The global investment environment is currently a mix of troubled government finances and excess liquidity: Adrian Saville

Adrian Saville, CIO of Cannon Asset Managers writes that there is evidence of growth in the global investment environment, but growth should be seen against a backdrop of weak fiscal positions and excess liquidity.

The primary trend taking place in the global space at the moment is that the world's larger economies are starting to recover from their recessionary conditions.

We have seen a variety of evidence of this return to economic growth. For example, during the downturn, stockpiles were slashed and they are now being replenished. The manufacturing sectors in the US and south-east Asia are showing an upward trend, and recent data released in the US show that the non-manufacturing sector also is recovering. In turn, this has translated into greater optimism amongst consumers which is showing in spending patterns. This trend should specifically benefit the global consumer and manufacturing sectors during 2010.

However, there are two caveats to this rosy scenario: the global economic recovery takes place against a backdrop of weak fiscal positions and monetary systems that have been flooded with liquidity. Broadly speaking, the western governments and some Asian economies are running huge fiscal deficits.

In some cases, the deficits are taking place against a backdrop of high levels of sovereign debt.  For instance, the ratio of debt-to-gross domestic product (GDP) in Japan is greater than 200%.  In recent history no large economy has developed debt of this order, which implies that elimination of this debt, or reduction to acceptable levels, will involve the writing of history. 

Although only anecdotal at this stage, the state of California (which would rank as the world's tenth largest economy) is rumoured to be on the point of defaulting on its debt (last year the state started issuing coupons because of funding shortages).

Whilst South Africa is not immune to global impacts, by comparison the domestic economy is in a substantially better position than many of the world's large economies. Based on the most recent treasury data, our annualised budget deficit is expected to be of the order of 7.5% of GDP and the national debt-to-GDP ratio around 40%. While the looming budget deficit is large — the last time we were at the levels was during the democratic transition phase of the early 1990s — it takes place against the backdrop of a sound sovereign balance sheet. Further, with improving economic fundamentals, the local situation is not as concerning as the global picture at this stage.

As intimated, western economies also have resorted to running their printing presses as a means to stimulate their ailing economies and fund government spending. By way of example, the US money supply has more than doubled in the past 18 months.

Given this scenario, the global investment landscape shows a heady cocktail of dire government finances combined with a ballooning in liquidity. This is likely to yield two outcomes: investor enthusiasm and price inflation. To boot, international interest rates are at or near zero percent which will also fuel investor sentiment.  In this setting, it is hard to imagine the next asset bubble not forming.

Some evidence of this exuberance can be seen in the performance of global markets. The MCSI Emerging Markets Index rose 73% in dollar terms in 2009. By contrast, the JSE All Share Index posted a more "modest" 29% rise last year in rand terms and 61% in dollar terms.

Another aspect to consider in this framework is that if countries are running fiscal deficits and price inflation is expected to follow from growing money supplies, these countries' currencies must come under threat. Safe havens such as cash provide no protection in such situations, so investors have to take refuge in non-cash assets.  Gold is a notable case in point.  But the gold market is not yet displaying signs of a bubble. Gold could rise further (even substantially so), but other commodities, such as oil and platinum, which have a consumption use and not just a hording function, suggest a more sensible and less emotive set of assets in which to invest.

From this argument, the South African platinum producers are worth revisiting. Investors could look at Impala Platinum and Northam Platinum as the best points of entry into that market. For oil, Sasol is an interesting play, with the oil price comfortably above $70/barrel. If there is any rand weakness, it will serve to improve the outlook for all three of these companies.

Looking at the domestic financial sector, it is significant that consumers' balance sheets, while stressed, are showing an improving trend. Banks, in particular, should be able to benefit from this. The banks have been conservative in their accounting over the recession and are likely to emerge strongly from the downturn, possibly during the next six months. The bank stocks that stand out are Investec and Nedbank, as well as the smaller bank, Sasfin.

Industrial companies also are starting to benefit from the improved consumer environment. Interest rates and consumer price inflation are low while wage settlements have been of the order of 8% to 12%. This means that we will see a real income effect in South Africa, leading to higher consumption levels. A company like Bidvest is extremely well positioned to benefit from this set of forces because of its varied interests that range from motor retailing to consumer discretionary spending. In addition, its exposure to the hospitality industry could benefit (albeit temporarily) from the 2010 World Cup.

Investors can also consider consumer cyclical stocks such as furniture retailer Lewis Group and clothing and jewellery retailer Foschini Group as opportunities to benefit from the consumer recovery.