Offshore equities still offer real returns, and so do local bonds


With the plunge in the rand/dollar exchange rate, most of the economic news of the last few weeks has focused on either the currency or the rate hike – and been pretty gloomy to boot. But according to Old Mutual’s Peter Brooke, it’s not all bad news. Indeed, he finds a lot to be optimistic about when looking at various investment options. He thinks, for example, that international equities will offer real returns over the next year as global cash flows back into developed markets. Looking at the domestic South Africa side of things, he anticipates some good investment opportunities on the fixed income front. As rates rise and investors react to evolving risks, there could be some exciting buying opportunities in bonds or listed property in South Africa. In this interview, Brooke reminds us all that money can be made in any market, if you know where to go. – FD

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GUGULETHU MFUPHI:  Joining us now for a macroeconomic, or market outlook for this year is Peter Brooke head of macro solutions at Old Mutual Investment Group.  Peter, perhaps when you take a look at what’s taking placed on the markets globally, it doesn’t seem as though there’s a positive outlook.  There’s a weak rand, talks of continued tapering as well as this Emerging Markets exit story.  From an equities or market perspective, is the outlook positive?

PETER BROOKE:  In terms of the equity market the outlook has deteriorated and the simple reason for that is, that we had such a good year last year, the market rerated, the PE, the Price Earnings ratio became a lot higher, and therefore, our expected returns fell.  The interesting thing though in terms of asset classes at the moment is, this turmoil is causing fixed income to become cheaper; so both bonds and listed property in terms of our expected real returns.  Just to clarify, if we look at the world and we say ‘what do we expect is going to happen in the next five years and we look at those valuations’…so where we were very negative a year ago, we’ve actually be upping our expected returns from property and bonds.  In the last month, the further selloff has actually started to increase those expected returns even more.

ALEC HOGG:   That’s interesting.  If you have Quantitative Easing, which is creating money hand over fist and creating huge amounts of debt, at some point in time that debt is going to have to be repaid, or heavily reflated, so bonds…

PETER BROOKE:  I think there’s a difference between global bonds and SA bonds.  If you think back, we’ve always had a real return in terms of our inflation-linked bonds.  Now those have actually just increased dramatically in the last month.  Inflation-linked bonds sold off by four percent, so if we do get inflation those assets are still protected and will still give you a real return.  The point I’m making is, where we had negative real returns on global bonds, we’ve now pulled that up to probably nothing, which is still an attractive investment.  On South African bonds, we’ve now increased that from an expected real return of 1.5 percent to two percent, and the next move will be increasing that to 2.5 percent.

ALEC HOGG:   Good thinking…I think everybody can buy that argument, but globally bonds…a little bit scary.  Peter, just to take what we brought back from the World Economic Forum: the Americans are more confident.  They are growing more rapidly.  Europe, also – their problem four: Greece, Spain, Portugal, and Ireland are out of intensive care.  Other parts of the world are looking better.  Japan of course, Abenomics seems to be working…  Developed markets do appear to be in a better shape at the moment.  From your perspective, would there still be value in the equities?

PETER BROOKE:  Yes is the short answer.  We have cut our expected return from global equities because they were also rerated, but in terms of expected real returns from here, I still think you’ll get a decent real return on a relative basis.  Remember, you’re competing with negative to nothing on cash and bonds overseas.  I think equities will still have the edge.  In South Africa it’s a little bit trickier because our market has rerated quite materially and unlike the rest of the world where there macro is getting quite a lot better, we are starting to get rate hikes – providing a head wind.

GUGULETHU MFUPHI: Peter, what about the overall risks involved?

PETER BROOKE:  Look, I think in terms of risks, the big risks are ‘it’s too hot’.  In other words, America grows too fast and that causes short rates in America to come up quicker than we expect, which will be bad for asset markets – particularly equity, I think.  The other risk is ‘too cold’, which is Chinese growth slows down and that’s clearly the risk that’s playing out at the moment with the latest industrial production – PMI numbers – coming out of there.  In both cases, South Africa sits, caught between the two, and that’s really our problem.  We’re the ham on the sandwich, so we get it from both sides.  The other – final risk is Emerging Market contagion, which obviously affects us.  We have a situation in South Africa where we’re hiking rates because of what’s happening on a global basis, and not what’s happening in terms of growth.  In fact, growth in South Africa looks pretty soggy.

ALEC HOGG:   It’s interesting that you mentioned Emerging Market contagion, Peter.  Looking at the Indian situation in isolation, which is an important Emerging Market they’re quite confident that after their election in May, the economic growth yield will go from five percent to eight percent.  The Chinese are confident that 7.5 is their minimum.  Overall, surely, they’ll come back into favour.

PETER BROOKE:  I think in terms of the short term, you have to look at the delta of change, rather than the absolute growth.  The developed world is going from two to three – it’s a plus one.  The emerging world is basically flat, but at a higher level.  In the long run, that better growth – as long as it flows through to better profits, which has not been the case, would favour Emerging Markets.  In the short term however, the rebalancing that is being forced upon them in terms of weaker currency and higher interest rates, puts a severe wind to domestic consumption type growth and shares.

ALEC HOGG:   Obviously, the currency has a big impact when you’re talking about investing not only in the South African market, but also anywhere in the world.  The rand…we don’t have to tell you, has come under a lot of pressure.  Are we at an oversold position?

PETER BROOKE:  I think probably 80 percent of this move was completely justified, and we’re now moving into cheap.  The difficult is that markets don’t settle at fair value.  If you look at the real value of the rand, it doesn’t spend a lot of time around that average range.  It tends to overshoot, both at strength and in weakness, so it’s incredibly difficult to call that.  We are starting to see value.  It’s no longer a one-way bet that it is a weaker rand, but potentially we’re having rebalancing forced upon us.  It was interesting.  It was an article – I think in the Union – saying ‘we shouldn’t have hiked rates’, but the truth is that because our labour is being priced out of the market, because we’ve become uncompetitive through high real wage increases, we can no longer compete.  That’s why the currency was forced weaker and it’s why the SARB had to hike rates.  They were forced by global markets and that basically stemmed from our non-competitiveness.

GUGULETHU MFUPHI: So Peter, for South African investors…how should they position themselves, offshore versus local, perhaps?

PETER BROOKE:  We would still prefer offshore equity to SA equity.  That’s predominantly on a risk-adjusted basis and in terms of the relative value on offer.  I think in terms of the local market, as fixed income sells off we should be looking for opportunities in long bonds and listed property.  That’s really…on a longer-term valuation that’s starting to show a lot of opportunity, and you’re just balancing those off against those risks that I mentioned.

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