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Global markets rallied sharply (up 6% in USD) in the third quarter as US interest rates were forecast to decline faster than expected. In South Africa, a wave of optimism returned with the successful formation of the GNU, boosting the JSE All Share Index by 15% in USD or 10% in Rands.
Part of our quarterly market outlook includes predictions of market opportunities and risks. Our main view is that US equities are expensive and carry above-average risk. Other developed markets (mainly the UK and Europe) offer better value, while emerging markets overall are cheap and attractive. We maintain that South African equities offer value, especially in the more local SA Inc. sectors.
Leading up to the South African election, we published the likely market effects given certain election outcomes. One possible outcome was a coalition between the ANC and DA, which has effectively been realized through the GNU. With this outcome, we predicted that over the following 12 months, SA Inc. shares would rise by +30% and the Rand would strengthen to below 17.
Since the South African election, SA Inc. sectors have increased by +30%, with banks up +30%, retailers up +40%, and the small-cap sector up +20%. The Rand/Dollar strengthened from 19 to 17. We believe these sectors have further potential for growth and that the Rand may strengthen further, which we will address later.
Key global investment market drivers remain the speed at which interest rates will decline, the strength of the Chinese economy, and, in South Africa, gaining confidence in the effectiveness of the GNU. The ongoing conflicts in the Middle East and Ukraine do not currently appear to be major market issues, but they will become significant if material escalations occur.
Key Global Market Issues:
Interest Rate Cuts – In September, the US cut interest rates by 50 basis points, more than expected, which boosted markets. Subsequently, the US job market reported stronger-than-expected results, suggesting that inflation may remain higher for longer. Speculation is growing that rates may not decrease as quickly as anticipated. Over the longer term, we expect interest rates to come down, which is good for equity markets. However, markets have become too focused on the short term, leading to continued high volatility driven by computer trading.
US Interest Rates
US inflation rates
Record High US markets
US equity markets are at record highs as they price in the anticipated economic benefits of lower interest rates over the next few years. Although it’s difficult to time markets, entering at a high point can have a long lag to achieving positive returns, as shown in the graph below:
US Equity Market Valuations are Historically High
US Market mostly driven up by big tech.
Big technology companies incorporating the Magnificent 7, now comprise a staggering 29% of the S&P 500’s capitilisation. They have mostly been driven up by AI (Artificial Intelligence) hype and their valuations are some 50% higher than the rest of the market, which we believe is posing a threat to US equity markets.
Magnificant 7 and S&P 500 forward P/E ratios
China’s Market Recovery
China’s equity market has collapsed over the last three years as its economic growth has slowed and investors have lost confidence in the stability of its financial industry.
This has lead to the Chinesse market being significantly oversold as foreign investors withdrew, resulting in very low valuations.
Recently, the government has announced significant economic stimulus packages, prompting investors to rush back in and causing the market to spike by +30%.
China is an important economic growth engine for the world and forms an important part of the emerging market sector, which we believe is attractively priced.
With global interest rates starting to decline, emerging market economies should benefit significantly and a strong US dollar is likely to weaken. These factors should support emerging market outperformance.
Escalating Middle East and Ukraine wars
Generally, markets do not believe this will happen and hopefully global powers can assist in a de-escalation and avoid further conflict that is dividing the global population.
The US Election
Latest polls show it is difficult to predict a winner. But as we have written about it previously, we do not believe a result either way will have a material impact on investment markets due to the probable stale mate of parties in Congress and the Senate.
Key Local Issues:
Confidence in the GNU – Having a functional GNU is critical for economic improvement in SA, as it will bring much-needed confidence that government is being constructive and held accountable, which is essential for attracting foreign investment inflows.
Foreign investor SA bond and equity flows
Foreign investors are starting to return to SA, buying government bonds, which is very positive. Surprisingly there are still net equity outflows, despite the strong performance of the local market over the last three months.
GDP growth to surprise on the up – SA GDP growth is forecast to grow only 1% in 2024 and then below 2% for the following two years. We believe the two-year forecast is too low for the following reasons:
- Load shedding is likely to be over – It is now 190 days without load shedding, driven mainly by lower demand due to solar installations, and improved output from coal stations. It was estimated that loadshedding last year extracted 2% from GDP growth.
