Despite headwinds, SA assets still offer attractive opportunities in 2022

After the unusually high returns from SA equities (and even local bonds) that investors enjoyed in 2021, some may be expecting much lower results over the coming year.  After all, inflation has been rising and the South African Reserve Bank (SARB) has started what is expected to be a lengthy interest rate hiking cycle, which is detrimental to economic growth, most company earnings and bonds already in issue. Add to this the current higher starting asset valuations compared to last year, and  we can see why there may be legitimate reasons to be pessimistic about returns in 2022 and over the medium term. Some investors may also worry that they have missed the lion’s share of the local equity rally and be tempted simply to invest more in cash to take advantage of higher interest rates.

However, at M&G Investments we don’t agree with this pessimistic view because it ignores just how cheap our asset valuations have been. Throughout the recovery from the pandemic, negative investor sentiment has weighed more heavily on the South African market than many others, to the extent that our equity and bond valuations remained much more attractive than many others (and compared to their own history) in early 2022. The price-to-book value (P/B) of the FTSE/JSE All Share Index stood at around 1.9X as at 31 December 2021, below its long-term average of 2.2X and still attractively priced -- reflecting, in our view, still-excessive levels of pessimism.  This compares to the world equity market’s P/B of 3.2X, which is above its historic average and skews to the upside the chances of South African equities outperforming the rest of the world going forward from current levels.

At the same time, within the South African market, many mining companies continue to experience elevated revenue and earnings as the prices of commodities remain at high levels. These strong commodity prices are supportive not only to the companies mining them, but also to the South African economy via growth, higher tax revenues and added consumer spending.  We believe that earnings and dividends should show a strong return to growth over the medium term. This dividend growth is based mainly on a reversion to more normal dividends from the mining companies and banks, whose balance sheets are now very healthy.

Meanwhile, we believe local nominal bonds also still offer investors an attractive opportunity to earn lucrative returns over time. Despite last year’s rally, the yield on the 20-year government bond remains near its highest level since 2001 at around 10.0% , or 5.5% after inflation. We believe this also reflects overly negative market sentiment regarding inflation and other risks.

Finally, in our view cash continues to be the least attractive investment option, despite the expected further interest rate hikes. This is because of the very low base off which our rates are rising – potential cash returns are still very unattractive compared to those from SA equities and SA bonds, especially in real terms with rising inflation. Based on the SARB’s projections, it will take time before cash becomes a viable option for longer-term investors.

So in conclusion, despite some headwinds presented by worsening economic conditions in 2022, we believe longer-term investors should take the opportunity presented by still-attractive SA equity and bond valuations to add more of these to their portfolios (according to their risk profiles), and to resist adding to cash assets. The latter would, ironically, increase the risk of not beating inflation over time.

For more information and to invest with M&G Investments, please feel free to contact our Client Services Team on 0860 105 775 or email us at info@mandg.co.za.