those in developed countries.
In the matter of offshore investment destinations, it seems that Coronation and Old Mutual are in agreement.
An article in Old Mutual’s Fundamentals newsletter by Tendai Musikavanhu, the chief executive of global index trackers at Old Mutual, promotes the view that those who ignore emerging and frontier markets, such as Africa, may be losing out.
“The challenges of investing in Africa are deterring global investors, but, as a result, they are overlooking the many growth opportunities that exist across the continent,” he wrote.
Musikavanhu notes that Africa offers the largest GDP growth outside of Asia. Its growing middle class is now larger than that of India’s, and 45 percent of the African population is under the age of 15.
The report by the London Business School notes that, 30 years ago, emerging markets made up just one percent of the capitalisation of world equity markets and 18 percent of world GDP, compared with today’s figures of 13 percent of the shares that are available to the investing public and 33 percent of global GDP. The report says these weightings are likely to rise steadily in the developing world’s favour, because the developing world will grow faster than the developed world.