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Financial market forecasts.
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Maximising your after-tax returns.
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Global Report: Financial market forecasts
By Nick Downing
Equity markets across the world are expected to make strong gains, at least for the next 12-15 months, amid strong earnings growth, falling interest rates and a cyclical broadening in performance across sectors and regions. Central banks usually cut interest rates to avert recession. This is not the case today. In fact, the world is enjoying synchronised economic expansion and company earnings are accelerating. Global forward earnings estimates are in a strong uptrend and momentum (the year-on-year growth of forward earnings) is picking up. These trends should persist if, as we expect, the global economic expansion continues. US forward earnings are outpacing the rest of the world, but the latter are now also gaining momentum.
Interest rates are falling because inflation is returning to central bank targets, reversing its surge during the supply shock over the Covid pandemic and the start of the Ukraine war. There have been downside inflation surprises across major economies, including the UK, Eurozone, Canada and New Zealand. Inflation is even falling back to target in the US, where concerns over “sticky” inflation have been the most pronounced. The Federal Reserve began its interest rate easing with an outsized 50 basis point rate cut, followed by a 25 bp cut in November. A further 100 bps of Fed rate cuts are expected to follow over the easing cycle. Interest rate easing cycles, which have begun in all developed economies, besides Japan, are expected to continue over the next couple of years. Easing cycles are still at an early stage.
The most likely risk for financial markets is to the upside, involving a productivity led disinflationary boom which could unfold in 2025 and beyond. A synchronised global expansion driven by rising labour productivity may result from major AI-related investment spending, which could rival the internet revolution of the 1990s. The internet lifted US labour productivity by 1-1.3% per year for a ten-year period from the second half of the 1990s, creating a disinflationary boom. Investment in AI technology could achieve similar productivity led growth over coming years. Although the valuations of AI-related sectors have risen to elevated levels, most of the rally has been backed by strong earnings growth, which shows no signs of slowing. By comparison with the dotcom bubble and its duration, AI-related shares are cheap, and the rally is still in its infancy with the potential to continue through to the end of 2025.
The backdrop of accelerating earnings growth combined with monetary and fiscal stimulus is emphatically positive for equity markets. The bull market is expected to continue into next year. Despite high valuations in the US, its equity market should continue outperforming amid growing enthusiasm for the AI theme and an expanding productivity gap with the rest of the world. While US earnings growth maintains the upper hand, the rest of the world is rebounding which should result in more regions and sectors participating in the equity bull market. The table below summarises projected returns for 2025 from independent investment research firm Capital Economics.
Donald Trump’s decisive election victory has given his government significant executive and legislative power to enact sweeping fiscal and regulatory changes. The initial market reaction was euphoric. The “Trump trade” powered the S&P 500 index higher by 10% between mid-September and the week after the election. Having won the national vote and control of Congress, he has a strong mandate to enact the pledges made on his campaign trail. During his first term, Trump led with pro-growth policies including tax cuts and deregulation. In 2017, the S&P 500 index climbed 22%. The rally took a breather in 2018 when his trade protectionism policies began, but Trump pulled back from a full trade war when equity markets started tumbling and threatening a US recession.
Trump’s campaign pledges include both pro-growth and well as growth limiting policies. Tax cuts and deregulation will propel earnings and equity markets higher, while trade tariffs and immigration restrictions will do the opposite. It is unlikely that Trump’s more extreme proposals will be implemented. If the bull market in equities starts to unravel because of his policies, he will likely water them down. Financial market stability is a key measure by which Trump himself measures the success of his administration. The last thing he is likely to want is a resurgence of inflation, which is one of the main reasons President Biden lost his popularity and ultimately cost the Democrats the election. Even so, if Trump does implement his tariff pledges, the impact may not be as extreme as feared. In China, exports of goods to the US comprise less than 3% of its GDP and this impact could largely be offset by a weaker exchange rate and fiscal stimulus. China’s manufacturing output could also be redirected elsewhere. Trump may simply want Chinese manufacturers to build factories in the US and hire American workers as the Japanese were encouraged to do in the 1980s during the Reagan presidency. In many respects Trump’s economic policy is likely to resemble the supply-side economics adopted by President Reagan in the 1980s.
On a longer-term perspective, US outperformance may be tempered by its extreme valuation premium over the rest of the world. Valuations are often poor predictors of performance over 1-3 years but tend to be reliable predictors of long-term returns. US equities now account for around 65% of global equity market capitalisation and have become expensive relative to other markets. As a result, there may be a major shift in performance between the US and the rest of the world over the coming decade, with the Eurozone, UK, Japan, China, India and other emerging markets likely to benefit.
