Over the last quarter of 2012, both local and global equity markets continued to register strong gains. The SWIX Index (which represents the performance of the South African equity market) returned 10.06% over the quarter and 29.09% over the year, while the MSCI AC World Index (which gives an indication of the performance of international markets) returned 4.03% over the quarter and 20.87% over the year (all when measured in rands).
There were, however, significant differences in performance across the various sectors of the equity market: Healthcare (up 15% for the quarter and close to 60% for the year) and consumer services (up 11% for the quarter and almost 50% for the year) significantly outperformed basic materials (up just 8% for the quarter and 5% for the year), as well as oil and gas (up 0.6% for the quarter, but down 1.4% for the year).
Nonetheless, strong market returns were observed despite a clearly deteriorating global and local economy. In October, in its World Economic Outlook (WEO) report, the International Monetary Fund (IMF) revised downwards its expectation for global economic growth for both 2012 (down by 0.2% to 3.3%) and 2013 (down by 0.3% to 3.6%).
South African economic fundamentals also deteriorated over the year, reflecting its vulnerability to a weak European recovery, poor export growth and increasingly antagonistic local labour. According to Stats SA, the South African economy grew at an annualised rate of just 2.3% year-on-year in the third quarter of 2012. At its Monetary Policy Committee (MPC) meeting in November, the Reserve Bank revised its expectation of 2012 economic growth for South Africa downwards to 2.5% (from 2.6% previously) and for 2013 to 2.9% (from 3.6%).
This leads us to observe that the recovery in equity markets during 2012 does not reflect improved economic conditions (hence the especially poor performance of resource shares, whose fortunes are especially linked to an economic recovery), but rather accommodative monetary policy worldwide that has driven a search for yield. The US Federal Reserve has committed itself to keeping interest rates low for at least the next two years, while the tone at the November MPC meeting from the Reserve Bank was for future interest rate cuts if necessary.
Valuations of equities (with the noticeable exception of resource shares) and property now look somewhat stretched. The level of outperformance of industrial shares relative to resource shares is of a magnitude that has not been seen since 2004 – the last time the Reserve Bank aggressively cut interest rates. This trend could reverse should the Reserve Bank begin to increase interest rates. At the same time, investors have driven down bond yields to levels not seen in the previous 25 years, which may present significant upside risk.
2013 promises to deliver as many surprises in terms of investment market performance as 2012, once again highlighting the importance of constructing a well-diversified portfolio.
