South African investors are facing an increasingly challenging investment environment. With upward pressure on global interest rates, definite signs of a slowdown in the US economy and increasing fears of higher inflation on the back of sharp hikes in commodity and food prices, the prospects are deteriorating. However, fresh in most investors' minds is the experience of the last few years, where an investment in almost any financial or physical asset would have delivered meaningful real returns - with the exception of sovereign bonds perhaps.

This unprecedented increase in asset prices around the world means that most available investment opportunities are priced at or above their fair fundamental value, which augers average or below average longer term returns if bought at these prices.

The JSE is a very good example of just this. On the back of the strongest global economic growth since the Second World War, very low global rates of interest and very strong commodity prices, South African companies have generated very strong profit growth. As companies were able to put spare capacity to work, JSE profits over the last three years have grown by the highest rate since the early 1960's. Aggregate profits have grown on average by 28% in excess of inflation for three years now.

This growth in company profits was not a South Africa-specific occurrence - the same happened around the world. UK company profits, as measured by the FTSE 100 Index, have grown by more than 25% per annum for the last year, European profits have grown by more than 22% per annum while on a global basis US profits were the laggards with growth of between 17% and 20%, over the last three years. Only in South Africa though, did share prices outpace the growth in profits, which means that the local market has become increasingly expensive while global developed markets have become increasingly cheaper.

The outlook for local corporate profits has deteriorated. While most commentators still firmly believe that the local economy will deliver sustained strong growth, anecdotal evidence suggests that capacity constraints in fact starts to hamper company profits. For many years now, analysts have been too pessimistic on earnings. This might just be the year when analysts finally catch up and over-estimate profits. Local companies will remain profitable, but current market valuations already reflect those expectations and therefore leave very little in terms of valuation to generate good returns. Investors will have to settle for subdued returns from the local markets for a while.

Similar or better returns are available in offshore markets, especially in the developed markets, where corporate balance sheets are healthy, prospects are good and valuations are fair.

ISSUED BY:

CITADEL

For further information please contact:

Daleen Cornelissen
Media Liaison
Tel: (012) 470 2500 or 083 302 0827
daleenv@citadel.co.za

OR

Jan van Niekerk
Chief Investment Officer
Tel: (021) 940 7200 / 083 285 6596
E-mail: janvn@citadel.co.za