12 Mar 2018 laia

Economic impacts for 2018

The start of a new year is usually when questions around investment predictions arise, especially questions around predictions for asset classes over the next 12 months. As always, at the top of the list of questions is the rand and the domestic equity market.

A new crowd favourite is Bitcoin and the family of cryptocurrencies including ethereum, ripple and who knows what’s next. After nearly 10 years, I recently re-read The Black Swan, by Nassim Nicholas Taleb. It was a strong reminder that not only are predictions difficult, but the unknowns may have the most significant impact. By definition these cannot be anticipated, but is there anything we think we should look out for in 2018?

As South Africans we are accustomed to politics being a meaningful part of our daily conversation. With the outcome of the ANC elective conference at the end of 2017 and the seeming shift in internal powers there is bound to be an enhanced political drive leading into the national elections in 2019. The election of Cyril Ramaphosa as ANC president and most recently as the president of South Africa was viewed as being positive for the economy.

We saw this playing out with the appreciation of the rand post the conference and again with the appointment as state president. The next step will be to see if actual measures will be put in place in order make business easier for South African companies and whether this in turn can have a positive influence on the unemployment level in South Africa. The hope is that this can be one of the catalysts that can improve the Gross Domestic Product (GDP), which for an emerging market economy has been disappointing.

In terms of economic indicators, both inflation and the interest rates are at relatively low levels, which means the Reserve Bank will need to continue the balancing act of considering a decline in interest rates (at a time when most of the world is trying to increase rates) without unduly risking the possibility of increased inflation.

For the most part, inflation forecasts have remained within the 3% to 6% target band for 2018, but revisions of this metric have at times, been quite wide. The rand may have been the surprise package of 2017. After strengthening roughly 12% against the dollar in 2016, the rand further strengthened by nearly 10% in 2017. This unsurprisingly came with a fair amount of volatility and highlighted the difficulty in trying to forecast in the liquid currency market.

The current view is that historical valuations suggest that the rand may be undervalued and may continue to strengthen as a result. However, as with all financial valuations, the timing and volatility is unknown.

In terms of valuations, the domestic equity market experienced a particularly strong 2017, which begs the question about the possibility of another strong year in 2018. While this may be impossible to answer, it is important to note where returns have come from and what the impact will be if this reverses.

A number of the large listed companies get the majority of the earnings in foreign markets. An important consideration for equity managers in 2018 is whether these large corporations are valued prudently, and whether conditions are conducive to them performing well or whether local earning companies have been devalued to the extent that they are priced cheaply and are set to benefit from prevailing economic conditions.

With all these question marks around the economic impacts in South Africa in 2018, we must remember that we do not operate in a bubble. Arguably the biggest impact on interest rates and asset class returns has been the global appetite for risk. South Africa and other emerging markets have benefitted when developed markets have taken the risk-on trade and bought equities and high yielding securities.

In addition, the risk of a downgrade by Moody’s (the only ratings agency that has as yet not downgraded SA debt to junk status) cannot be ignored.

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