- Rail and Port improvements – Although significant upgrades are needed, which will take many years, small improvements to our freight lines and port delays are already driving up volume growth.
- The retirement two pot withdrawals – It is estimated that between R50bn to R100bn will be withdrawn from retirement savings over the next 12 months, with the majority expected to be spent on consumer goods. This is beneficial for retailers and should add at least 0.5% to GDP growth.
Declining Interest Rates –  Interest rates are expected to decline by at least 1% over the next 12 months as inflation dips well below Treasury’s 4.5% target range. This will bring welcome relief to a very indebted consumer and should uplift a supressed consumer spending base.
SA inflation and Electricity Prices
With SA inflation forecast to decline to near 3% in 2025, along with the benefits of lower fuel prices and a stronger Rand, there are concerns that a potential +30% increase in electricity prices could derail this much lower than expected inflation.
Although this graph is showing potential further price increases, these increases have not been approved. SA Treasury, who manages our fiscus, still has a 12% electicity increase in their 2025 inflation forecasts.
Electicity comprises 3.7% of the CPI basket and therefore a 30% increase will have around a 0.5% direct effect on overall inflation.
Relative to the rest of the world, SA has the 42nd highest electricity prices. Our $0.21/kwh is higher than the USA’s $0.18kwh but lower than Germanys $0.36kwh.
A Stronger Rand to Continue
The Rand has strengthened significantly from 19 to a low of 17 over the last four months, post-election. With the formation of the GNU, there is some political confidence and positivity surrounding SA’s economic growth prospects, which is key to stemming our high level of debt. This reduces our risk of a debt-spiral-crisis and returns some normality to the value of the Rand.
The Rand’s fundamental value against the US Dollar (R/$) is determined by purchasing power parity (PPP), which reflects what R1 can buy compared to US Dollars. Our model currently estimates PPP to be around 14.5.
However, due to economic risks like high debt, low growth, and a dysfunctional government, a risk premium was added to the PPP valuation, ranging from 20% to 30% as these risks fluctuated.
As these risks are mitigated, particularly the removal of the debt trap with improved growth prospects, the risk premium should decrease, leading to a stronger Rand. Historically, this premium has even fallen to zero, but that only occurs in exceptionally favourable conditions, and evidence of such a scenario might take time to emerge.
We believe that a stable governing coalition (GNU) adhering to the ANC/DA agreement could propel the Rand below 17 against the Dollar over the next year.
The Prosperity Fund Celebrates 10 years of Outstanding Performance
We are delighted to celebrate the Prosperity Worldwide Flexible Fund of Fund’s (Prosperity) 10-year anniversary as it has generated superb, annualised compound returns of 10% per annum. Simply put, a R1m investment 10 years ago, is now worth R2.5m. To date, total assets under management are R475m.
Prosperity fund performance since inception (19 Sep 2014)
Its unique investment management style primarily involves taking short-term tactical positions in asset classes that are irrationally priced, based on a combination of top-down and bottom-up fundamental research. To a lesser extent, longer-term strategic positions are included when major market opportunities are identified.
The Fund prioritises capital preservation through conservative management. It caters to investors seeking a balanced portfolio with local and international exposure, offering consistent investment returns.
It represents Investonline’s in-house investment market views, which we attempt to replicate over our different investment risk strategies for our clients.
Investment Strategy and Outlook
Globally, we view US equities as expensive. In developed markets, the UK and Europe offer better value. Overall, we prefer Emerging Markets, as the valuations are low and the interest rate cutting cycle has started, which favours the sector.
We remain positive on SA equities, despite their robust growth over the last four months, post-election. With better-than-expected economic growth in 2025 and 2026, a potential influx of foreign investment could push SA equities, especially the SA Inc. sectors, significantly higher over the next two years.
SA All Share Index P/E ratio
Review your Investment Strategy
With widening global investment valuations, ensure that your investment portfolio is correctly balanced and adjusted to suit your personal risk profile to achieve your goals. Check that your financial plan is up to date. It is critical to ensure that the risk you take in your investment portfolio matches your financial plan, especially when nearing or during retirement.
