Asset Class Outlook
Download the July 2017 edition of the MacroSolutions Perspectives PDF
We update our medium-term (five-year) asset class outlook twice yearly, or if conditions change significantly. This outlook influences both our strategic and tactical investment decisions. Please be aware that there are risks in simply implementing these views into a portfolio without carefully considering the dynamic nature of the environment and how change impacts each asset class. As we continuously examine this environment, we have been very successful in converting our asset allocation outlook into performance for our investors.
Note: These are long-term, real returns expected over the next five years, as at 30 June 2017. The international return expectations are quoted in US dollar terms; any REAL rand depreciation will add to domestic investor returns. To understand the table consult 'The symbols' below.
Note: These are long-term, real returns expected over the next five years, as at the end of June 2017.
* The international return expectations above are in US Dollar terms; any rand depreciation will add to returns in rands.
- Key take-aways
GLOBAL OUTLOOK IMPROVING, SA STALLS
The world has shifted. The big bond bull market is over and there is a move away from monetary policy stimulus to using fiscal stimulus to revive economic growth. Monetary policy (specifically low interest rates and quantitative easing) has gone as far as it can go in its effectiveness in boosting growth. The next step is fiscal stimulus − increasing government spending and/or lowering taxes to stimulate demand (an approach favoured by economist John Keynes). A more expansionary fiscal programme in the US will support growth and should result in global earnings going up in 2017. That is good for equites relative to bonds and within equites, it is good for value-style investing over growth-oriented shares and for cyclicals over defensive shares.
GLOBAL GROWTH ON THE UP
Our global themes remain unchanged and are continuing to come through – namely reflation with synchronised global growth leading to strong earnings and strong equity markets. We expect this growth to continue as there are limited signs of overheating and global inflation remains well behaved. The risk to this view is a Chinese hard-landing and policy errors from central banks.
South African has disappointed relative to our expectations. The two big positive drivers that we were expecting occurred: good rains across most of the region brought an end to the crippling drought and sharply lower local inflation led to higher real incomes. The unexpected ingredient was the dent to confidence inflicted by the firing of then finance minister Pravin Gordhan in March this year. This means that although SA’s GDP will improve in 2017, it will still be below 1% − resulting in a tough environment for corporate profits.
As expected, the South African Reserve Bank (SARB) has cut interest rates, providing some relief, and we forecast a further 50 basis points decline in rates during 2018. It is clear that the SARB is keeping a close eye on politics while setting interest rates – meaning rates have been higher for longer, which has exacerbated the stagnation of the economy.
Looking forward, political uncertainty will keep investment on the side lines and mean another year of sub-trend growth. This makes the ruling party’s December policy conference a critical crossroads, with potential binary outcomes. We expect the ANC to muddle through, but have used a bar-bell strategy to build our portfolios to manage the risk of unknowable outcomes.
Due to good news internationally and disappointing SA news, we maintain our preference for offshore equity over SA equity. With global interest rates expected to rise and monetary stimulus programmes expected to be wound down, we still find global cash and bonds unattractive. Within SA, we still get good real returns on fixed-income assets and lower cash yields should push some investors off the side-lines where they sit with high cash holdings. We think that locally-listed property will deliver a decent real return.
- Asset class commentary
We have reduced our expected real return to 4.5% a year over the next five years, down from 5%. This is due to lower trend growth and a hostile profit environment impacting long-term earnings growth expectations. However, local shares have gone nowhere, which means pockets of value are appearing and we are opportunistically taking advantage of specific weakness and better valuations.
This sector also faces headwinds from a tough economy, but long-term leases and escalations mean that dividends are secure. The locally-orientated companies should also benefit from a falling cost of capital (on the back of interest rate cuts). With SA-focused funds yielding 8%, our models show a good real return from property of 5.5% a year.
Bonds have performed well and, due to our high political risk, offer some of the best real yields in the world. Lower inflation and lower rates are good news from bonds, but we are becoming more cautious over the longer term and have revised our view from being slightly positive to sellers.
Cash has been an attractive asset class over the last year, beating equity, but it is not a long-term option. With the economy on its knees and inflation falling, we expect rate cuts despite US rates rising.Cash has been a tough hurdle to beat, delivering good returns over the past three years. We think rates are too high and, as the economy is on its knees, the SARB will cut rates. This will reduce the available return from cash.
Strong earnings growth has been good for global equity and we expect continued synchronised growth. However, a lot of the good news is already in the price and it will be more difficult to deliver returns going forward as the bull market matures. This feeds into our long-held theme of a low return world. Our outlook for this asset class over the next five years remains unchanged, and we maintain that global equity offers the best option for real returns.
Global bonds are still expensive and the pressure from reducing monetary policy liquidity in the market leaves us bearish.
Artificially low real returns will normalise. While it is still too early, global cash will start looking more attractive as interest rates rise.
- The symbols
Neutral: Real returns will be at or around the long-term historic average over the next five years; the weight in each of our portfolios is roughly equivalent to that of their benchmark, where applicable.
Neutral +: Real returns will likely be at or around the long-term historic average over the next five years. However, as there may be some opportunities available for us to capture some alpha, the weight in each of our portfolios may be slightly overweight to that of their benchmark, where applicable.
+ (positive): Real returns will be above the long-term historic average over the next five years; our portfolios are overweight compared to their benchmarks, where applicable.
Neutral −: Real returns will likely be at or around the long-term historic average over the next five years. However, due to prevailing negative conditions, it is likely that our portfolios may be slightly underweight compared to their benchmarks, where applicable.
−(negative): Real returns will be below the long-term historic average over the next five years; our portfolios are underweight compared to their benchmarks, where applicable.