Do not take on more risk, investors in South Africa warned

By Tom Elliott, deVere Group’s International Investment Strategist

Now is not the time to take on more risk. Diversify your investments and sit still. That is the message that I gave in a series of briefings, presentations and media interviews during a recent tour of Johannesburg and Cape Town.

It is my view that many investors are becoming too complacent to growing threats.

There are justifiable, or perhaps understandable, motivations for this optimism.

Stock markets have gained momentum after a lacklustre start to the year, with continental Europe the strongest performer. Indeed, many Eurozone stocks climbed to new multiyear highs last week as the European Central Bank (ECB) further outlined its considerable asset-buying programme.

Low oil prices and loose monetary policy are important drivers for this rally of European stocks, but it is the encouraging growth data coming out of the Eurozone that is, arguably, the main factor.

New European Commission economic forecasts predict a recovery this year for all the EU’s main economies at an average of 1.7 per cent – something that hasn’t happened since 2007. Similarly, the Eurozone’s growth forecast is predicted to increase to 1.3 per cent.

And, of course, there is the positive growth data from the U.S. The American economy is bounding ahead, creating jobs at the fastest pace since the late 90s and with GDP having grown at an annual rate of 2.2 per cent in the fourth quarter of 2014.

On the surface, there are certainly rosy signs. But are investors underestimating the plethora of risks? I would insist that, yes, they are.

Currently, the main threats to South African investors’ portfolios come from the inevitable hike in U.S. rates. It is likely that this would take place this summer due to the recent strong economic data. Although South Africa’s current account deficit has shrank over the last 12 months due to the fall in oil prices, financing it with an appreciating dollar and a higher dollar interest rates may prove taxing.

Other risks pertinent to South Africa are creaking infrastructure, particularly in the power generating sector, and fragile business confidence.

Other key risks are geopolitical. They include the ongoing crisis in the Ukraine, Greece still putting the question mark over the Euro should it be forced to leave, and a possible UK exit – or ‘Brexit’- from the European Union.

Of the latter, investors in UK assets should certainly fear any poll gains by the UK Independence Party (UKIP), as this may translate into a role in a Conservative-led coalition government after May’s general election. This, in turn, makes the referendum promised by the Conservative party on the UK’s membership of the EU more likely to happen. A referendum will introduce considerable uncertainty into the outlook for the British economy, since UKIP and other eurosceptics are running a populist campaign. It challenges the evidence of economic history as to the benefits of being within free trade areas, such as the EU’s single market.

Furthermore, the uncertainty caused by a possible Brexit will put pressure on sterling, on UK equities and on gilts. Investors may start to focus on structural problems in the UK economy, particularly excessive reliance on household consumption based on borrowing. Like South Africa, the resulting large current account deficit risks being exposed by higher global borrowing costs, once the U.S. begins to raise interest rates.

The overarching point is that investors have to be careful of a wide range of political hazards at the moment. These are in addition to the uncertainties caused by the unusual financial environment created by quantitative easing (QE) and ultra low interest rates. After all, how normal is an investment climate in which a third of the outstanding European government bond market are offering negative yields?

Bearing all this in mind, and taking account of modern portfolio theory which emphasis the ability to reduce investment risk through diversification, I would suggest that it would be wise not to jump into this rally, but to maintain a well diversified portfolio –by geography, asset class and industrial sector- and to invest for the longer-term.