CIARAN RYAN: As much as we would love the gift of foresight, no one can predict with certainty what the future holds, much less what the markets will do next. While we may not be able to predict specific market shocks, we know events that will likely impact markets and economies are inevitable, making uncertainty part and parcel of any investment cycle. Instead of being caught off-guard, this allows investors to review their long-term investment goals and future-proof their portfolios, preparing for any eventuality.
Joining us to discuss this is Adriaan Pask, who is chief investment officer at PSG Wealth. Welcome, Adriaan. We know that making predictions is a dangerous game. On what do you typically base your future projections?
ADRIAAN PASK: Hello, Ciaran, and thanks again for having me on. Yes, it is inherently difficult and risky to put predictions or forecasts forward, but I think you can never underestimate the value of good research as well. So I think it’s just a case of balancing that properly. You put your neck out to make a forecast that you are reasonably sure will materialise. So good research underpins quite a bit of what we do.
CIARAN RYAN: Okay. So we’ve had a 40-year bull market in bonds which now appears to be over. What does this mean for the future of US bonds, and particularly for South African investors who want to be exposed to that?
ADRIAAN PASK: Absolutely correct. If you look at the historic data over the last 50 years or so, we can obviously see that interest rates are at record-level lows, both locally and abroad – and with this yield curves have also fallen, which is typically good for bonds. But at this stage interest rates have only one way to go and that’s up, and obviously the bond yield curves will adjust for that, so yields should move higher. The implications are quite profound. I don’t think investors are quite expecting this to take place. Many investors haven’t seen this in their investment life.
As this is going to take place, we will see quite significant volatility on bond capital values. That also has some consequences for multi-asset portfolios abroad; in particular the more conventional 60:40 portfolio, which is often used in the offshore space, where portfolios are set up to invest 60% in equities and 40% in fixed income. That’s a static that isn’t really adjusted. So if you can’t make adjustments to that 40%, the implications can be quite profound for your portfolio as well.
CIARAN RYAN: The [US] Fed’s manipulation of the bond yields, which we know has been going on for many years, that’s also receding and interest rates will soon begin to reflect market forces. But that’s a fairly gloomy outlook for bonds. What is your outlook for US equities?
ADRIAAN PASK: I think if you look at US equities, and the S&P 500 in particular, it’s really not much better, to be honest. We are seeing many valuation metrics at this point in time signalling that the market is overheated. So, if you compare some of the valuation metrics relative to their 25-year averages, they do signal that the market is significantly overpriced.
We expect a tougher time. If you were to look at price/earnings (PE) ratios, for example, they already are at roughly that 22 level on forward PE, which is already quite generous in terms of earnings forecasts that still look to improve quite a bit. If those earnings don’t materialise, you sit with a problem and PEs in themselves are also quite high. The same can be said for dividend yields as a valuation measure, priced-to-book, priced-to-cashflow yields and so forth.
It does look quite lofty. If you learn from history and see what equity portfolios in particular have done, from these valuation levels over a one-year period you can maybe expect single-digit returns; but if you look at five years and longer, history shows that you expect on the lower end of the single-digit return levels. Actually it’s closer to zero. Again there’s quite a lot of optimism around US equities in particular, and that’s why those valuations are so stretched. Those ratings are quite high.
So if you look at their current valuation levels and an entry point onto the S&P 500 at the moment, then that doesn’t look attractive at all to our minds. So, like I said, returns expected for the next five years are closer to that 0% level.
CIARAN RYAN: Wow. Okay. What does this mean for investors who are obviously concerned that the economic winds are shifting?
ADRIAAN PASK: I don’t really think it’s necessarily a case of economic winds that could be shifting. I think if you look at industrial production, it’s still good economic growth, it is trending in the right direction. I think the key problem that you sit with on the S&P is more on the valuation end of things because, remember, you’ve got essentially three things driving returns over the long term. The one is dividends, another is earnings, and the third re-ratings.
