The rand can be expected to continue its downhill slide, but a R20-to-the-dollar scenario or worse is unlikely, Herman van Papendorp, the head of macro research and asset allocation at Momentum Asset Management, says.
Speaking at a media presentation, Van Papendorp said that, taking into account the falling rand, foreign equities continue to offer fair value and should be high on your agenda as an investor.
He says the world economy faces three possible scenarios over the next five years:
* A base-case or “muddle-through” scenario, with a 65-percent likelihood of happening, in which policy measures by governments aimed at stimulating economic growth bring some normalisation, but growth, inflation and interest rates remain below historical norms. In this scenario, economic growth in the United States can be expected to out-perform Europe, while growth in China will remain subdued. Commodity prices will remain under pressure.
This means South Africa’s growth potential will slip. The rand will continue to lose value, particularly because of the current account and fiscal deficits and the perceived high risk of investing in the country. There could be a further downgrading of South Africa’s credit risk rating, although it would remain investment grade.
Under this scenario, South Africa will see economic growth of between two and 2.5 percent a year, inflation of between 5.5 and six percent a year, an average repo rate of 7.5 percent and a US dollar exchange rate ranging between R12 and R14.
* A worst-case or “deflation” scenario, with a 20-percent likelihood, where policy intervention proves ineffective and a combination of zero nominal interest rates and continuously falling prices fail to stimulate real demand.
Capital preservation will become the sole objective of most investors against a background of plunging industrial and commodity share prices. They will seek fixed-interest investments, such as bonds, rather than equities, with the US dollar being seen as a safe haven.
Emerging markets will suffer as the “dollar stays at home”, which will result in a massive fall in the value of the rand.
This scenario will see widespread unemployment, with civil unrest and even a break-up of the European Union.
For South Africa this will result in economic growth of less than 1.5 percent a year, inflation of less than 4.5 percent a year, an average repo rate of 4.5 percent and a US dollar exchange rate ranging between R14 and R16.
* A best-case or “reflation” scenario, with a 15-percent likelihood, where policy measures are fully effective in restoring the global economy to its long-term growth.
In this scenario, improving business and consumer confidence become self-sustaining, global growth reverts to its historical upward trend, demand-pull inflation picks up and interest rates normalise, risk appetite increases and capital “goes global”. In this scenario, the the US dollar would weaken, with the result that emerging markets, including South Africa, would benefit. But South Africa will benefit less if its current policy paralysis persists, Van Papendorp says.
Equities will be the best asset class, with major capital losses in government bonds.
For South Africa. this scenario will mean economic growth of between three and 3.5 percent a year; inflation of six percent a year, an average repo interest rate of 8.75 percent, and a US dollar exchange rate of between R10 and R12.
Van Papendorp says South African equity returns, which have been good for a number of years, will be more subdued over the next five years under any of the three scenarios. In the “muddle-through” scenario, real (after-inflation) returns can be expected to average between four and five percent. They would be only about two percent in the deflation scenario and between five and six percent in the reflation scenario.
For fixed-interest (mainly bond) investments, all three scenarios will see returns improve, with “muddle-through” real returns averaging slightly more than two percent, reflation returns averaging just under one percent, and the best returns, averaging more than six percent, coming from the deflation scenario.
Cash returns will also improve under all three scenarios. The deflation scenario would offer the best outcome, with a four-percent real return, against almost three percent for “muddle-through” and less than two percent for reflation.
Van Papendorp says property is currently expensive, with the deflation scenario offering the best prospect for future prices in real terms.
He says equity in developed and emerging markets is the place to look for value in the muddle-through scenario, particularly with the anticipated continued fall in value of the rand against developed market currencies.