Local assets offering better returns this year, but value trap on the horizon
US and South Africa (SA) elections as well as rising geopolitical tensions are presenting increasing investment risk moving this year.
On the flip side, local assets could deliver strong real returns next year as SA is expected to enjoy some interest rate relief and improvement in energy availability, but longer term, local assets are offering a value trap.
Examining key themes influencing the markets
Looking ahead to 2024, we have identified four key themes that will drive our investment decisions next year, which ultimately all underpin our investment outlook. Our first theme, called ‘Global Cycle Down’, holds the view of an imminent US and EU recession. We still anticipate that the lagged impact of global rate hikes is likely to trigger a recession in both these regions, as we’ve not yet seen the full impact of restrictive monetary policy. We’ve therefore positioned our portfolios accordingly against this view.
The key implication of this is that this environment is going to be bad for risk assets and we therefore prefer cash and bonds over equity, as well as cheap defensives over quality stocks.
Locally, 2024 will likely see better growth, but the trend will be anaemic. This is summed up under our theme of ‘SA a long-term loser’, which is driven by expectations around low growth, failed state-owned enterprises (SOEs), political uncertainty and a general lack of reform implementation. While this year is looking like it could yield better local returns thanks to interest rate relief and better energy availability, longer term, we ultimately see SA assets as a value trap right now.
‘Peak Rates’ is another key theme for 2024, based on our belief that short rates have peaked globally. With cyclically lower inflation and weaker growth, central banks can pause with cuts to follow. We expect global rates to start coming down towards the second half of next year, with local rates following suit. Against this backdrop, we prefer SA bonds, global bonds, cheap equity with rerating potential.
With constantly evolving geopolitics and a trend around deglobalisation taking front and centre in 2023, a ‘A New World Order’ is our fourth and final investment theme influencing investment decisions for the year ahead, which is driven by a secular change in the global landscape.
US recession inevitable
While the US consumer has been surprisingly resilient in 2023 and provided US GDP growth with a positive once-off shock, these tailwinds should fade in 2024 and the inverted yield curve still suggests a high risk of recession in the US. Given current inflation still being too high and an understaffed labour market, the Fed will need to maintain a tightening bias. This approach, combined with concerns around tightening credit by US banks, increasing delinquencies and depleting consumer cash levels, is likely to impact the resilient growth we’ve seen to date.
With a US election on the horizon for later this year, Swartz says that a recession would undoubtedly be damaging for President Joe Biden’s re-election hopes. But on the other side of the coin, you have Donald Trump facing multiple legal challenges. For us, it’s the policy implications that we need to watch. Historically a larger deficit at the start of a presidential term leads to some fiscal restraint, however it is highly unlikely that either of these two candidates are likely to tap the brakes on spending from 2025, and thus we do not hold out much hope of an improving US fiscal situation.
Short-term gain, long-term pain for local assets
Looking at local assets, a cyclical improvement in the energy crisis and interest rate relief will drive stronger real returns in SA this year. 2023 was most likely the peak of the energy crisis, with increased capacity coming back online in 2024, as power plants such as Kusile and Koeberg come back into service, and a groundswell in renewables and private generation bringing us back down to a happy medium of stage 1 load-shedding in 2025.
With regard to interest rate relief, while all of the last three MPC meetings have held rates on hold, the last meeting was the first one where the decision was unanimous, indicating a stronger leaning more towards cuts as the next move, and in addition, the upcoming petrol price cuts will give the MPC more room to ease monetary conditions during the year.
There is also the very significant issue of the SA elections to consider, expected to take place in the first quarter of 2024. The polls are showing ANC voters sitting at just under 50 percent. Our position is that this outcome is likely, and the ANC will only need to form a coalition with a smaller party. The two market shock results we’re watching out for, however, will be an ANC/EFF coalition and an ANC/DA coalition.
However, while cyclically, local assets could have a good 2024, on a secular basis we are still negative on local markets given the secular risks facing the economy and believe it will offer a value trap over the longer term. Unless the government can lift long-term potential growth via growth enhancing reforms and resolve the long-term fiscal risks, local assets will not be an investment destination of choice outside of a cyclical commodity upswing and remain appearing as compelling value with no catalyst to unlock that value. DM/BM
Author: Jason Swartz, Portfolio Manager, Old Mutual Investment Group