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Cash vs. Equities
Date: 01 Jun 2009
If history has taught us anything, it is that a period of severe and sustained decline in economic growth, such as the one we have been experiencing over the 18 months or so, is invariably followed by a period of significant economic growth and recovery, as far as financial markets are concerned of course.
There are already strong indications that the South African equity market, for example, has bottomed out and that a recovery is imminent. We’ve also learnt that clients' potential return on their investments can be maximised by making the correct investment decisions early on during such a recovery phase.
Current situation
Government bond yields are at or near historic lows. Corporate bond yields on the other hand have spiked, thereby creating a massive yield gap. Equity markets are in negative territory, both on poor sentiments and depressed earning expectations.
The value of property maintains its present lull, with little if any indication of an imminent upward swing. Banks are becoming more and more reticent to extend any credit, not even for immovable assets such as homes.
To counteract the severe credit and economic crises governments use various combinations of fiscal and monetary policies. The first reaction in many countries was the reduction of their central bank’s lending rate.
So, where to put your money?
The question is whether the time has come to start moving some of this cash hoard back into equities, with evidence mounting that the worst of the global financial and economic crisis is behind us, even if a fully-fledged recovery is not yet in the offing.
History has taught us, over and over again, that a period of severe and sustained decline in economic growth, such as we have witnessed over the past year and a half, is invariably followed by a period of significant economic growth and recovery in financial markets. There are strong indications that the South African equity market, for one, has bottomed out and that a recovery is imminent. Another truth is that clients' potential return on their investments can be maximised by helping them make the correct investment decisions early on during such a recovery phase.
It is against this background that the time has come for our clients to seriously consider changing the composition of their investment portfolios in favour of growth assets.
Arguments against:
Arguments against such a move include the still uncertain outlook for company profits, which makes it difficult to be confident about current valuations. But when will equity investments ever be free of uncertainty? It is exactly this risk that is rewarded over time with higher returns than those offered by safe haven instruments.
Arguments in favour:
- The returns on cash are declining rapidly as the South African Reserve Bank continues to reduce its repo rate. To date the repo rate has been cut 400 basis points since December 2008, and it is possible that this will be followed by further reductions in excess of what has already been discounted by the money market.
- The result is that money market returns after tax are lower than current inflation and can be expected to remain so for some time.
- The after tax yield on an investment in the money market currently equals the dividend yield (tax free) on the JSE All Share Index, without the prospect of capital appreciation offered by the latter. Even if dividends are reduced in the coming year as expected, money market yields are also forecasted to decline further and the argument will remain valid.
- Share prices are currently 35% below their peak reached in May 2008 and valuations have declined to the level that prevailed at the start of the bull market in 2003, and are compatible with a decline in company earnings of up to 20%.
Taking the plunge
There are a few things you should keep in mind before investing in equities:
- In order to gain on equities you should invest in undervalued shares. This way you benefit from capital gains when the share price recovers when the economy experiences its expected upward swing.
- Although equities are generally considered a sound long-term investment vehicle, caution should – as with all investments – always be top of mind.
- Listen to the experts.
- Don’t charge in blindly. Once you have found that “good buy”, make absolutely sure before you commit yourself. Don’t just put all your eggs in one basket. There is nothing wrong with initially only investing a conservative amount that you can comfortably afford and rather increase your investment over a period of time.
Therefore, the case for testing the waters, as it were, seems compelling. In the long run, the bulk of an investment portfolio should be in growth assets.
Just keep in mind that returns on equities in the next few years will in all likelihood be lower than during the 2004 – 2008 bull market, although probably still higher than on cash and bonds, because of lower economic growth and therefore lower growth in company profits.
Buying into equities now may seem risky, but just keep in mind that there are currently good buying opportunities and you will need to hold equities to protect you against inflation in the future. High inflation will come; the only question is when?
Click here for previous issues of Money Matters.
Kind regards
The Sanlam Web Team
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