By Adriaan Pask
As 2022 comes to a close, the majority of the world still faces stubbornly high inflation, aggressive interest-rate hikes and geopolitical tensions brought on by the war in Ukraine.
Some of these events were foreseeable, some perhaps not so much. One thing is certain: in 2022 investors have learnt that it is entirely possible to lose money by investing in good businesses – if you overpay.
Thinking back to the beginning of the year, most people were still unsure as to where global interest rates would go. The consensus was that they would go higher, but very few expected them to go as high as they have, as quickly as they have.
Our view at the beginning of the year was that inflation would be a lot stickier than expected at the time, and the logical implication was for interest rates to surprise to the upside.
As interest rates go up, valuations start to matter a whole lot more. Growth comes into focus, fears around recessions develop, and then stocks will derate in price in line with the elevated risks in the macro environment.
It was no surprise that counters that came under strain in 2022 were high-duration, high-growth stocks, or stocks that are pricing in elevated levels of growth for a very long period.
Typically, these were tech companies, which had high-profit margins. They were priced as if they would sustain those margins and growth rates for a very long time, and over the past few months, these companies have started to sell off.
A key lesson here is that there’s a meaningful difference between a good business and a good investment. None of these tech companies are bad businesses, but they don't necessarily make for good investments in the current environment.
The time will surely come around when the environment normalises and valuations for these counters become attractive again.
Our view on persistent inflation and rising rates also made us cautious of developed market bonds. We felt that the yields on these bonds were very low, even after the pandemic, and essentially they could only go up from there.
2022 consequently has been very painful for investors as both developed market bonds and equity sold off heavily during the year, subsequently, the performance of offshore portfolios suffered.
Another key influence on markets during 2022 was China. China is a key consumer in the global environment, and the health of the Chinese economy is important for commodity producers like South Africa.
Despite seeing slower growth out of China, compared to what we have been used to over the past 20 years, it remains relatively high compared to the rest of the world. There are also existing supply-side constraints, which have been the key driver behind elevated commodity prices. This has been positive for South African capital – in particular, our mining stocks.
Looking ahead
Looking ahead to 2023, we will be keeping a close eye on company margins. We expected margins to come off as the cost of capital increases (as interest rates increase), as that’s when the sentiment will start to turn further against said companies.
We have seen some of that start to come through already, but margins are still a lot higher than we think they will be during a recessionary environment.
We do expect that the US interest rates will peak next year, and that will result in interesting investment opportunities. It is not clear whether we have seen the bottom yet, but we are increasingly seeing quality businesses trading at attractive ratings.
We also believe that more conservative asset classes will start to contribute to portfolios again in 2023. In a higher interest rate environment, bonds and cash have a supporting role to play in a diversified portfolio again. This will be positive for clients in these strategies.
Another key theme for 2023 in our view will also be dollar weakness and the impact that will have on portfolios and asset classes. Our view is that the dollar is unsustainably strong and could weaken over the short term.
This translates into a stronger rand, and our bonds and SA Incorporated companies will react positively to this development.
Finally, one has to be realistic about the uncertainty around the global political environment. One would be naive to position a portfolio that won’t be subject to some political turbulence.
I think politics will continue to have a big impact, especially over the short term, where sentiment can influence asset prices. Expect the unexpected!
Adriaan Pask, Chief Investment Officer, PSG Wealth.
* The views expressed here are not necessarily those of IOL or of title sites.
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