Wednesday, 17 October 2012 - 20:00

 

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Slowing Global Growth

Last week, the IMF (International Monetary Fund) released updated world growth forecasts in their detailed World Economic Outlook report. Expected growth for 2012 has been reduced to 3.3%, down from 3.5% in their July forecast, which in turn was down from their April forecast. This is due to low growth and uncertainty in advanced economies affecting emerging and developing economies. Their projection is for advanced economies to grow by 1.3% compared to 1.6% last year and 3% in 2010.

These forecasts rest on some assumptions – the important ones being that European policymakers will adopt policies that will ease financial conditions in affected countries and in the US policymakers will be able to prevent a major negative impact of the looming tax increases and spending cuts – the so called fiscal cliff.

Emerging and developing countries are expected to grow by 5.3% from 6.2% in 2011 and 7.4% in 2010. China’s growth is expected to come in at 7.8% compared to 10.4% in 2010. The report makes the note that there is a 1 in 6 chance of global growth falling below 2%.

Everything being equal, lower economic growth forecasts are negative for markets, but we have noted before the low annual correlation between a country’s specific GDP and its market return. It is important to look at all the components of return that make up the total return. These are:

• The dividends received;
• Growth in earnings which can translate into higher dividends; and
• The change in the valuation of those earnings.

Dividends are the most stable component of total return. This is especially the case in times of slower economic growth. A growing company will be able to grow earnings and hence its dividends, being the second component of total return. Thirdly an important, but by far the least predictable, element of total return is the valuation of those earnings.

The chart below reflects total return from the US market per decade from 1926, splitting between the dividends and capital (growth and change in valuations). The period 2000-2011 was a low growth period, not because companies did not grow their earnings, but because starting dividend yields were low and valuations were very high.

Equity returns by decade: Dividends and Capital Appreciation

Source: Pimco, Standard and Poor

Historically US shares have produced around a 6.6% real return. Pimco’s view is that in a lower growth environment, this is likely to come down to around 3% - 4%, with most of this return derived from dividends. In order to boost this, active management becomes even more crucial as does looking for growth in companies that are expanding into emerging markets.

Kind regards,

Ian de Lange

www.seedinvestments.co.za
info@seedinvestments.co.za
021 914 4966

Wed, 17 Oct 2012

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