LOCAL MARKETS IN A NUTSHELL
The South African stock market fell sharply during the quarter as global recessionary fears have accelerated. The JSE All Share Total Return Index fell 11.69%, led once again by financials and resources stocks. On a year-to-date basis (01/01/2022 – 30/06/2022) the local stock market is still one of the better performing markets around the world.
Chart: Performance of the FTSE/JSE All Share Index over the past ten years (2012/07/01 – 2022/06/30)
Source: Trading economics
Since the start of the year, the market has had to digest complete and utter uncertainty as both political and economic events unfold. There is evidence of an impending recession The local market has begun to price this in as commodity prices fall, as a result of expected lower future demand.
Local financial stocks such as the banks and insurers have also fallen in price in anticipation that if the world is going into another recession, the South African consumer will be even more financially distressed and therefore people will have less money to spend and company profits will fall.
In a nutshell, the market is pricing in a negative financial reality.
The local currency weakened significantly on the back of inflation and recession fears. The rand fell 11.43% against the US dollar and 3.26% against the pound. Despite the volatility over the past 6 months, the rand/US dollar exchange rate is similar to where it was at the start of the year.
Source: Profile Data 30/06/2022
* Annualised Performance
“2022-05-Market Update and Outlook-Managers Q&A”
In the API 2021 Fourth Quarter Summary, we noted that “both local assets as well as the rand, are likely to experience high levels of volatility throughout 2022”. Although no one could have reasonably forecast the events of 2022, it was important to have the correct expectations going into the year.
As events continued to unfold and volatility and uncertainty increased, API endeavoured to engage with the various fund managers in order to try and achieve a “consensus view” regarding current events as well as the outlook for future returns. API posed four questions to six prominent and well-respected fund managers.
The four questions that were put to the fund managers were intended to answer the follow points:
- What’s going on?
- What’s being done to manage risk?
- Have longer-term return expectations changed?
- Should clients expect further volatility over the short term?
In highly fluid environments such as the one that we are currently experiencing, it’s important for investors to have the correct expectations.
The media is perhaps one of the more unreliable sources for anyone who is seeking a balanced view on emotive topics, which includes economics and financial markets. As the saying goes there’s a degree of comfort when one is able to get feedback “straight from the horse’s mouth”. As such, we have made the fund managers’ responses available to our clients as well as a summary of their responses.
What are the managers doing to manage risk in the portfolios?
It’s important for investors to remember that the underlying fund managers are actively managing the asset allocation and stock selection within the portfolios. Some managers are utilising hedges or exposure to precious metals such as gold for exposure to uncorrelated defensive assets.
Fund managers are active but not necessarily reactive when markets are volatile. Investors sometimes feel that they need to react when markets fall (as was the case during the covid crash). However, the reality is that doing nothing as an active decision is in fact doing something, and that “something” is allowing the managers the time to navigate various markets environments as they are in the best position to do so.
Is it still reasonable for investors with a balanced risk profile to expect an annualised return of inflation +5% in rand terms over the next 5 years?
All of the managers with the exception of Allan Gray have overtly stated that they feel this return is reasonable and achievable over the next 5 years. All of the asset managers including Allan Gray are optimistic about asset prices outside of the US, particularly after the recent market fall.
On balance they feel that an annual return expectation of inflation +5% is achievable over the next five years in a balanced risk mandate.
Investors may find that the average return over the next five years may be very lumpy (periods of poor returns, followed by periods of high returns being delivered in a “lumpy sequence”). This speaks to the next question regarding volatility.
Should investors have the expectation that over the next 6 – 12 months, markets may continue to be fairly volatile?
Yes. Each manager expressed their expectation that volatility is likely here to stay over the next 6 – 12 months as many market factors continue to play out. Investors need to be prepared for the volatility. We remind clients that volatility, whilst uncomfortable, gives managers opportunities to buy into attractively priced assets.
Simply put, clients should expect to see further fluctuations in the value of their investments. We remind clients that this does not reflect a poor investment decision but rather a short-term shift in sentiment. In other words, the market’s “feelings” (sentiment) is likely to shift from being positive to negative more than usual which results in volatility.
We encourage investors to read the full report in order to better appreciate the various managers detailed responses. Investors can access the report via the link below:
Volatility may be painful, but inflation is the silent killer
South African investors have been through a decade of relatively low returns in local balanced funds. In a relatively low interest rate environment South Africans are less convinced as to whether bank deposits are the way go. Inflation is also relatively high, and some industry experts are expecting inflation to increase a further 1% – 1.5% before moderating to a lower level.
One of the goals of any investment should be to grow the capital over and above the rate of inflation. This ensures that the capital maintains its purchasing power. A notable dilemma with investing the bulk of one’s retirement savings in bank deposits or other cash instruments over a long period of time, is that the capital (after income tax), has historically struggled to grow over and above the rate of inflation.
In other words, if one invests the bulk of their retirement savings in bank deposits, it may struggle to grow ahead of inflation.
The table below was taken from an article in Businesstech. The table shows the average cost of various goods in 1980 compared to the cost of the same goods in 2022.
When one sees the extent of how inflation erodes one’s purchasing power, we are reminded why we need exposure to growth assets.
The snapshot below highlights two key points:
- Over the last 92 years, cash investments have only grown by 0.9% more per year, than the 6% inflation rate over the period.
- Historically it has taken 86 years for cash investments to double the value of your capital over and above the rate of inflation.
