Warning for South African investors going offshore

The sky-high valuations US companies are trading at will constrain future returns from stocks in the S&P 500 and Nasdaq 100 despite some tailwinds. 

This is feedback from Momentum Investments’ head of asset allocation, Herman van Papendorp, who outlined the asset manager’s approach to 2025. 

Historically, US stock markets have performed well during interest rate-cutting cycles that have occurred outside of a recession. 

Although the potential Trump reflation policies are likely to further minimise recession risk in 2025, the strong returns shown by the US stock market before the first cut in September 2024 are likely to limit subsequent returns. 

Van Papendorp said that US stocks have already discounted at least some of the good equity fundamentals of strong growth and falling interest rates in advance. 

Although the fundamentals described above should be supportive for the US equity market in the interim, across-the-board challenging valuations will possibly constrain future returns.

Regardless of whether looking at forward P/E, forward price-to-book, forward price-to-sales, or forward EV/EBITDA valuation measures for the US stock market, all of these are trading well above historical averages. 

Van Papendorp also highlighted that at the time of writing, year-to-date US equity returns in 2024 have been one of the strongest calendar year performances in the last century and the strongest in the 21st century.

Relative valuations favour US bonds over US stocks, with bonds now 1.7 standard deviations cheaper relative to equities versus their very long-term history. 

However, the near-term slightly positive environment anticipated for stocks, compared to the overwhelmingly negative fundamentals expected for bonds, could cause this valuation gap to remain in place for some time.

The valuation gap between US stocks and bonds is shown in the graph below. 

Despite this, South African investors continue to look offshore, with demand for investment products with international exposure remaining strong. 

Following a strong rally in local financial markets after the formation of the Government of National Unity (GNU), some thought investors would pivot back to South African assets. 

However, FNB Wealth & Investments CEO Bheki Mkhize told Daily Investor that South Africans take their money offshore mainly for diversification purposes and access to sectors that are not on the JSE. 

Mkhize said it was clear that this is not based on anti-South Africa bias or fear of another Ramaphoria period. 

From engagements with their clients, it is much more of a portfolio diversification strategy, where individuals look to find assets that they cannot invest in locally. 

“There are some sectors that we don’t have exposure to that will inherently lead people to want to go offshore to invest and get returns in those themes, whether it’s AI, Big Tech, healthcare, and renewables in some instances,” he said. 

People think, based on past performance, that these investments will continue to grow faster than others that investors are limited to in South Africa. 

And so, Mkhize said FNB had not flagged a shift from local investors allocating more of their cash to South Africa or returning capital from overseas markets. 

Rather, the recent rally has largely been driven by local asset managers and retail investors pumping cash that was sitting on the sidelines into the stock market. 

This cash was left in fixed-income investments or savings accounts as investors adopted a wait-and-see approach in the buildup to the national election at the end of May. 

Mkhize said the local market is still relatively cheap from a valuation perspective and offers some good opportunities for investors. 

However, many will still wait to see if the new government can drive structural changes that can unlock much faster economic growth. 

Foreign investors, in particular, will want to see tangible evidence of improved economic performance before allocating capital to South Africa.