A Difficult 2016 is Over

Directors and staff of Royal Union Financial Services (PTY) Ltd Wish you and yours a very fulfilling and prosperous 2017,

And….. in one breath, we almost want to say, “good riddance to 2016”!

 

A DIFFICULT 2016 IS OVER

Aside from the political drama here and abroad (including Brexit, Trump, State capture and SARS wars), investment returns have been disappointing. The looming threat of downgrades – thankfully postponed for now – probably dissuaded a lot of managers from investing in bonds.

Some global markets have performed better in 2016, with the S&P 500 at record levels and a 12% return as at mid-December 2016. The FTSE 100 benefited from a weak pound and returned 15% in 2016, but Eurozone markets are flat in euros. The MSCI Emerging Markets Index returned 13% in US dollars. The problem for South African investors, though, is that the rand has gained 11% against the greenback, 13% against the euro and 24% against sterling. Therefore, translating global returns into rands results in negative returns. The stronger rand this year is also a factor behind the disappointing returns of local equities, given that the majority of earnings of JSE-listed companies are earned abroad.

 

DISAPPOINTING RETURNS

According to Morningstar, the average retail balanced fund returned only 0.7% January to end November 2016. The range of returns over this period is very wide, with the top fund returning 20% and the worst fund -8%. This is a fitting testament to the difficult environment. However, the longer-term picture looks better, with the average balanced fund achieving an annualised 6.6% return over three years and 10.5% per annum over five years.

 

THIRD QUARTER GROWTH DISAPPOINTS

South Africa’s economy grew at a slower pace than expected in the third quarter. What matters now is to watch out for signs of improvement. Turning points are, however, difficult to spot as data is usually mixed while sentiment remains negative. The biggest contributor to the disappointing quarterly growth rate was a 26% quarter-onquarter drop in exports, followed by a 1% decline in real fixed investment. The sharp decline in exports was due to a drop in both volume and export prices during the quarter. However, Transnet reported strong growth in export cargo volumes at its ports in November.

 

HIGHER INFLATION

A big part of depressed real growth locally is higher inflation. The GDP deflator, a broad measure of inflation at all levels of the economy, increased 6.6% year-on-year in the third quarter. To gauge the earnings ability of companies operating in the local economy, one needs to look at nominal growth. The economy grew by 7.5% in the year to the end of the third quarter, a rebound from nominal growth of only 4 - 5% at the end of last year.

 

REAL INCOME GROWTH STILL POSITIVE

Employee compensation (the wage bill) is still growing at 8% per year, despite high unemployment. With inflation expected to decline this year, helped along by a firmer rand, it implies positive overall real income growth for households in total, supporting their spending ability. While debt constrains this ability, it has been easing. Household consumption spending grew by 2.6% quarter-on-quarter in the third quarter, but would have been 3.2% if the decline in transport spending (mainly vehicle purchases) hadn’t happened. However, new car sales have already increased by 6% compared to the third quarter in 2016.

 

IS THERE LIGHT AT THE END OF THE TUNNEL?

Economic conditions on the ground appear to be improving globally and locally (at the very least they are not deteriorating). Market valuations are generally good signs of the prospects of future investment returns. There is also a large divergence on a sector level, creating opportunities for active management to outperform. Local property fundamentals remain challenging, but the sector is offering more value after its 10% decline. An improved domestic interest rate outlook should benefit property too, but also shows that there is little upside to money market investments. Despite the rout on global bond markets in November, developed market bond yields are not attractive. Global equity valuations are slightly above long-term averages, with US equities more expensive than European equities. These valuations suggest global equity returns could be broadly in line with long-term averages. Emerging markets are cheap compared to developed markets and offer attractive long-term returns. Returns from global assets will clearly depend on where the rand goes. With our large current account deficit, the rand is vulnerable to shifts in global risk appetite and capital outflows, which in turn are likely to be influenced by the expected path of US interest rates. Nonetheless, the big drivers of the rand – the US dollar, commodity prices and sentiment towards emerging markets – are already close to historically extreme levels. From this angle, substantial declines in the rand are unlikely. However, global diversification is prudent, irrespective of what the short-term outlook for the exchange rate is.

 

OUR KEY TAKE-OUT MESSAGE

The key for you as our client is to remain focused on your long-term financial plans. 2016 was full of surprises and 2017 will probably also be. Don’t get side-tracked by the headlines, surprises and unexpected developments that are bound to happen. You will experience potholes, speed-bumps and delays on any long journey. The key is to stick to your goals, objectives, strategy and focus on your long-term plan.

Extractions written by: Dave Mohr & Izak Odendaal, Old Mutual Multi-Managers

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If you would like more information, or to arrange an appointment, please contact us:

Telephone: 031 717 2700

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Postal Address: PO Box 68, Kloof, 3640