South Africa remains exposed ahead of the next round of capital flow volatility associated with shifts in the US Federal Reserve policy, according to Novare Investments.

Francois van der Merwe, Head of Macro Research at Novare Investments, said the local economy has lost momentum through lower government spending and weakness on both the demand and supply side.

“It faces mounting risks of further weakness. The precipitous drop in commodity prices and its impact on South Africa’s trade through lower export prices is just one of them. Insufficient demand is a limitation on companies’ expansion plans, and consumer and business confidence levels are at historical lows. Overarching all of this is the shortage of electricity,” he said.

Van der Merwe said that, while the valuation of the local stock market has eased from its recent peak, the FTSE/JSE All Share Index still trades at a historic price-to-earnings multiple of 17.5.

“This is uncomfortably high compared to its long-term average, and given company earnings expectations that are overly optimistic. Companies whose earnings are not dependent on the local economy are trading at even loftier valuations. There is little margin of safety in the local equity market,” he said.

The local bond market has a high dependency on short-term capital flows, and is characterised by high levels of foreign ownership, weak growth prospects and deteriorating credit quality.

Local bond yields are somewhat more attractive than they were a few months ago, but there’s a probability of them underperforming cash over the next 12 months.

Van der Merwe said that in an environment of increasing global volatility, an overweight position in offshore assets where investors can take advantage of potential rand depreciation and diversification benefits could be prove to be beneficial.

“Given positive economic and policy fundamentals, there’s a case to be made for global equities. Although valuations are slightly rich, earnings expectations are low and have the potential to surprise on the upside,” van der Merwe said.

“Overall, a slowdown in emerging markets will be a drag on global growth, with the International Monetary Fund (IMF) forecasting 3.3% this year and 3.8% in 2016,” he added.