Look to SA bonds, equities for better chances of outperformance

Despite the bad news headlines prevailing in South Africa in 2023 so far and the uncertain conditions globally, the good news for investors has been that our local equity and bond valuations have been trading relatively cheap (below their historic averages) and offering attractive potential returns, especially compared to their offshore counterparts. At M&G Investments, we look to asset valuations to determine our asset class preferences for our portfolio, as low (or cheap) valuations   often indicate higher prospective returns.

For example, the FTSE/JSE Capped SWIX Index started the year at a 9.2X 12-month forward P/E ratio, well below its historic average, and the SA 10-year government bond was offering a yield of 10.9%. Compare these to the MSCI All Country World Index 12-month forward P/E of 14.7X and the US Treasury 10-year bond yield of 4.0%. While we are holding global equities and global bonds in our multi-asset portfolios, this is in more neutral positions. In our view, future inflation, interest rates and growth still pose risks to global assets, which are not being adequately compensated for in asset valuations. Meanwhile, SA valuations are more than compensating for holding SA equities and nominal government bonds, and so we prefer these assets in our portfolios. Equally, the weak valuation of the rand against the major global currencies supports our preference for local assets over global assets.

We are leaning away from SA listed property because, even though property stocks are trading at attractive valuations, we prefer exposure to non-property shares that we believe offer better value propositions for less risk. Conditions in the local property sector remain uncertain given the rising local interest rate cycle (many property companies are reliant on capital markets to expand their portfolios) and relatively weak growth prospects, among other fundamental factors. And as for inflation-linked bonds, we believe they are solid holdings for real return portfolios. Currently their real yields are relatively attractive (with the 10-year ILB at 4.5%) compared to their own history and our long-run fair value assumption. However, compared to nominal bonds their valuations are less attractive and they have lower return potential, so they are less desirable for other types of portfolios.

Lastly, the SARB’s interest rate hikes over the past year have made SA cash relatively more attractive as an asset class. However, we still prefer most other local asset classes (apart from listed property) for the higher real yields available on both an absolute and relative basis.