By Alwyn van der Merwe
In December 2010, Sanlam Private Investments (SPI) held the view that South African shares – as measured by the All Share index (ALSI) – were likely to hit the 45 000 mark. However, when our market surpassed this level, commentators immediately questioned the sustainability of the trend and the actual level. In short, investors were worried.
Closer analysis would suggest that the market recorded this elevated level for the wrong reasons. The earnings growth expected in 2010 never materialised. Resource earnings, in particular, disappointed on expectations. The market recorded these levels largely on a re-rating or a higher rating in shares. To put it differently, investors were prepared to pay higher multiples for disappointing earnings. In addition, although macro-economic numbers would suggest that the global economic recovery is gaining traction; many sceptical analysts are not convinced about future growth prospects given well documented structural risks. The problems experienced in the developed world created an environment where the emerging world policy makers were hesitant to address their own structural issues. This is normally not a cocktail for sustained appreciation in share prices.
South African shares followed the international trend. Globally, developed market equity prices recorded regular new highs as they have climbed the “wall of worry”. Despite these concerns, investors internationally have added to their equity holdings and, locally, collective investment schemes data suggests that retail investors still switched out of cash into balanced funds – this effectively implies a very belated increase in equity exposure.
Despite valuations that look cumbersome, we do not think global equities as an asset class are in bubble territory. Profit or earnings growth are also roughly in line with expectations. Balance sheets of companies are generally very strong. It is hard to argue that our own market will collapse when we don’t think a 2008-like correction is awaiting global equity markets.
Importantly for SPI, the alternatives and, specifically interest-bearing investments, are not attractive. Interest rates are artificially low. Although we don’t see a rapid rise in rates it is hard to justify an investment in a bond where the yield hardly beats inflation. Cash at best can only protect the capital of investors over the short term. It is hardly a viable long term investment option with sub-inflation rate yields.
Our advice to clients is simple. Lower your return expectations for local equities. However, we still believe that the asset class is likely to beat inflation over three years despite valuation concerns. Pick portfolio managers who have demonstrated the ability to outperform the average market. There are opportunities for active managers to utilise market inefficiencies to add value to clients’ equity portfolios. An environment where asset classes act in a volatile fashion also necessitates active portfolio management.
To summarise, although investors need to re-calibrate expectations, there are still enough “tools in the box” to allow money managers to negotiate the future challenges successfully on behalf of their clients.
Alwyn van der Merwe, director of investments at Sanlam Private Investments.