On the earnings side things are still looking reasonably okay. It’s unlikely that we will be able to sustain the current earnings-growth levels, but we will still see earnings growth. The problem is that the market is currently pricing in loftier earnings growth, so a re-rating downward is definitely anticipated. A lot of that earnings growth will be essentially consumed by re-rating downward – and that is where we see the risks.
CIARAN RYAN: Are we seeing a rotation from developed markets to emerging markets, and do you think the momentum in emerging market equities will persist?
ADRIAAN PASK: I think so. If you consider some of the key drivers behind emerging markets (EMs), they all seem intact. If you look at relative valuations, for example, as I mentioned, some of the developed markets do look quite pricey, whereas on the other end you’ve got emerging markets that have been downrated in the previous cycle and are actually now rebounding. That could persist.
Earnings revisions – we currently see more momentum in the emerging-market side to sustain positive upward revisions taking place, where a lot of that’s priced in the offshore space.
A global industrial cycle, like I said global economic growth, seems intact. So that will actually benefit emerging markets as there’s a lot of demand for, one of the things these emerging economies provides, many of them are commodity exporters that are ultimately used to fuel the growth that we are seeing globally. So that’s also why we see higher commodity prices, which is very positive for many emerging markets. The US dollar that’s been weaker is also something that’s very positive for South Africa. There are quite a few of these variables that are favouring an EM stance at the moment.
CIARAN RYAN: All right. And do you foresee another market correction in the near future?
ADRIAAN PASK: I think the easy answer there is “always”. I don’t think investors probably appreciate how often these take place. If you look at the US market over the last 70 years, for example, on the S&P we’ve seen about 38 corrections of between 10% and 20%. Even if you look at the last 25 years, we’ve seen four market corrections in excess of 20%. So it’s a bear market, effectively. These occur quite often.
If we just think of the last few years – obviously the one from last year and then before that we had 2018, 2008 – it seems like investors always seem to think that these things are temporary, that this is an anomaly and it’s abnormal; if it’s not going to be this, then it’s going to be something else.
So I think if you look at history and how often markets correct to between a 10% and 20% drawdown, we should expect that every 18 months or so. And in a bigger bear market in excess of 20%, you’ll do well to expect one, maybe two, coming over the next 10 years. Why that’s important information is not so much that you should sit on the sidelines and wait for these [things] to take place, and play it safe. I think it’s more to say that typically what we do see in the market is that when these things do take place investors de-risk portfolios in a trough of the market. But if you expect them to take place and they do come around, then obviously you are less prone to make a mistake from a portfolio-error perspective.
CIARAN RYAN: All right, Adriaan, final question: do you think the South African investment landscape will be better in the next decade than it was in the last?
ADRIAAN PASK: This is obviously the controversial one. What we do see at the moment is that SA consumer confidence is low but it’s recovering quickly. And the same can be said for South African business confidence. As these confidence indicators improve so will sentiment, and the expectation is that ratings can start to improve as well. If you look at our leading business indicator published by the Reserve Bank, it is pointing towards a strong economic recovery, and the bank bases that on fairly solid economic variables.
So good high commodity prices have helped us a great deal. We’ve seen what’s been published in terms of our current account. They really have helped a lot. They help quite a bit for tax collection as the mining companies make more profits. They help for employment as well, and help vulnerable communities often. So there’s a lot that’s in our favour this time around. If you think back maybe to 2007, not many people were expecting a tough time, but that’s exactly what we ended up having.
We are pretty much at the opposite end of that at the moment. I think many people are still quite negative around the prospects for South Africa, but there are quite a few things that are turning direction, and those are the things that we need to keep a careful eye on.
So I would expect South African returns to outperform those of the US over the next 10 years, which is maybe a somewhat controversial comment, given how our offshore investments are favoured. But looking at the valuations and the other variables that I’ve mentioned, if you’re comfortable, that’s the view.
CIARAN RYAN: We are going to leave it there. That was Adriaan Pask, who is chief investment officer at PSG Wealth.
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