South African equities are going to be challenged by high volatility and multiples for the remainder of 2016, Peter Brooke, Head of Old Mutual Investment Group’s Macro Solutions boutique, has said.

Brooke said that SA equity markets are currently undergoing the highest level of volatility on record, driven by global growth factors, domestic policy issues and uncertainty about the Chinese economy.

He expects the current situation to improve in 2017, saying that in the meantime the remainder of this year is going to be a challenge for investors.

Speaking at Old Mutual Investment Group’s (OMIG) second quarterly media briefing for 2016, Brooke said that the current situation has important implications for South African market in terms of the allocation of capital.”

“Because of higher volatility levels, investors need to be rewarded for risk. Based on our valuation work, we do not see this reward in SA equity and are looking for alternatives such as global equity, private equity and hedge funds,” he said.

“One of our major concerns is about South African corporate profitability. Inflation has gone up to 7%, with food inflation peaking around 15%, which is ultimately putting pressure on the consumer. This means spending power will come under pressure, and at the same time, the ability for companies to pass on cost increases has diminished, given that growth is under pressure based on higher interest rates,” he added.

Brooke said that the good news is that we are already going through this process, with interest rates having already gone up and inflation accelerating.

“As a result, we can start looking ahead to 2017 where things are expected to start improving, as inflation peaks and comes down again. With the SA economy starting to rebalance, exports growing and imports contracting, and the current account deficit narrowing, we’re starting to move towards a better place, but it is still too early to get there,” he said.

“This creates a better environment for the rand and bonds while still creating a tough environment for local profits,” he added.

OMIG is overweight offshore equity, underweight SA equity, overweight SA interest-bearing assets and underweight offshore interest-bearing assets.

“This is based on where we see the best risk-adjusted returns. We’re seeing high yields in SA, while offshore equities are offering better yields than bonds and cash,” said Brooke.

“We’re also running with more cash than we would normally hold, and are more positive on the rand than before. Overall, we’re looking for yield wherever we can find it, which is very much an absolute return mentality, without taking excessive risk,” he added.