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On My Mind
– Beware the momentum wave
Former CEO of Sanlam Private Wealth
Mar 02, 2018
The global economy has enjoyed a recovery since 2010, with profits, capital expenditure and real GDP growth buoyant and beating expectations. While many anticipate the equity rally will continue, several analysts have warned that we’re in an advanced stage of the economic cycle – and may in fact already be approaching injury time.
The red flags that have been raised include the unusual length of the current cycle, signs of complacency among investors with an increase in risky behaviour, rising government debt levels worldwide in the aftermath of the global financial crisis, and elevated price-earnings multiples in global markets, which makes it difficult to find bargains. Both equities and bonds are currently expensive compared with their historical norms – in the case of bonds, this is due to prolonged historical low interest rates worldwide.
Many developed economies are now starting to function at their full potential, with the so-called ‘output gap’ – the gap between potential and actual growth rates – having all but closed. This normally leads to stricter monetary policy measures, so a shift to monetary policy normalisation is likely, led by the US Federal Reserve. Aggressive developed markets policy normalisation will always pose a risk to emerging markets, including South Africa.
Another concern is uncertainty on the political front – especially around the unpredictable actions of the present incumbent of the White House. Any market shock resulting from yet another ill-considered policy or utterance from US President Donald Trump could derail the current global recovery.
Fears that a bear market may be in the wings spooked investors in the US into selling off equities early in February – a pull-back that reverberated across global markets. The dust now appears to have settled, and most analysts are viewing the sell-off as an overdue correction, not the end of the bull market. The prospects for global growth momentum remain strong – but investors will do well to note that significantly increased volatility in the markets is probably here to stay for the foreseeable future.
We’ve mentioned in previous writings that the political shenanigans in our own country have prevented the benefits of the extended period of synchronised global growth from filtering down to our economy. Our main challenge has been a lack of confidence – in terms of both investment and consumer spend. These drivers of economic growth were under severe pressure last year.
The ‘Cyril effect’ has certainly changed the general mood – Ramaphosa’s election as our new president, his inspiring State of the Nation (SONA) address, former Finance Minister Malusi Gigaba’s Budget Speech last week, and this week’s Cabinet reshuffle have had a dramatic impact on both business and consumer confidence levels. This should lead to improved consumer spending and private sector investment, badly needed to kick-start the economy.
The biggest risk factor facing our economy, however, remains government’s unsustainable fiscal position. Treasury has now committed to closing the ‘jaws of the crocodile’: the widening debt-to-GDP ratio. The weak financial position of our state-owned enterprises (SOEs) is another key risk, and Budget 2018 has promised effective SOE reforms. A looming credit downgrade by rating agency Moody’s, which will result in exclusion from the Citi World Government Bond Index, now seems unlikely. So too do further downgrades, at least for the time being.
Under the circumstances, Gigaba’s maiden (and as it turned out, only) Budget was fair. In my view, Treasury’s decision to raise value-added tax (VAT) to 15% was correct, and long overdue. Campaigning by some opposition parties against the hike is nothing but cheap politicking and populist rhetoric, and certainly not in the interests of either our country or its finances.
It needs to be remembered that both Budget 2018 and the new Cabinet announced this week are transitional measures intended to take us to the next elections in 2019. This certainly explains why we’re still stuck with a few fossils from the Zuma era in what remains a bloated top leadership structure – Ramaphosa has, however, committed to a much smaller final Cabinet going forward.
The most encouraging appointments to our president’s top team are those of Nhlanhla Nene, who’s back in his old job as Finance Minister, and Pravin Gordhan as Public Enterprises Minister. Nene’s first challenge will be to rebuild the expertise and talent pool within Treasury, after the general exodus of senior officials under Gigaba. And Gordhan is certainly the right man for the job at Public Enterprises, where he’ll have to focus on turning around the dismal state of our SOEs. Both these appointments, together with that of Gwede Mantashe as Mineral Resources Minister, have demonstrated Ramaphosa’s commitment to fixing these key areas of our economy.
The next step for our president is getting the promised presidential economic advisory council off the ground – it won’t be a complete surprise if he brings former Finance Minister Trevor Manuel back into the fold to play a role, perhaps even as chairman. This would indeed be good news, since we may well then see a revival of the National Development Plan, which has essentially been gathering dust for the past few years under the Zuma tenure.
The biggest potentially dark cloud on a promising presidency in South Africa is the land issue – the noise around possible expropriation without compensation (and not just of farmland) has ruffled local markets and placed the banking sector at risk. Parliament’s Constitutional Review Committee is now to consider amending the Constitution to allow for this – not that this could legalise a practice internationally accepted as being illegal. It should be remembered that property rights are one of the cornerstones of a healthy economy, and fiddling with these may well usher in serious new risks to the local economy and destroy the overwhelmingly positive sentiment created by the new president.
It’s clear from the recent correction in global markets, and some local market uncertainty in the face of potential spokes in the wheel driving our country forward, that investors shouldn’t get too carried away by momentum – and in the process ignore that most crucial of factors: price or valuation. It seems there’s a tug of war between the momentum in the economic arena, both globally and locally (and stronger earnings of companies associated with that momentum), and valuation.
At Sanlam Private Wealth, price is central to our investment philosophy. When we buy stocks, we always look at intrinsic value. It’s disconcerting to note that when the market goes up in the way it has, investors seem to develop a ‘FOMO’ or ‘fear of missing out’ mindset and become less concerned about the value or price of risky assets. Which is all very well when the going is good, but a change in momentum – such as the global market pull-back – brings with it increased risk, particularly if prices are high. And it’s almost impossible to forecast when that change will take place.
In our own country, if the current positive mood continues, investor confidence will remain high and support the market. But if the euphoria around the ‘Cyril effect’ dies down, or if expectations of a better economic outcome aren’t realised, there’s an increased risk that our market will come under pressure. Investors should therefore not become too complacent, and remember that over the longer term, price will always trump story. As the American economist Benjamin Graham – known as the ‘father of value investing’ – put it: ‘The only thing to fear is the lack of fear itself.’
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