IN THIS ISSUE:

• Part One (A): 34,000

  • Part One (A): 34,000; Sidebar

• Part One (B): Sovereign Ratings

• Part Two: RA Season

  • Why invest in retirement annuities?

  • What is the relevance of RA season and does it apply to me?

Welcome to the January edition of NFB AM’s Monthly Market Report. This edition is going to be quite different from our usual monthly Reports in that we’ll spend the first part reflecting on how local equities are performing and on European sovereign debt and the second on retirement annuities and their role in personal financial planning; particularly from a tax planning perspective..

Part One (A): 34,000

The JSE All Share Index reached an all-time high during January; closing above 34,000 for the first time on the 26th of the month. The last time the Index was reaching new highs was in the middle of 2008, prior to the Credit Crisis.

South Africa
JSE All Share Index
April 2008 – January 2012, Daily

A brief review of market conditions at the time of these two peaks is highly instructive:

Despite being around 3% above its previous peak the JSE All Share Index now presents better value to investors. PE (price divided by earnings) ratios are down close to 20% between May 2008 and January this year and dividend yields are up 13%. Current PE ratios, however, are only slightly below their historical averages and dividend yields are at their averages. A similar scenario exists for offshore markets. For these reasons the NFB Cautious Fund of Funds has an overweight position of 26.5% in equities (local and offshore equities) versus a neutral position of 25%. Similarly, the Balanced Fund of Funds has an overweight exposure of 64.5% versus a neutral position of 60%.

Those of you with an enquiring mind may be wondering how the market is able to reach new highs while the PE ratio is falling. The balancing figure is earnings, which are up 26% over the same period.

Part One (A): 34,000; Sidebar

In addition to the market presenting slightly better valuation characteristics despite having attained new heights, the broader economic environment itself, within which the market operates, is also better than that of 2008 as the table below illustrates:

	22 May 2008	26 Jan 2012
USDZAR	7.61	7.81
SARB Repurchase Rate	12.0%	5.5%
Inflation Rate (CPI)	10.7%	6.1%
Real Interest Rate	1.3%	-0.6%

Note: the greater the real interest rate (the inflation rate subtracted from the repurchase rate) the more restrictive monetary policy. A negative real interest rate, as we have at present, is highly unusual. We can only find two such instances since 1999, both in very recent times (2008 and 2009).

Part One (B): Sovereign Ratings

On Friday the 13th of January, we’re certain the date carries no occult significance; the S&P ratings agency downgraded a broad swath of European countries’ sovereign debt ratings. Italy, Portugal and Spain were downgraded by 2 notches; France by 1. Germany and Ireland were left unchanged.

Downgrading Portugal by 2 notches has left them in sub-investment grade territory, the consequence of which is that investment vehicles the world over with mandates not to invest into sub-investment grade debt have to get rid of all of their Portuguese sovereign debt exposure. The chart below clearly illustrates the jump in yields as these instruments were sold back into the market (there is an inverse relationship between the yield on and the price of fixed interest instruments). Yields rose from 12.4% on the Friday to 14.3% on the Monday, and currently are in excess of 15.5%:

Portugal
10-year government bond
January 2012, Daily

S&P’s ratings downgrades does very little to change our stance on European sovereign debt, of which we have written at length about in previous editions of this Report.

Part Two: RA Season

As we approach the end of February we enter what is known as “RA season”. It is, effectively, a time to assess one’s taxable income over the previous year and then see if one has contributed the maximum permissible amount to retirement funds.

Why invest in retirement annuities?

The primary benefit associated with RA’s is that the contributions to these vehicles, subject to certain rules and limits, are tax deductible.

Investors can effectively contribute 15% of non-retirement funding income into RA’s and get a tax deduction.

In basic terms this means that the contribution can be offset against taxable income, bringing down an individual investors’ overall tax burden. A 40% tax payer can therefore get 40% of the contribution “refunded” through tax deductibility – an investment where 40% of your contribution is paid by SARS!

There are additional tax benefits in that the returns generated in RA’s are free of any tax and RA’s are not subject to any estate duty.

What is the relevance of RA season and does it apply to me?

RA season allows investors the opportunity to see if they have taken maximum advantage of the allowable tax deductions associated with RA’s for the tax year. If, for example, an individual has non retirement funding income of R1,000,000 they could commit R150,000 to an RA and get a “tax break” of R60,000. If they have only committed R75,000 during the year to their RA, they can use February to top their contribution up to the maximum permissible amount and get the associated tax benefit through a once-off lump sum contribution.

Given that time flies past so quickly and that any RA top ups must be concluded prior to 29 February, we would like to encourage investors to contact their financial advisors as soon as possible if they believe they could top up their contributions to take maximum advantage of the tax breaks associated with RA’s; the mechanics and details of which can be discussed in detail at that point.