The start of a new year is a good time to reassess your finances, particularly if you receive a salary increase from January 1 or if you make financial resolutions for the coming year. It is also a good time to review your investments and consider your options for the year ahead if you are saving for retirement or depend on invested capital for an income.
When assessing your budget and your investments, you will have to make some assumptions about the inflation rate and the growth you will earn on your assets. Although no one can accurately predict either of these, you will have to make some educated guesses for planning purposes, and a look at how the markets performed last year is a good place to start.
Peter Brooke, the head of Macro Solutions at Old Mutual Investment Group, says the major indices reveal that in 2014 you would have earned the best returns from local and global listed property. Local listed property, as measured by the FTSE/JSE SA Listed Property Index, delivered 26.6 percent for the year to the end of December, he says.
If you had invested in local equities that track the FTSE/JSE Shareholder Weighted Index, you would have earned a return of 15.4 percent in 2014, while global equities, as measured by the MSCI All Country World Index, delivered 15 percent in rands.
Brooke says these were good returns, considering where valuations (share prices relative to earnings) were at the beginning of last year.
The year-on-year inflation rate, as measured by the Consumer Price Index, was 5.8 percent in November 2014.
South African bonds, as measured by the SA All Bond Index, delivered 9.7 percent and cash returned six percent.
Although listed property started 2014 on a forward yield (the expected rate of return based on expected rental income) of 7.5 percent, its current forward yield is 6.5 percent, Brooke says. This is because the prices of listed property shares have increased, lowering the expected return as a percentage of the price. You should therefore not expect as high a return from listed property in the year ahead.
In contrast, he says, the local equity market has not rerated significantly, and much of its return was from growth in earnings, or the profits made by listed companies and the dividends they paid.
Local equities started 2014 on a forward price-to-earnings (PE) multiple of 14.1 times, and it is now 14.4 times, Brooke says, indicating that the price increases of the underlying shares have been lower than those of listed property shares.
(The forward PE measures the price of shares relative to their expected earnings.)
Global equities are on a forward PE of 14.8 times, which is relatively high, but global equities could still deliver a reasonable real (after-inflation) return from this level, Brooke says.
He says that, after a five-year bull market, achieving good returns will be more difficult, and there is a greater risk that the market will fall instead of rise, but a reasonable estimate of the real returns from global and local equities is about five percent and 5.5 percent respectively.
Another asset class that did surprisingly well last year was global bonds, where yields are now exceptionally low, Brooke says.
Current yields indicate that, over the next five years, you will earn negative returns from German, Japanese and Swiss bonds before inflation, he says.
Brooke says the biggest factor affecting investments last year was the halving of the oil price, which has reduced inflation globally. This is good news for bonds and most equities.
The lower oil price makes it likely that interest rates will stay low around the world, except in the United States, where there could be a small interest rate increase, Brooke says.
In fact, there is likely to be more monetary stimulus and high levels of liquidity, which is not good for cash returns, he says.
The yields on global bonds and on local and global cash will stay low, and you will probably lose money on these investments after inflation, Brooke says.
South African bonds are still on reasonable yields, and, with a lower oil price expected to reduce inflation, you should earn a real return of 2.5 to three percent from most local bonds, except those that are linked to the inflation rate.
Adrian Saville, the chief investment officer of Cannon Asset Managers, says South Africa is beginning 2015 in a better state than it was in 2014, with some positives on the horizon. However, severe challenges remain and only subdued economic growth can be expected.
Saville says the biggest determinant of South Africa’s economic growth over the past 20 years has been global growth, and, fortunately, the world economy is in decent shape, helped by the slump in the oil price – the largest economies are oil consumers, rather than producers.
But South Africa faces some headwinds that will constrain the economy – in particular, the electricity crisis, Saville says.
In addition, although the demand for commodities is healthy, prices across the spectrum, from iron ore to oil, are under great pressure, he says.
He expects consumers to benefit from lower inflation, and that the lower oil price will improve South Africa’s trade and current account balances, and this will ease some of the pressure on the rand.
The rand remains cheap when its purchasing power is compared with that of other currencies, Saville says, but for a cheap rand to benefit the economy, South Africa needs higher levels of productivity and more disciplined fiscal spending.
Saville says the price of South African equities reflects their full value, and they are not a compelling investment.
On a variety of measures, such as dividend yields or PE ratios adjusted for market cycles or price-to-book ratios, South African equities rank towards the bottom of the table relative to global markets, he says. However, he says these measures relate to the FTSE/JSE All Share Index (Alsi) as a whole, and pockets of great value can be found in certain shares.
Saville says about 50 percent of the Alsi is made up of large industrial companies, which are on very expensive PE multiples and became more expensive last year.
Within the Alsi, large-cap industrial companies are “dangerously” expensive and resources are cheap despite low commodity prices, while financials offer fair value, Saville says.
YOU NEED A BALANCE SHEET AND A BUDGET
You need two key documents when you assess your finances, Lara Warburton, the managing director of Imara Asset Management, says.
The first document is a schedule of assets and liabilities. The schedule should be divided between lifestyle assets, which do not produce an income, such as your vehicle, and growth assets, which need to grow to achieve your financial goals, such as education, retirement and holidays.
The second important document is a budget outlining the income you receive and your monthly expenses.
Warburton says everyone refers to equities as risky investments, but if your investment horizon is seven years or longer, do not be afraid of equities – growth is essential if you plan to out-perform inflation.
“One of the biggest risks I see is investors who do not take enough risk when they are young and can afford it. They ignore the risk of being unprepared for retirement, and the uncertain future that comes with it. Be brave, be bold, and understand all the risks, current and potential. That will enable you to make informed decisions,” she says.