In summary, we expect the equity bull market to continue next year with the US in the vanguard, but expect solid returns from other markets, which offer better valuations and a greater margin of safety and therefore form a crucial part of a balanced global portfolio. Due to their demanding valuation and the outsized weighting of US markets in the global index, we would be reluctant to allocate the full 65% benchmark weighting to the US in OAM’s global balanced portfolio.
Local Report: Maximising your after-tax returns
By Werner Erasmus
Introduction
The only two things in life that are certain are death and taxes. Investing is a powerful tool for building wealth, but taxes can significantly affect the returns on your investments. When it comes to investment returns and comparing investment options, tax is a very important consideration. Investors should always look at the after-tax returns when analysing investment returns. Many investors mistakenly base their decisions on pretax returns, which can lead to suboptimal outcomes.
Types of taxes
Understanding how different types of investments are taxed and planning accordingly can help you maximize your after-tax returns. In South Africa the following taxes apply to investments:
Dividends Withholdings Tax (DWT): Levied at a 20% flat rate on dividends. Investors are paid the after-tax amount by dividend paying companies. For example, if the declared dividend is R100 000 then you as the investor holding shares in the company will receive R80 000.
Capital Gains Tax (deferred tax): When you sell an investment for more than you paid for it, the profit is classified as capital gain, and it will be subject to Capital Gains Tax (CGT). CGT is also referred to as deferred tax because you will only be liable to pay tax if you dispose of the asset. The maximum CGT rate an individual will pay is 18% (assuming your effective personal income tax rate is 45%. If it’s less than 45%, you will pay less than 18%).
Income tax (accrual tax): Income tax is also called accrual tax as it is levied annually. This is the tax you pay on income generated from your investments, such as interest on cash in the bank or coupons from bonds. The interest income is included in your personal income tax calculation and taxed at your effective tax rate. Your effective tax rate is your average tax rate which depends on your annual income and calculated according to SARS’s sliding scale. The highest rate that you will pay as an individual is 45%.
The impact of different taxes on investment returns
The amount of after-tax return you earn as an investor will be different under the different types of tax regimes. Below is an example, comparing the after-tax return of an investment earning capital gain versus earning interest.
Example: Assuming your personal effective tax rate is 45% and you invest R 1 million for one year in either a share portfolio (assuming all the gains are capital gains in nature) or an interest-bearing account for one year (all the returns are interest in nature) and both investments generate a 10% return over that period. Your after-tax returns will be 8.9% on the share portfolio and 6.6% on the interest-bearing account as summarized in the table below.
Although both investments generated a return of 10% before tax over the one-year period, the after-tax return is very different. The share portfolio’s after-tax return is 2.3% more than that of the interest only (cash-in the bank investment) account because of the nature of the return and the tax applied to it.
Tax drag
The impact of tax on an investment is called tax drag and can have a major impact on investment returns especially over longer time periods. It also has a higher proportional impact when the rate of pre-tax return is higher, the investment period is longer, and investment returns are taxed annually.
Capital gains tax is taxed on a deferred basis, resulting in a lower tax drag, because the price appreciation is not taxed until the asset is sold and the gain is realised. The annual gains effectively accumulate tax free until the end of the investment horizon when they are taxed.
Strategies to minimize impact of taxes on investments
Utilizing tax advantageous accounts: Allocating investments to tax-exempt accounts and tax advantageous accounts such as tax-free investment accounts or a retirement fund (pension fund or retirement annuity) can improve your after-tax returns.
Strategic allocation: Allocate investments with the highest tax rates to accounts with tax advantages or that are tax exempt for example:
- Interest bearing investments: Allocate to tax exempt accounts
- Equities: Can be invested in directly
Tax loss harvesting: Tax loss harvesting involves selling investments that have lost value to offset gains from other investments. This strategy can reduce your taxable income and help manage your tax liability.
Hold investments for the long term: Long-term investments are often taxed at a lower rate than short-term investments. By holding onto your investments for a longer period, you can benefit from lower capital gains tax rates.
Conclusion
Taxes are an inevitable part of investing, but with careful planning and strategic investment choices, you can minimize their impact on your returns. Understanding the tax implications of your investments and using strategies like tax-loss harvesting, holding investments for the long term, and utilizing tax-advantageous accounts can help you keep more of your hard-earned money.
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Reference: Capital Economics – Historical bond and equity return data.
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