Chris Freund, Head of SA Multi-Asset at Investec Asset Management, discusses his investment views for 2014

What are the most important themes that will drive returns in 2014?

We believe there are a number of themes that will drive both global returns and also impact South African assets.

• Markets will be focusing on the timing of the tapering of quantitative easing (QE) as 2014 unfolds, leading to market volatility. If US Treasury yields start to pick up, then emerging-market currencies, including the rand, are likely to weaken.
• The Chinese GDP growth rate is likely to moderate to around 6%. The level of non-performing loans in the Chinese financial system, whether it be the formal banks or the more informal wealth management and trust companies, could be an issue. The appreciation of the renminbi may also hurt China’s economy.
• Commodities could face challenges in 2014 with China’s growth moderating. With increased supply of key commodities such as copper and iron ore, it’s hard to argue that commodity prices in dollars will go up.
• A more positive global theme is that the US economy should gain traction in 2014, with the risk of the country falling back into a recession receding and fiscal drag now less of an issue.

Where is the consensus wrong?

We think the consensus is broadly that the world is normalising and the levels of systemic financial risk continue to decline. However, what’s not appreciated at this stage, is that there might be a ‘melt up’ in equity (and property) markets in 2014. In such a scenario, central bankers will want to gently let the air out of any bubble that’s forming. This could be an interesting exercise.

What are the key risks?

The election: 2014’s general election in South Africa will create some volatility, but should not be a big issue. Political leaders may make inflammatory statements in early 2014 which could raise the political temperature and cause some anxiety in markets. But we believe we should look past the rhetoric, and take a longer-term perspective.

Tapering: Of course, the South African market will also be subject to how the Fed’s tapering plan unfolds. There will be some up and down months as investment returns are unlikely to be uniform. The focus will be on how central bankers manage to take their foot off the monetary accommodation accelerator without disrupting markets too aggressively.

Interest rates and the rand: We believe economic growth is too weak for the South African Reserve Bank (SARB) to aggressively raise rates. However, if the rand was to weaken substantially, the pass-through from the weaker currency to inflation may force the SARB to increase rates in order to preserve its market integrity.

When the Fed starts to taper QE it could have a negative impact on the rand. On a more positive note, South Africa’s current account deficit will likely improve in 2014 because of potentially more competitive exports that could bolster the trade account. Even though the rand will be volatile in 2014, we don’t expect the currency to become much weaker over the next 12 months.

What is the outlook for the different asset classes in 2014?

We anticipate the South African bond market will weaken if global bond markets sell off on QE tapering. Because the yield curve is very steep in South Africa, it’s not clear whether South African bonds will outperform cash or whether bonds will underperform cash.

There are three factors that drive equity markets: valuation, the economic cycle and the extent of liquidity. Even though valuations are relatively demanding, this should not put a dampener on South Africa’s equity market returns over 2014. It’s only when valuations are at extremes, very expensive or very cheap, that they are likely to drive returns.

The economic cycle is broadly supportive of equity markets in 2014. Currently the liquidity accelerator is very supportive of equity markets but this could change with the Fed’s tapering plans. We believe the new Fed chairman Janet Yellen will take a nuanced approach to US unemployment and labour issues. We don’t believe there are going to be any overly aggressive moves on the monetary policy front in 2014.

How are you positioning your portfolios in terms of strategy and style?

Our portfolios are fairly long equities. Tactically, equities could suffer a quarter where they could have a pullback. Equities have virtually gone up in a straight line for a while now, so it would be no surprise if there’s a period of consolidation.

On a medium-term horizon, we are long equities and comfortable with the volatility that comes with maintaining this exposure. Our portfolios are fairly neutral between bonds and cash at this stage.

Within equities, we have a preference for the life insurance sector because we expect these companies to regain market share in the savings industry. We still like some of the bigger banks. FirstRand remains our preferred play in the South African banking sector.

We are relatively underweight the broad commodity complex, mainly because of concerns about China’s growth and the demand-supply dynamics of key commodities such as iron ore and copper.

Many of our large industrials are global companies, such as British American Tobacco, SABMiller and Richemont. These companies can’t be considered cheap anymore having done very well over the last few years. SABMiller and British American Tobacco can be regarded as defensive stocks but given we believe global growth should be supportive, we don’t need the level of defence in our portfolios that these broad consumer staples provide.