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The NICE decade for equities


In today’s newsletter we have a view from Max King of Investec on global equities and we share some thoughts on the local market from Sanlam Senior Equity Analyst Andrew Kingston

The NICE decade for equities

Max King, global strategist, Investec Asset Management, examines the long-term outlook for global equities

Mervyn King, the Governor of the Bank of England, recently warned of “the end of the NICE decade.” NICE is an acronym for Non-Inflationary Credit Expansion, but it was also pretty nice for consumers and governments.

In the last twenty years, the “Phillips curve,” the trade-off between unemployment and inflation, ceased to be a constraint.  In the OECD, unemployment has fallen from nearly 8% in 1994 to 5.5% now, despite a temporary pick-up in 2001-3, while core inflation, over 10% in 1988 and still over 4% in 1994, fell to under 2%.

Consumers enjoyed a virtuous circle of falling interest rates and lending margins, greater availability of credit, rising house prices, an expanding economy and rising salaries. Governments enjoyed the benefit of low bond yields, increasing market appetite for debt, rising tax revenues, escalating expenditure and the illusion of economic competence.

That has all changed. Lenders have stopped lending, forcing consumers to stop borrowing and therefore to spend less. The threat of ballooning budget deficits is forcing governments to restrain public spending. Property prices are falling, living standards are under pressure and economic growth is slowing. The virtuous economic cycle has gone into reverse, compounded by the spiralling cost of commodities.

Equity investors, however, missed out on the party. In mid 1998, profits were growing rapidly, Asia and emerging markets were booming, the technology sector was starting to take off and every mega-cap merger was greeted with soaring share prices. Though markets continued upwards until the millennium, that proved to be only the first leg of a ten year roller-coaster. Over those ten years, the 3.5% annualised return of the UK All Share index and the 2.5% return of the S&P scarcely kept up with inflation. The annualised return on the MSCI World index has been 4.7% in Dollars, but only 2.8% in Sterling and 0.9% in Euros.

Bond investors have done rather better, with UK gilts and US Treasuries returning over 5% annualised. So much for the notion of equities for the long term and for the long-term evidence of excess equity returns averaging 4%. The actual figure has been -1.7% in the UK, -2.8% in the US and -1.8% globally.

Warren Buffett once commented that “the mistake that investors repeatedly make is that they are habitually guided by the rear-view mirror and, for the most part, by the vistas immediately behind them.” This should serve as a warning not to extrapolate the past 10 years into the next. The economic outlook now is as gloomy as it was rosy in 1998, but equity markets have been progressively de-rated to the lowest multiple for over 20 years.

This leads us to make one very confident prediction: over the next 10 years, equity returns will handsomely beat both inflation and the returns from government bonds. The nice decade for the economy may be over, but the nice decade for equity investors is about to start.  

Good value for the patient

Andrew Kingston, Senior Equity Analyst at Sanlam Investment Management, says we have seen a divesting of equities over the last six months and the large institutions have high cash holdings. “At some point this will flow back into the market. But as a trend world markets and the direction they may take is very unclear and many are waiting for more clarity before moving back into the market.”

Kingston says that foreigners have been neutral on SA equities of late. There has been support of broadbased resource shares but generally foreigners are underweight South African equities.  The more popular resource counters are platinum and Sasol, both of which are more niched and unique to South Africa.

Kingston manages the SIM Industrial Fund. One of the big advantages with industrials as a sector is that in itself it is diversified so you are not hostage to any one particular sector. There is a variety of shares to choose from, and there are local and international shares in the sector. Kingston says industrials are driven primarily by interest rates.

Is there a clear direction on interest rates? Kingston says the recent move in bond yields could be an indication that interest rates would start coming down in 2009.

Essential to good fund management in this climate – stock picking and looking for good ideas.

Africa has definitely come to the fore and Kingston says it is flavour of the month as investors are starting to feel it is more stable and is offering good long term returns. “It’s definitely a theme but the investable universe is quite small as there are not a lot of listed shares. There is a lot of scope in the long term.” Telecoms are a definite theme as are some of the consumer industries. There is a lot of expansion in Africa from the local banking and telecoms sectors and companies like Shoprite. In addition in Africa there is a lot of consolidation in the telecoms industry.

For the rest of the year, Kingston says “we are very cautious but recognize that there is reasonable value in the market – especially in financials and industrials in the long term. Banking shares have come down a lot, and locally are good businesses but are affected by international events like sub prime.” The international market does not look like picking up soon and it is difficult for industrials to outperform when international markets are so slow.

“There is good value but generally you have to be patient and on a three or more year view.”

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