The global economy is possibly poised for an extended recovery period, with the US showing the way and the Eurozone still having quite a way to go.
This is according to Old Mutual Equities Strategist, Graham Bell, speaking at the Old Mutual Investment Group Q3 investment briefing. He says the global growth run-rate is rising and, while South African equities are currently looking expensive, they can still perform in a risk-on world.
Speaking about the current economic environment Bell compares economies to a swinging pendulum, saying that when things go severely wrong, they leave significant room for self-correction.
“For example, Eurozone car sales versus consumer spending has reached 20-year lows. This signals a large degree of pent-up demand. Looking at the same comparison for the US, a strong recovery followed collapsed car sales and there is still room there for further upside.”
Bell also uses the US housing market to illustrate the point. In mid-decade too many houses were being built, but after the credit crunch there were too few. “Eventually, the collapse in supply sowed the seeds of recovery and prices have started to rise again. Low periods in the economy are usually accompanied by much pessimism and doubt as the subsequent recoveries are often slow to build, but then pick up momentum over a sustained period.”
Rian le Roux, chief economist at Old Mutual Investment Group, also addressed the conference. He believes that the global economy is making progress despite the headwinds and risks it is facing.
“We are of the opinion that during this process the global financial crisis has been contained, with financial and macro-economic conditions looking far more stable,” he says. “We are starting to see signs of recovery generated by policy stimulus, however this still a relatively slow recovery compared to history.”
When it comes to China, Bell is less optimistic. “China has seen a period of excessive growth in social credit, which is credit extended outside of the banking sector,” he explains. “Overall credit is increasing at a rate of about 20%, while the economy’s nominal growth rate is closer to 10%, creating too much credit in the system. Therefore credit growth needs to be managed down, which is a difficult transition to effect.”
Despite this challenging environment, Bell compares China to a giant corporation under new management and believes it will introduce a number of key reforms in the upcoming Third Plenary session next month to help the transition process. “Fortunately, China has many cushions in the system to absorb any shocks.”
Le Roux believes that China’s growth is facing cyclical stabilisation, although structural downside risk still remains. “China has been growing 10% per annum since 1978 and actual growth has been consistently higher than Government target over the past decade. Recently, however, the gap has closed sharply as actual growth has slowed to more or less in line with the government’s target. Over the medium term the risk is that China’s growth continues to slow, faced with mounting cyclical and structural challenges as well as dealing with policy reforms.”
When it comes to the South African environment, le Roux says we face considerable challenges. “The cyclical growth and inflation outlook have deteriorated while structural problems and challenges are increasingly being exposed,” he says. “The outlook for growth and employment is unlikely to improve much in the near term as a result of cyclical macro headwinds, and we will probably see limited growth and employment enhancing reforms, at least in the near term. The SA Reserve Bank also faces a difficult situation, having to deal with a significantly weaker currency and rising inflation pressures against a background of weak economic and little employment growth.”
Bell agrees and says that the impact of this uncertain environment is causing a major dilemma for South African stocks. “Many industrials look expensive based on earnings relative to long-term trends, while on trend earnings Resources actually look quite cheap,” he says. “However, the big question is whether mining managements will be able to restore long-term earnings given headwinds from rapidly rising costs and excess supply.”
Overall, Bell believes the South African market looks expensive, especially relative to emerging markets. “However, two factors continue to support South African equities. Firstly, neither bonds nor cash offer attractive returns. Secondly, the US market does not look particularly expensive and at the end of the day is an important driver of our market. In addition, the continued growth of sub-Saharan Africa economies of 5% or 6% per annum provides support for the South African economy and businesses operating in or supplying that region.”
Looking at other South African sectors, Bell says that retail stocks have pulled back but are by no means cheap, while the banking sector is looking fair value currently.