2011 was a year dominated by a number of events which certainly weren’t on the radar at the beginning of the year. The horrific Japanese tsunami, the Eurozone debt crisis, a downgrading of US debt and uprisings in the Middle East, all of which were unpredictable and resulted in huge volatility across the markets. Consequently high returns were generated in unexpected places like global bonds and global property. Offshore assets did well, benefiting from a blow-off in the Rand in late 2011, while local equities returns were disappointing. We managed to navigate our funds through a very uncertain 2011 to deliver returns in excess of both cash and inflation on the back of our defensive asset allocation strategy and high offshore exposure.
Returns in 2011
The question is where to now? At this stage there are a number of positive trends both offshore and locally.
• Although world growth is expected to slow to 3.3% from 3.8% according to the IMF, this is not a massive fall and growth still remains above 3%. Encouragingly, better US job data, manufacturing and housing data all point to firm growth in the US of around 1.8%. This combined with positive growth in Asia will help offset the drag from recession-stricken Europe.
• The risk of a global banking crisis was reduced in December when the European Central Bank lent 489 billion Euros at 1% for 3 years to 523 Eurozone banks across the 17 Eurozone countries. This dramatically reduced the risk of a systemic crisis in Europe for the year ahead by ensuring that banks have adequate liquidity.
• Global inflationary pressures are easing with both oil and world food prices lower compared to this time last year. This will allow emerging market policymakers to ease rates while monetary policy in the developed world will remain stimulatory. In fact, over the last 5 months there have been 62 cuts in interest rates around the world, whereas in 2011 there were twice as many interest rates hikes as cuts, all of which will be growth supportive.
• On the local front, growth is expected to reach 2.8% this year, slightly less than last year. This will be largely driven by consumer spending as disposable income has been boosted by 7%-plus wage agreements, record low interest rates and public sector employment growth. Manufacturing and mining remain sluggish.
• Inflation which is running at 6.1% is expected to remain above 6% for the rest of the year due to high administered price (electricity, water, fuel etc) increases as well as the recent Rand weakness. The extent to which these price pressures will impact inflation will be influenced by the strength of the domestic economy which is currently slowing, thereby creating less opportunity for companies to pass-on cost increases.
• At this stage the inflation rate is unlikely to pose a significant concern for the monetary authorities. The Reserve Bank seems reasonably comfortable in tolerating an inflation rate slightly above the target, especially in an environment where economic activity is subdued and global inflation is projected to moderate during the course of the year. Hence the Reserve Bank is expected to leave interest rates unchanged well into late 2012.
Although developments on the economic front do seem to be more positive there are a number of risks out there that we are very cognisant of, such as: the ongoing sovereign debt crisis and the potential restructuring of the Eurozone, tension around Iran, slower growth in China, presidential elections in the US, the weak US housing sector, the large US deficit and the potential for a global banking crisis if policymakers blunder.
These are a few of the major risks we can identify for 2012 but as in the words of Donald Rumsfeld “There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know.” And the latter could well end up dominating the headlines once again!
Fund overview and positioning
Given the risks mentioned above, we maintain our cautious stance within the funds with an overall neutral weight to equities. Within that we are overweight offshore equities and underweight local equities. Given the current attractive valuations and positive growth story we will look to add to equities opportunistically. Our view remains that we want low cash holdings, given the negative real yield offered and favour inflation-linked bonds as a hedge to rising inflation. We will also look to add to our global property exposure as it offers more attractive yields than global bonds.
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Chief Investment Officer