Central banks’ policies aimed at stimulating economies around the world have diverted money into various financial markets, including some of our own, causing price bubbles and distortions.
Although local fund managers prefer to call the high prices that South African markets or market sectors have reached “distortions” rather than “bubbles”, they warn that there could be a retreat from these levels.
Gavin Wood, chief investment officer of Kagiso Asset Management, says low interest rates around the world and massive central bank buying of government bonds have resulted in money flowing into emerging market equities and bonds, creating significant distortions in the prices of these assets.
The flow of foreign investment into South Africa is causing a huge distortion in the prices of consumer-orientated industrial shares, pushing their prices to levels well above what the fundamentals of the businesses justify, he says. Investors in these overvalued shares are at risk of permanently losing a portion of their capital, Wood says.
Dibanisa managing director Craig Chambers says a price bubble appears to be forming in the global information technology sector, as well as in the consumer goods sector and other “defensive” sectors (those where shares do well even when the economy is performing badly). A herd mentality among investors has created a demand for these shares, driving up their prices, Chambers says.
Neville Chester, senior portfolio manager at Coronation, says when central banks’ policies force interest rates to remain at very low levels, resulting in negative real (after-inflation) interest rates, investors are compelled to take on more risk to generate returns.
When interest rates normalise, there will be a big shake-out in a number of asset classes, he says.
John Kinsley, managing director of Prudential Unit Trusts, says although various sectors of the local market are expensive, Prudential will not go as far as to characterise this as a bubble.
However, this doesn’t mean investors shouldn’t be cautious, because there could be a meaningful correction in the prices of expensive shares – and this is typically characterised by capital losses for investors, Kinsley says.
One way to tell if a market is expensive is to consider the price-to-earnings ratio (p:e) of all its shares.
The p:e of a share shows the price of the share relative to the profits or earnings the company has earned – its trailing p:e – or will earn (usually in the year ahead) – its p:e on forward earnings.
A market’s current p:e is often compared with its long-term average p:e to see if the shares in the market are expensive or cheap.
Managers say the local equity market has a trailing p:e of 14, which is in line with the market’s average p:e of 15 over the 10 years to the end of September. Managers’ forward p:e’s range between 12.5 and 13.2, which, they say, is not out of line, either.
However, Craig Pheiffer, general manager of investments at Absa Investments: Private Client Asset Management, says the local equity market is a story of two halves: non-resources (financial and industrial) shares and resources shares.
The FTSE/JSE Financial and Industrial Index is on a heady p:e of 22 and is looking expensive, whereas the resources sector is on a p:e of 11 and is looking cheap relative to its historical levels, he says.
Andrew Dittberner, senior investment manager at Cannon Asset Managers, says resources shares are at their lowest valuations (price relative to earnings or profits) in over a decade.
Clyde Rossouw, manager of the Investec Opportunity Fund, says the earnings of resources shares are depressed, and the prices of some shares – such as Sasol, Implats and Assore – could rise.
Non-resources shares are “quite stretched” and are trading on high p:e’s. In particular, the shares of companies whose activities are limited to a single region look very expensive, Rossouw says.
Kinsley agrees there are significant differences between the valuations of different market sectors. Although resources look cheap, Prudential believes there are risks to future earnings in this sector.
Industrials and financials, on the other hand, have run fairly hard and are on the expensive side, he says.
More specifically, consumer shares have experienced a phenomenal run lately and are up about 40 percent on their value 12 months ago. Prudential would certainly argue that this sub-sector is looking expensive, Kinsley says.
Kinsley says Prudential believes the bond market is expensive and the listed property market is expensive relative to its long-term history, but Pheiffer disagrees, saying these sectors are fairly priced.
Alan Ehret, director of business development at Stanlib Retail, says in the fixed-interest market, the yields offered on South African instruments remain attractive when compared with the yields offered by developed markets (currently, less than two percent).
Rossouw says listed property is definitely expensive and dividend yields are below those of bonds. The prices of these shares could fall.
Bonds are expensive relative to their historical prices, but, given that South Africa’s level of indebtedness (debt-to-gross domestic product) is still manageable, bond prices are not too high, and it is likely that bonds will continue to out-perform cash, Rossouw says.
Ehret says the only bubble that Stanlib sees forming is in the bond markets of the developed world, where central banks’ monetary policies and historically low interest rates have squeezed bond yields almost as low as they can go (and therefore bond prices are high). If that bubble bursts and yields spike, money will flow out of South Africa, he says.
Regarding global equities, Pheiffer says the next few months will show whether companies will continue to produce good profits.
Cost-cutting has enabled many international companies to report acceptable profits, but in the longer term companies need sales to rise and business to expand, he says.
‘OFFSHORE EQUITIES OFFER GOOD VALUE’
Despite the worldwide economic problems, most local asset managers are looking to global equities to deliver the best investment opportunities in the medium term.
Neville Chester, senior portfolio manager at Coronation, says Coronation is still of the view that global equities – and, in specific regions, global property – will offer the best returns over the long term, due to more favourable valuations relative to their earnings outlook.
Clyde Rossouw, manager of the Investec Opportunity Fund, says dependable, income-oriented, high-quality offshore equities will remain a key driver of returns.
John Kinsley, Prudential Unit Trusts managing director, says Prudential believes there are good opportunities in developed market equities, and it is finding opportunities in quality companies in Germany and Asia, specifically South Korea. Selected equities in Germany and South Korea offer much better dividend yields than their counterparts in South Africa, he says.
Kinsley says Europe is still very attractively priced.
Alan Ehret, director of business development at Stanlib Retail, says global markets are still offering better value than local markets, because global markets have stagnated over the past 12 years and it costs less to raise capital abroad than in South Africa.
Kinsley says government bonds in developed markets are expensive, and Prudential would much rather invest in blue-chip corporate bonds, where the yields are better than on equivalent government bonds.
Locally, asset managers agree that cash is not the place to be.
Cash returns will continue to be low, and, once you consider tax and inflation, you do not want to be in cash for an extended period of time, Craig Pheiffer, general manager of investments at Absa Investments: Private Client Asset Management, says.
Kinsley says Prudential is more positive about the value that local corporate bonds offer relative to local government bonds.
Pheiffer says as long as global interest rates are kept low and South African bond prices stay where they are, it is likely that investors in local bonds will continue to be rewarded with returns of seven to eight percent.
Most managers say there are opportunities for stock-pickers in some sectors of the JSE.
Pheiffer says you can expect an annual return of between five and 15 percent from local equities.
Ehret says Stanlib sees value in the financial and the resources sectors, although these sectors are now more risky because of uncertainty about economic growth in China. Selected industrials, such as construction shares, still offer good value, he says.
Rossouw says it is now more important than ever to diversify across markets and asset classes.
Ehret says you should allow the manager of a balanced unit trust fund to decide on your behalf how to move your money between asset classes and regions.
Pheiffer says the rand has weakened as a result of industrial unrest and the problems highlighted by the recent downgrading of South African bonds by ratings agencies. These problems include limited opportunities to expand government spending, growing government debt and political uncertainty, he says.
Over the medium term, a weaker currency will manifest itself in a weaker market, all other things being equal, Pheiffer says.