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Global and local investment markets remain volatile as investors battle to navigate the consequences of higher inflation. The market is obsessed with whether inflation stays higher for longer or if it is pivoting and ready to decline, with its trajectory described as looking either like Table Mountain or the Matterhorn.
JSE All Share Index
Selective markets offer attractive value
Barring the US, the rest of global markets offer attractive value, despite some cautious views that inflation may stay higher longer, which we believe is unlikely, given central bankers’ determination to drive inflation down by sharply raising interest rates.
The chart below shows the global MSCI Index’s (ex the US) forward P/E ratio, at an approximate 20-year average. This is attractive given that we are most likely at the top of the interest rate cycle. The US P/E valuation is elevated due to the tech sector’s euphoria over AI (artificial intelligence), which we cover later.
SA Equities are historically cheap
The ‘forward-looking’ scatter graph below tracks the JSE’s historical performances for the next 5 years when its (JSE’s) P/E (price/earnings) valuation reaches certain levels. Generally, the lower the P/E the better the future returns. Based on historical market performances, when the JSE is at current levels, namely a P/E ratio of 11.4, the subsequent five-year average annual real (above-inflation) returns have been 8.8%. This is 2.3% higher than the long-term average real returns, which is significant, and highlights the current attractive entry point that SA equities offer.
Key global themes
Inflation higher for longer?
US core inflation in August dipped to 3.9%, well off its recent peak of 5.5% in 2022. The target range is 2% to 2.5%, but when it will be reached is debatable. Key indicators signalling lower inflation are rising unemployment, which is still at a low 3.8% and lower wage growth, which has moderated down to 5.7%. Unemployment needs to rise above 4% and wages need to ease further for inflation to drop into the target 2% to 2.5% range.
US Core Personal Consumption Expenditure Inflation
Euro Area Inflation
Global economic slowdown
Global GDP growth for 2023 is expected at 3% and to slow to 2.7% in 2024 as the effect of rising interest rates take hold.
China’s slowing economy
The World Bank cut its growth forecast for China in 2024 to 4.4% from 4.8%. A slowing Chinese economy is also reducing global trade which declined 3.2% (year-on-year) in July.
China consensus GDP forecasts
In China, consumer and business confidence is low and youth unemployment is over 20%. An unbalanced economy is part of its woes, with consumption and investment spending comprising 37% and 42% of GDP, as opposed to advanced economies of 60% and 20% respectively.
The MSCI China Index is down 50% off its 2021 highs and is trading at a relatively cheap 10x price/earnings multiple.
However, while the rest of world is fighting rising inflation and raising interest rates, China is worried about deflation and is cutting interest rates to stimulate its economy, which makes its relatively cheap equities attractive.
The AI (artificial intelligence) phenomena
The digital revolution started in the 1980s with the introduction of the internet, which has materially changed our daily lives. It’s made the world far more productive leading to companies being more profitable.
AI, the latest digital invention, has seen tech shares soaring. However, over the long term, the real winners, akin to the internet, are companies that utilize this technology to enhance their businesses. Below is a forecast by the World Economic Forum of predicted AI usage in different industries.
% of firms proposing to use AI by 2025
Be careful of chasing the winners
As with the IT bubble in 2000, one needs to caution against the significant spike in tech shares this year, which is largely driven by AI hype. The graph below shows the five largest shares as a percentage of the US stock market in 2000 and their diminishing contribution thereafter, i.e. underperformance. Currently, the magnificent seven (Nvidia, Meta, Amazon, Microsoft, Apple, Alphabet and Tesla) contribute 23% to the US market, with expensive valuations near twice the level of the rest of the US market.
It’s tempting to chase these success stories, but there’s a cautionary tale about being late to the party and suffering a similar underperformance experienced by the top five companies after 2000.
SA’s economic and political woes remain
Government debt spiral fear
This fear has reared again as government expenditure in 2023 is exceeding budget. Its austerity policy introduced last year has been questionable. Furthermore, we believe it is a tall order to execute for this ANC government that is at risk of losing its majority in next year’s election. It has conflicting agendas, whereby it needs to appease its supporters with grants and higher wages.
This year, there is an estimated 10% (R40bn) revenue shortfall due to lower commodity prices and expenditure is expected to be R30bn higher largely due to unbudgeted wage increases. Overall, an estimated budget deficit of R50bn is likely, which will push our debt to GDP ratio above its targeted 72.2%.
We have always highlighted rising debt as a long-term risk, which has underpinned our long-term negative view on the Rand. The only sustainable way to reduce debt is through economic growth, which remains anaemic.
Economic growth remains low
The Reserve Bank increased its 2023 GDP forecast to 0.7% from 0.4% in July and kept its 2024 and 2025 forecasts unchanged at 1.0% and 1.1% respectively.
Core inflation for 2023 is revised down to 4.9% (5.2%) and forecast at 4.7% and 4.5% for 2024 and 2025 respectively. This is good news for interest rates and supports the view that SA interest rates are pivoting down.
El Nino and food inflation
An El Nino weather phenomenon for the summer season is expected to bring below-average rainfalls and is a risk to food inflation. Previous El Ninos have driven food inflation up by around 10%.
Next year’s election is daunting
Numerous surveys have different predictions. But it does seem like the ANC maintaining an outright majority is unlikely and that a coalition government will be formed. Although this is daunting, given the ANC’s neglect of the country, any change may be better, barring the unlikely inclusion of the EFF.
The Rand is expected to remain volatile
The Rand/Dollar has retraced from its spike to 19.8 in June but remains very volatile with the renewed fears of a government debt spiralling and the negative effects of a volatile US Dollar as markets try to anticipate future interest movements.
Our Rand/Dollar fair value is 17.8, which is a 25% risk premium above purchasing power parity of 14.2, due to SA’s weak economic outlook, rising debt and dysfunctional ANC government.
The Prosperity Fund continues to produce good steady returns
The Prosperity Worldwide Flexible Fund of Funds (managed by Investonline director, Nick Brummer) has returned an average annual return of 8.5% (net of fees) since inception (Sep 2014).
The fund is conservatively managed with an emphasis on capital preservation. It is well suited for investors who want offshore exposure and a steady investment return.
Investment Market Outlook
Selective global markets are attractive as we reach the top of the interest rate cycle. These markets are European, Emerging Market and SA equities, and broad-based global and local bonds.
SA equites are particularly cheap per their 20-year low P/E valuations and the likelihood that interest rates are turning down.
JSE All Share Index P/E ratio
Most importantly, global central banks are determined to reduce inflation, which they have been doing by initiating sharply rising interest rates. Although this may lead to an economic recession in the short term, longer-term, lower inflation will afford lower interest rates and stimulate economic growth.
Currently, most of the potential economic recession or slowdown is priced into markets, in our opinion. Therefore, investment markets offer attractive long-term valuations.
Review your Investment Strategy
Ensure that your investment portfolio remains properly balanced and adjusted to suit your personal risk profile to achieve your goals and 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.
