Actually, it’s a potential triple whammy: high margins, high valuations, strong dollar. How much good news is priced into the US, and how much bad news is priced into the rest of the world? At the point when it inevitably turns, you don’t want to be near too many dollar assets.
Across the various strategies of global equity, it is increasingly clear where opportunity lies:
Growth funds are highly priced, it’s time to take profits. We may miss the ‘next big thing’, but experience tells us that when you have outsized returns, it makes sense to bank some. This was the case with Baillie Gifford Long Term Global Growth, a material investor in NVIDIA, Amazon and Tesla.
Quality oriented funds, likewise, remain highly priced (currently 6x price to sales, relative to a long term average of around 4x. That’s a third too high). They have been in this territory for some time, and it remains to be seen if these managers will eventually start cutting these expensive assets for other quality assets in other regions such as the emerging markets and Europe which are harder to find.
Value funds have rerated from the lows of 2022 (a forward PE of 9x earnings) and now stand at ~12.4x – a 37% rerating. This solid performance has been somewhat overshadowed by the NVIDIA’s of the world, and they now look around long-term average levels for valuations. This is a decent place to be, but less exciting than they have been on an absolute basis. Relative to alternative types of equity, they remain the attractive option.
Emerging Markets look cheap to fairly valued, and yet growth expectations are decent, and margins are strong. The main catalyst for the emerging markets will be a) a weaker dollar and b) China making progress in recovering from the past few years of economic volatility and repositioning itself within a global economy looking to reduce dependence on it.
In short, markets dominated by a handful of large winners present high specific risks looking forward and we need to exercise caution and consider banking profits where possible. However, opportunities still reside in value funds and emerging markets, where we continue to hold our most significant positions.
Global Interest Rates
Fortunately, global interest rates remain attractive, and with inflation levels remaining lower than cash rates, parking funds in cash remains a safe option for now. US CPI has trended up marginally of late, now standing at 2.9%, and this is causing the Fed to be more conservative on their rate cutting cycle. This in turn has supported a stronger dollar as investors look to the higher yields available (the virtuous cycle from above). The bond market doesn’t play games though – yields have risen to ~4.6% for 10-year US Treasuries, indicating that inflation may be higher for some time to come.
South Africa
In South Africa, 2024 was a good year and returns across most asset classes decent, providing welcome relief for investors who have endured a never-ending series of own goals (load shedding, political turmoil, etc). The outcome of the election was positive for markets, and this was captured in returns across domestic equity, property and the bond market, with all asset classes showing performance in the mid-teens for the year. Equities would have delivered more if it were not for the underperforming resources sector (down 7%), which still constitutes a significant component of our equity market, and its supporting industries. Nevertheless, we can see some light for a change and there are increasing stories highlighting turnarounds in key industries – privatisation of the rail networks, no loadshedding since March 2024, increasing construction orderbooks and other domestically oriented opportunities. Within the SA equity market, these domestic role players are a relatively small faction (mainly banks, retailers, insurers, industrials). The balance is made up of rand hedges (Richemont for example), resource companies (operate locally, but returns dependent on commodity prices set offshore) and Naspers/Prosus (Tencent in China is their main asset – it’s a large technology platform like Google, Facebook, Amazon and a few others stitched together). That’s where SA equity gets a bit mixed: rand hedges are not obviously cheap, the local shares still offer a compelling case, miners are grappling with a commodity cycle at a high point, and lastly Naspers/Prosus face challenges as Tencent has just been added to the US Military Blacklist, limiting engagement with US businesses. Naspers fell ~10% on the news and it is yet to be seen what the longer-term impacts could be (other than obviously negative, and a sign of the risks of investing outside of the US!)
Yet overall, SA equities are trading <10x forward earnings, growth expectations are 20% in earnings, and price to sales is 1.1x. These are not stretched valuations. Risks remain elevated, but opportunities remain and so we will be retaining a decent exposure to domestic equities.
SA bonds rallied after the GNU was established but have retraced of late as US bonds sold off. This has more to do with the US than anything SA has done, and we still have the debt problem to fix which is not a simple task. Yields remain attractive, >10% over 10 years, which implies a real return of over 4% on an expected basis. Whilst this is high for bonds, it reflects the risks of investing in the SA government and economy. They are approximately fair value.
SA money market and cash rates remain attractive earning at least 8.5% which is well above inflation. These are good times for cash investors, and it is a good parking spot for now.
And then lastly the rand. At around R18.70 to the dollar, it remains relatively cheap. However, compared to other currencies like the GBP or EUR, it is less so, as they face their own challenges. For the rand to strengthen it is likely that a lower US CPI (and resultant rate cuts) will be the catalyst in the near term.
Overall, we are cautious on pockets of the global equity market, favour yield assets locally and offshore, and can justify holding relatively high levels of domestic assets relative to the past decade. It is quite possible to build a well-diversified domestic balanced fund with sufficient equity exposure. Offshore, however, we believe it is prudent to hold lower equity than usual, considering the points made above.
Complacency at this point is potentially costly. When markets are positive, returns are high, and factsheets look good – that is the time to be critical of positions and to test portfolios. This is something we are focussed on, weighing up the risks and opportunities to ensure portfolios are appropriately positioned in future
Asset Class Outlook
