Economic outlook differs for the emerging and advanced nations
The outlook for global economic performance in 2013 is double edged. On the one hand, we expect the dynamic, emerging markets – countries such as Indonesia, India, China, Chile, Nigeria, Vietnam, Kenya, Turkey and Ghana – to maintain strong economic growth supported by positive structural factors. These structural factors include rising connectedness on all fronts (trade, investment and infrastructural corridors); increasingly stable and coherent economic policies; positive demographic forces, including steady improvements in human capital; and the effective translation of savings into productive investments.
Alongside positive economic growth that is above the global average, these countries are likely also to display ongoing evidence of rising competiveness, such as lower volatility in key macroeconomic variables and a rising share of foreign direct investment and international trade flows. These positive forces should also mean a growing presence of south-south economic relationships that exist (and thrive) independently of economic events elsewhere.
South Africa sits on the edge of this set of dynamic, emerging economies – while we belong to this dynamic set our membership is qualified. Factors that will aid our economic performance in 2013 include robust macroeconomic policies, especially monetary policy. Rising connectedness with sub-Saharan economies, which are amongst the fastest growing in the world, will also help. In 2012 South Africa’s exports to sub-Saharan Africa grew 20.8 percent compared to exports to the rest of the world that grew just 1.4 percent. Rising connectedness will also flow from South Africa’s strong corporate balance sheets, which are cash flush and ready for investment opportunities. Another positive factor will be some improvement (albeit still grossly inadequate) in human capital.
The factors that qualify our membership are those that work against us, and education and healthcare are South Africa’s two greatest structural headwinds. Yet these factors are inside of our control, which leaves me on balance positive – but not yet ebullient – for South Africa’s longer-term economic prospect. Near term, we must deal with social disruption, entrenched unemployment, a dwindling manufacturing sector and policy uncertainty.
However, by far the greatest near-term effect on South Africa’s economic progress will be the performance of advanced economies – including Japan, US, UK and Western Europe – to which our economy remains closely tied. The factors that ail the advanced world in 2013 are the same as 2007 – as a result, the advanced world essentially has achieved zero economic growth in the last five years. In other words, the ailments plaguing the advanced economies are structural in nature. Unfortunately, the policies that are in place in these economies do not address structural issues – including demographic decline and massive indebtedness – but rather they are cyclical in their treatment, using aggressive fiscal and monetary policies to treat material structural weaknesses.
These policies have not worked between 2007 and now, and are unlikely to suddenly start working in 2013. For these reasons, I expect a year of muted economic performance in the advanced world in terms of growth.
Consumer price inflation could be sparked by the spectacular printing of money that has occurred over the past six years. This is unlikely, though, for two reasons: while money is easy, the appetite for credit is extremely low. This is a classic liquidity trap. Moreover, even if consumer prices are ignited by credit spending, I expect political administrations in the advanced world will do all in their power to report low price inflation and repress any call for tighter monetary policy (higher interest rates).
What policy makers cannot control are global commodity prices, and against this backdrop, I expect commodity prices to remain firm in 2013 supported by easy money and concrete growth in the aggregate world economy. Indeed, in the first few weeks of the year iron ore prices and manganese prices have scaled to fresh highs.
The moribund outlook for advanced world economic growth can be captured by the case of the US where the successful negotiation/navigation of the so-called fiscal cliff at the start of 2013 was much celebrated. However, it does nothing to change the fact that economic growth is a function of three key influences: population growth; labour absorption rate (the proportion of the working-age population aged 15-65 years that is employed); and productivity gains.
To illustrate this, between 1951 and 2000, US economic growth was 3.3% per annum. This was underpinned by annual growth of 1.4% in population, 0.3% in the labour absorption rate and 1.6% factor productivity. Chris Brightman of Research Affiliates expects US economic growth over the next 20 years to be just one-third of the annual 3.3% recorded since 1950, dragged lower by much slower population growth (0.7%) and a declining labour absorption rate (-0.2%) along with more muted productivity gains (0.5%). In short, slower growth in the advanced world is structural in nature and is likely to be with us for a very long time.
