JASON SWARTZ: Local assets offer better returns this year, but value trap lies ahead

US and SA elections, as well as rising geopolitical tension, are presenting increasing investment risk this year. On the flip side, local assets could deliver strong real returns, as SA is expected to enjoy some interest-rate relief and improvement in energy availability. But in the longer term local assets are a value trap.

Examining key themes influencing the markets

Looking ahead for 2024 we have identified four key themes that will drive our investment decisions, which ultimately all underpin our investment outlook. Our first theme, which we called Global Cycle Down, assumes imminent US and EU recession.

We still expect that the lagged impact of global rate hikes is likely to trigger a recession in both of these regions, as we’ve not yet seen the full impact of restrictive monetary policy. So we have positioned our portfolios accordingly against this view.

The key implication of this is that this environment is going to be bad for risk assets, and we therefore prefer cash and bonds over equity, as well as cheap defensives over quality stocks.

Locally, 2024 will probably see better growth, but the trend will be anaemic. This is summed up under our theme of SA Long-Term Loser,  which is driven by expectations over low growth, failed state-owned enterprises (SOEs), political uncertainty and a general lack of reform implementation.

While this year is looking as if it could yield better local returns thanks to interest rate relief and better energy availability, in the longer term we see SA assets as a value trap.

Peak Rates is another key theme for 2024, based on our belief that short rates have peaked globally. With cyclically lower inflation and weaker growth, central banks can pause with cuts to follow. We expect global rates to start coming down towards the second half of next year, with local rates following suit. Against this backdrop, we prefer SA bonds, global bonds, and cheap equity with rerating potential.

With constantly evolving geopolitics and a trend around deglobalisation front and centre last year, A New World Order is our fourth and final investment theme influencing investment decisions for the year ahead, which is driven by a secular change in the global landscape.

US recession inevitable

While the US consumer was surprisingly resilient in 2023 and provided US GDP growth with a positive one-off shock, these tailwinds should fade in 2024 and the inverted yield curve still suggests a high risk of recession in the US. Given inflation still being too high now and an understaffed labour market, the Fed will need to maintain a tightening bias.

This approach, combined with concern about tightening credit by US banks, increasing delinquencies and depleting consumer cash levels, is likely to affect the resilient growth we’ve seen to date.

With a US election on the horizon for later this year, a recession would undoubtedly be damaging for President Joe Biden’s re-election hopes. But on the other side of the coin you have Donald Trump facing multiple legal challenges. For us, it’s the policy implications that we need to watch.

Historically, a larger deficit at the beginning of a presidential term leads to some fiscal restraint. However, it is highly unlikely that either of these two candidates will tap the brakes on spending from 2025, and so we do not hold out much hope for an improving US fiscal situation.

Short-term gain, long-term pain for local assets

Looking at local assets, a cyclical improvement in the energy crisis and interest rate relief will drive stronger real returns in SA this year; 2023 was probably the peak of the energy crisis, with increased capacity coming back online in 2024 as power plants such as Kusile and Koeberg return to service with a groundswell in renewables and private generation bringing us back to a happy medium of stage 1 load-shedding in 2025.

Regarding interest rate relief, while the last three Reserve Bank monetary policy committee (MPC) meetings put rates on hold, the last meeting was the first one where the decision was unanimous, indicating a stronger leaning towards cuts as the next move. In addition, the coming petrol price cuts will give the MPC more room to ease monetary conditions during the year.

There is also the significant issue of the general election, in the first or second quarter, to consider. Polls are showing ANC support sitting at just under 50%. Our position is that this outcome is likely, and the ANC will need only to form a coalition with a smaller party. The two market shock results we’re watching out for will be an ANC/EFF coalition and an ANC/DA coalition.

However, while cyclically local assets could have a good 2024, on a secular basis we are still negative on local markets given the secular risks facing the economy which we  believe will offer a value trap over the longer term. Unless government can lift long-term potential growth via growth-enhancing reforms and resolve the long-term fiscal risks, local assets will not be an investment destination of choice outside a cyclical commodity upswing.

They will appear compelling value, with no catalyst to unlock that value.

• Swartz is portfolio manager at Old Mutual Investment Group.