Source: Old Mutual Long-Term Perspective 2022
Although its extremely difficult to maintain one’s faith in growth assets after the disappointing decade of relatively low returns for South African investors, the principle of investing in growth assets for above inflation returns remains ever relevant in ensuring successful retirement outcomes.
The outlook for local assets remains positive. According to most fund managers the expected return over the next 5 years for a balanced risk mandate is for double digit returns. This is something which is desperately needed by South African investors on the back of recent poor returns. The return over the next 12 months is however likely to be fairly random as short-term returns are more correlated to market sentiment as opposed to market fundamentals. We therefore caution clients that the remainder of 2022 is likely to be highly volatile. However, now is not the time to abandon growth assets as they have already fallen in value based on the expectation of an impending global recession.
OFFSHORE MARKETS IN A NUTSHELL
Global equity markets had another tumultuous period, closing out the quarter -16.6% lower in US dollars.
The graph below represents the World Equity Index over 5 years in dollar terms.
*Performance as of 30/06/2022
The second quarter of 2022 was yet another uncomfortable period of negative returns. After the sharp bounce post the covid crash, markets were relatively stretched from a valuation perspective. The US market was considered to be expensive after its strong return in 2020 and 2021.
As the war in Ukraine wages on, the economic reality around the world has continued to deteriorate. Year-to-date the market has priced in a global recession in anticipation of weak economic data, and with the backdrop of tightening financial conditions and high inflation.
Simply put, the risks of an economic decline have become greater, and the market is trying to price this in before it happens.
“Recession is on its way”
The world entered 2022 expecting a fairly volatile period over the course of the year. What people didn’t expect was for 2022 to perhaps end in a recessionary environment. So, what has changed? At the end of 2021, the global economy was considered strong and robust albeit with concerns around supply chains and higher global rates of inflation. Unfortunately, the global economy was vulnerable to shock events.
The war in Ukraine was one such shock event that could send the global economy over the edge. As it continues to unfold, it seems that Russia’s timing as well as its resolve to continue the conflict and therefore the exogenous economic stress may be the straw that broke the camel’s back.
The chart below shows two indicators which overlap each other. The white line represents the ISM which is a measure of economic activity in the US economy (the largest economy in the world). The blue line is a composite index of various economic indicators which measure financial condition in the US. This measure has a 9 month lead. In other words, it attempts to anticipate the financial condition over the next 9 months.
The GMI Financial Conditions Index shows that economic activity is forecast to fall considerably and relatively quickly.
This chart speaks to why the market has fallen since the beginning of the year as it has attempted to price in a global recession.
Source: Global Macro Investor
The question is being asked as to whether investors should get out of the market as a “global recession is on its way”?
The chart below shows (according to Global Macro Investor) the extent to which the market has already priced in a sharp growth.
At the time of writing, the ISM was recorded at 53 which is shown by the white line in the graph. The blue circle which is highlighted by the title “S&P 500”, shows where the S&P 500 is pricing in the ISM at around 46 over the coming months.
Source: Global Macro Investor
Simply put, now’s not a good time to get out of the market as its already priced in (to some degree) a global recession.
We would also highlight the fact that the blue line – the forward-looking financial conditions indicator (which is highlighted by the green circle) appears to have already bottomed out and is perhaps starting to trend upwards.
Although the details of this article may be somewhat confusing for the average investor, it provides context and detail to the three points that we would like to leave you with.
- The world is in all likelihood heading for a global recession.
- The market has already fallen in value as it has attempted to price this in before it actually happens.
- The forward-looking indicator appears to have already bottomed out and is perhaps starting to trend upwards. Hopefully this indicates that the global recession won’t be long-lasting.
Its no secret that markets move in cycles. Market cycles can be divided into periods of gains (bull markets) and periods of declines (bear markets). The snapshot below shows the history of market cycles using the S&P 500 since 1942.
Since 1942 the average bull market lasted 4.4 years with an average return of 154.9% (from the market bottom to the market top) whilst the average bear market lasted for 11.3 months with an average decline of 32.1% (from the market top to the market bottom).
Source: Cabot Wealth Network
After recovery from the 2020 market crash, one had hoped that the new market cycle would be long lasting with at least 4 years of positive returns. What transpired was a relatively short recovery which lasted only 2 years.
The chart helps to remind investors that markets move in cycles of both ups and down. Its not something to be feared but rather understood.
As the world moves into a recession, investors are reminded that the global recession will ultimately end and the global economy will inevitably recover at some point, leading to a new market cycle or bull market.
Without a crystal ball it’s impossible to accurately and reliably tell when market crashes will happen or how far the market will fall. The same is true for a sustained market recovery. We therefore rely on the fund managers to navigate the full market cycle.
FORWARD OUTLOOK (OFFSHORE)
The outlook for global markets is uncertain. Investors are once again reminded that the remainder of 2022 is likely to be characterised by relatively high levels of volatility. Since the beginning of the year, global markets have fallen sharply as the risks have risen. As market cycles show, investors shouldn’t sell or liquidate their investments in a bear market.
Fund managers are very optimistic about the potential for very attractive returns over the next 5 years as assets have been mispriced and therefore provide opportunity as was the case after the 2020 covid crash.
Unfortunately know one knows when the market will begin a sustained recovery. However, investors need to look to the next 5 years for positive returns rather than the next 12 months which is more susceptible to market sentiment as opposed to market fundamentals.
In times of worry or concern regarding your investments, we urge you to make contact with your financial adviser.