Lower your return aims for 2014
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Long-term investors should not expect to enjoy this year the spectacular returns they earned last year, but they need not fear the end of the bull market, especially in global equities.
This is the view of a number of asset managers, who maintain a tempered optimism in the face of the recent market sell-off and the interest rate hike last week.
Managers say they are not expecting great returns from the local equity market, but there is a little optimism for local bonds and property after these sold off recently, and the prospects for global equity markets remain good.
For the calendar year to the end of 2013, the local equity market’s FTSE/JSE All Share Index (Alsi) returned 21.43 percent, and the global equity market’s Morgan Stanley Capital World Index returned 24.1 percent in US dollars and a whopping 52.43 percent in rands, as a result of the depreciation of the rand (according to ProfileData).
Peter Brooke, head of Old Mutual Investment Group’s MacroSolutions boutique, says that despite the great returns last year, the investment group still believes the world is in a low-return environment and, as a consequence of the good returns last year, you should lower your expectations for the year ahead.
Old Mutual Investment Group is expecting a long-term 5.5-percent real (after-inflation) return from both local and global equities, Brooke says.
He says local equity market valuations (share prices relative to earnings) are looking more expensive than they were a year ago and, as a result, you can expect less of a return in this asset class this year.
The market has become expensive because share prices rose last year by more than their growth in earnings, Brooke says.
Old Mutual Investment Group has cut its expected return from equities by about a percentage point from this time last year.
At the same time, it has slightly increased its expected return from bonds and listed property because these sold off.
Brooke says the recent pullback in these markets, as well as that in the equity market, are a result of negative sentiment about emerging markets as a whole, the surprise rate hike, and foreigners selling South African bonds.
Brooke says the next opportunity is in buying bonds, but the tricky part is that while it makes sense to buy bonds on a long-term view, in the short term, bonds could show further capital losses as foreigners sell more of them.
Offshore equities are only a little more expensive now than they were a year ago, despite their good returns last year, Brooke says.
Investors cannot, however, expect the same return kicker they enjoyed this past year from the depreciation of the rand, which boosted the strong returns from global markets.
Brooke says the economic recovery in the US is greater than that in South Africa, and the key will be whether global equities will deliver earnings (company profits) growth.
He says global equities will do better than local equities on a risk-adjusted basis because their growth outlook is better and local shares are no longer attractive on a relative valuation.
Paul Hansen, director of retail investing at Stanlib, says it makes sense to subdue your expectations for 2014 and expect a return of less than 10 percent from local equities.
He says despite the current correction, the local equity market will shortly enter its sixth year in a bull market.
Stanlib expects that, on average, local share prices will remain flat during 2014, and it will only be dividends, of three percent on average, that will push up the All-Share total-return index, which reflects returns after dividends are reinvested.
Over the next four years, Stanlib is expecting a nominal return of between eight and nine percent a year, on average, from equities, Hansen says.
Stanlib still favours quality rand-hedge shares (local shares that have significant offshore earnings), but its equity portfolios are underweight in other local shares, he says.
Hansen says Stanlib is expecting about five percent each from the bond market and listed property in the year ahead.
Hansen says there are fears that interest rates may be increased on four or five more occasions over the next two years, but Stanlib economist Kevin Lings is forecasting only one further hike of 0.5 percent this year.
Hansen says this is not a typical rising interest rate cycle and was rather a result of the negativity surrounding emerging markets and higher inflation resulting from the weak rand.
The recent interest rate increase will have a minimal effect on the economy, he says, and has not caused Stanlib to adjust its forecasts for equity returns.
From developed world markets, Stanlib is expecting a 10- to 15-percent return in rands.
The global recovery will result in stronger growth this year than last year in the United States, Europe and the United Kingdom.
In addition, Hansen says, China is likely to deliver economic growth of seven percent.
Despite last year’s good returns, global equity valuations are still reasonable, as earnings growth of 12 and six percent is expected in Europe and the US respectively.
Dividends are also continuing to grow, Hansen says, because companies are still cash flush.
Another positive is that developed markets continue to enjoy low interest and inflation rates, which means there is no need for central banks to raise interest rates.
Gavin Wood, chief investment officer at Kagiso Asset Management, is also of the view that you need to temper your expectations of local equity markets.
He says South Africa has benefited strongly from the world’s excess liquidity, and foreign investors in particular have bought up local industrial shares and government bonds, making these sectors vulnerable to sell-offs by foreigners.
At the beginning of this year, foreign investors held more than 50 percent of local industrial shares and more than 35 percent of local bonds.
So far this year, foreigners have sold more than R23 billion of bonds, reversing almost all of the R25 billion they bought last year.
They have also sold in excess of R8 billion of equities.
Further foreign outflows may occur as liquidity recedes, prospects improve in other parts of the world, the prospects for South African assets deteriorate or foreigners follow the herd out of emerging-market securities, Wood says.
Wood says the rand has weakened significantly and will probably not return to the level of R7 or R8 to the US dollar, but will rather settle at around the R10-to-the-dollar level.
However, it is not unlikely that the rand will weaken a lot more before it regains its equilibrium.
He says you should not panic about the rand remaining weak, but you should realise that a lot of the return on the local market last year was related to the currency weakening by 20 percent.
If the currency strengthens again, some of the rand hedge shares could come down, he says.
SMALL-CAPS OFFER VALUE
This is not the time to sell out of South African equities. Just be very careful which ones you own, Geoff Blount, the chief executive of Cannon Asset Managers, says.
Local share prices rose close to 18 percent last year despite a 6.4-percent drop over the year in the FTSE/JSE All Share Index’s (Alsi’s) earnings per share, Blount says.
Furthermore, he says, there was a big divergence in returns and earnings growth between the JSE Top 40 shares and small-cap stocks.
Price/earnings (PE) ratios for the top 40 large-cap shares, which make up 85 percent of the JSE, rose nearly 24 percent, despite their earnings falling eight percent in 2013, implying that investors have made them much more expensive relative to their declining earnings base.
(A PE ratio measures how |cheap or expensive a share is by comparing its earnings to its current market price.)
Blount says small-cap shares grew their earnings by 20 percent last year, yet investors marked them down, pushing their PEs |two percent lower.
He says small-cap shares are the elephant in the room that investors seem to be missing.
A staggering 11 percent of last year’s 18 percent market rise was from Naspers, Richemont and SABMiller. If you had owned all the other 157 companies that make up the Alsi, your return would have been just seven percent. Sixty percent of the shares on the JSE under-performed the Alsi, Blount says.
Blount says the JSE, on average, did well last year, driven by a narrow band of expensive, but good quality, large-cap industrials that got more expensive. These areas of the market are now an investment risk, he says.
While the sexy stocks grabbed all the headlines, many amazing opportunities have been created elsewhere in the market, including in smaller cap shares, he says.
See the Alsi in rands and US dollars, and a history of returns of different asset classes by clicking on the link below.