This is positive in some important ways, including pushing down on gross consumerism and offering some relief from resource consumption and depletion. However, from a very near-term economic perspective, and in terms of raw numbers, the unhealthy state of the advanced world will act as a headwind to economic growth in closely-related economies, such as South Africa.
Against this backdrop, I expect the South African economy to record positive-but-low economic growth in 2013 (greater than 2.5% would be a notable outcome) and interest rates will remain low because of low rates in advanced economies, sluggish local economic performance and domestic social pressure.
The rand will be heavily influenced by progress in Europe with regard to fiscal and monetary consolidation. Although extremely tough to call, I believe that the euro will hold together, which will be to the rand’s advantage. Whilst domestic issues also threaten the local currency, our models measure the rand as significantly oversold. On a purchasing power parity basis – arguably the single most robust currency valuation tool – fair value for the rand against the US dollar indicates our currency to be as much as 35% undervalued.
SA resource stocks and domestic industrials offer the best investment opportunities for 2013
On balance, the above scenario points to the economic setting of 2013 being modestly supportive for risky asset classes, whilst little will change for lower-risk asset classes. More specifically, for global cash the outcome is likely to be more of the same: as close as possible to rock-bottom interest rates in the advanced world, with emerging market currencies shifting about to deal with individual dynamics. For South Africa, I think the chance of a rate cut – even if modest – outweighs the chance of a rate hike. The most likely scenario is a year of the repo rate flat lining.
For bonds, I remain fearful of exposure to sovereign bonds in just about all advanced economies. Government balances sheets and income tax revenue streams that sit behind these bonds are flimsy, at best. Still, the sovereign bond market will enjoy the support of near-term rates that are kept ultra-low and longer-term rates that central bankers try to keep low. Emerging market sovereign bonds need to be considered on a case-by-case basis. For South Africa, the government balance sheet is strong, fiscal policy is reasonable and monetary policy is exceptional. As such, I think South African bonds are a better credit risk than many advanced country bonds. But given our structural inflation rate and current interest rates, my view is that further sovereign bond gains have the element of looking for the last pull out of a smoked cigar. Corporate bonds – globally and in South Africa – are another matter. As a collective, corporate balance sheets are strong, and if yield is on offer this is a position that holds far better prospects than the bulk of the sovereign bond market.
Considering property (chiefly listed commercial, industrial and retail property), the key drivers are real economic growth, price inflation and interest rate levels (and stability). The investment case then needs to be made against the backdrop of property prices relative to these drivers, with a careful consideration of country-specific attributes. For South Africa, I venture that property prices are fair, and will enjoy modest support from low-but-positive economic growth, modest price inflation and stable interest rates. This leads me to be marginally bullish on domestic property. I think risk is managed best here by placing emphasis on quality as much as price, given the domestic setting.
Last, with regard to equities, the environment looks supportive – but not rambunctious. Earnings – the key driver of equity value – should improve. Thus, valuation is key. The US, the world’s biggest equity market, looks expensive on a cyclically-adjusted price-earnings (CAPE) ratio of just over 20 times (a multiple of 16 times, translating into a real yield of 6% is considered fair value). However, the expensive end of the spectrum is dominated by emerging economies, such as Turkey, Asia ex-Japan, Latin America and China. The attractive end of the market is dominated by advanced markets, such as Ireland, Italy, the Netherlands, France and Germany. Our thematic argument for 2013, then, remains to seek well-priced companies – most likely found in advanced markets – that are exposed to global (and/or emerging) market drivers. A classic example is a business such as BMW.
With regard to South African equities, the CAPE ratio is rich, but masks the fact that the South African market hosts two extremely well-priced opportunities, namely commodity firms (that are on multiples last seen during the meltdown of 2008 and, before that, at the end of the early-noughties’ bear market) and domestic industrial firms which have strong balance sheets, good earnings records and have been overlooked by international investors.
As always, it is hard to know what a specific year will deliver, but from an investment perspective, I think that South African-listed resource firms and domestic industrials represent the two best equity investments in the current setting.