Macro Perspectives 33 | Unlocking investment insights: uncover the real power of valuations

In this episode, Peter Brooke digs deeper into how valuations impact future returns. Valuations might seem like mere blips on the radar in the short term, but their effect increases over time. Looking at the economy, profits and the ongoing load-shedding challenge, things do not look good in the short-term. But the big de-rating in SA assets is creating a rosier outlook in the long term.

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Chapters

• 0:27 Peter Brooke unpacks an analysis on how valuations impact future returns
• 2:34 The big change in South African assets
• 3:05 Similar patterns we are seeing in other countries

Transcript

Peter Brooke  00:01

Good day. I'm Peter Brooke, a Portfolio Manager at the Old Mutual Investment Group. This is Macro Perspective 33 of 2023, and I am in Durban to talk at the Think Tank, a big event for independent financial advisers run by Kevin Hinton of The Collaborative Exchange. I'm talking about some of the long term and more cyclical themes I've previously discussed on other podcasts. 

Peter Brooke  00:27

But an interesting addition is some analysis on how valuations impact future returns. Generally, valuations have very little impact in the short term, but become increasingly relevant over time. Now, every six months, you know we update our expected long-term real return for the key asset classes, and then weight them into an expected real return for a Balanced Fund. I looked at the past forecast against their actual delivery. And long-term listeners will remember back in 2015 to 2017, we had very low expectations, and were talking about a low return world. 

Now, 2015 specifically was a high point for valuations, where the JSE was trading on 16 times forward earnings. As a result, back then we expected real returns for a Balanced Fund of only three and a half percent. Five years later, those returns were actually only minus half. And that was because that landed exactly on the trough of Covid. If we look at those seven year returns since that date, the returns are 3.8% real, very much in line with the expectation back then. But importantly, disappointing relative to return targets of 5% for a Balanced Fund. And if we look generally, the higher the proportion of equity that funds have had, the higher the return target that they have, but more disappointing the five year numbers have been. 

So, while long-term delivery has been good, in the shorter term, returns haven't been as good. And the real reason for that has been the low returns from SA equity, SA property, and also global bonds. Now, as those markets have de-rated, the future returns have got better. So, a good example on global bonds, our expected returns have jumped from minus one and a half percent to plus one and a half percent. While not exactly a dripping roast, it is a 3% improvement. 

Peter Brooke  02:34

But the really big change has been in the South African assets. So, if we take a look at our expected real returns for a Balanced Fund, they used to be three and a half percent in 2015. And they've grown to 5.3% currently. But if we looked at an SA only component, that real return has grown to 6.6%. And you just have to look at the forward multiple on the JSE, which is now 10 times compared to 16 times. 

Peter Brooke  03:05

And it's interesting, we've looked at a number of markets around the world at the moment in terms of our global macro equity product. And we're seeing similar patterns in other countries. So, an example is the Philippines, which looks very interesting. It's just de-rated hugely on good numbers. But part of that is around the global cost of capital going up. And if your domestic savings industry is strong and you've got good buy in, then that will obviously protect your multiple. But in South Africa, actually the regulatory change has allowed more of our savings to go offshore, meaning there's a less natural buying for our market, and therefore in the absence of strong foreign interest, the market is de-rated. The relevance of all of that is if you look forward, while things might not look good in the immediate sense in terms of where the economy is at, where profits are at, loadshedding. The difference is when we plug in these expected real returns, the future is looking increasingly rosy. And that's one of the key messages of my talk. 

I hope you enjoyed this perspective. Until next week.