The book The Wisdom of Crowds by James Surowiecki refers to the idea that large groups of people are collectively smarter than individual experts when it comes to problem-solving, decision-making, innovating, and predicting. This is especially relevant as it pertains to financial markets, but there is an important caveat that participants in the crowd need to be diverse and have an incentive for markets to function efficiently.
Global markets sold off heavily in January after hawkish statements by the Fed following the release of higher-than-expected inflation numbers in the US. Indiscriminate selling appeared prevalent but was perhaps justified in certain instances where company-specific financial results disappointed. Meta, Netflix and PayPal were high-profile examples.
Yet, within the theory of The Wisdom of Crowds, a divergent view is emerging that points towards a continuation of high earnings growth on the S&P, even within the higher inflationary environment. The relevance of the theory may also be applied to the context of Bloomberg’s consensus earnings forecasts, with expected earnings growth of 20% one year out for this index.
Taking it a step further and from an empirical angle, Dynasty-sourced research shows that the S&P tends to gain in the six- and 12-month periods following the first hike in most interest rate cycles. Perhaps it was these factors that caused the S&P to recover by 4% since the late January lows. Meanwhile, the JSE has achieved all-time highs, having already gained 3% since 31 January.
This leaves us with the question of current valuations and whether markets are expensive by historic standards. Currently the S&P is on a forward P/E of 20.4x, whereas the JSE is somewhat cheaper on a forward P/E of 11.4x. These numbers compare with their long-term means of 18x and 13.2x respectively, inferring that US shares, while not cheap by historic measures, are significantly less stretched than they were in 2020 at 27x. While local shares appear to be offering value, it can be argued that the historic multiple of 13.2 factors in a period when SA was rated as investment grade.
“We don’t prognosticate macroeconomic factors. We’re looking at our companies from a bottom-up perspective on their long-run prospects of returning.”
– Mellody Hobson, President of Ariel Investments. (The quote urges investors to look for quality companies with the strength to make it through challenging economic environments)
Global News
- Goldman Sachs’s economists now expect the Federal Reserve to raise interest rates seven times this year to contain runaway US inflation, up from the five hikes they had forecast a few weeks prior. This is thanks to the US inflation rate climbing to an unexpectedly high level of 7.5% in January, its highest since 1982. The consumer price index rose by 0.6% in January alone, from December’s level. Food, energy, household furnishings and health insurance were the biggest factors driving up the cost of living.
- Despite this, the US economy added 467 000 jobs between mid-December and mid-January, according to the most recent Employment Situation Summary by the Bureau of Labour Statistics. Even with Covid-19 cases reaching an all-time high in the first weeks of January, employment growth surpassed projections. Upward revisions to previously published employment growth estimates for November and December now put the three-month average at 541 000 jobs gained.
- With the January inflation number released yesterday, US stocks eased back and were essentially flat for the week at the time of writing, after having gained nearly 2% by Wednesday, while tech shares followed the same pattern, having gained 2.5% by mid-week.
- Equities have historically held up well during interest rate hiking cycles. According to research published by Standard & Poor’s, FRB, Bloomberg and Credit Suisse, average returns on the S&P based on rate hike cycles, beginning in 1994, 1999, 2004 and 2015, were approximately 4.5% in the six months after the initial rate hike and 8.8% after twelve months.
- Stocks that are well positioned for an inflationary environment are those with quality attributes including enduring competitive advantages; high gross margins that mitigate the impact of rising input costs; capital-light businesses; and low financial leverage which would mitigate the impact of higher finance costs as rates rise to combat inflation. (This is based on Ninety One Asset Management’s “quality-style” characteristics as embedded in their Global Franchise Fund that we utilise).
- Gold prices continued to rise in London this week, reaching a two-week high on Wednesday against a weaker US dollar as longer-term interest rates eased from their strongest since mid-2019 ahead of US consumer price inflation data. With gold prices reaching $1 830 per ounce, Washington’s ten-year Treasury yield slipped three basis points from Tuesday’s new 30-month highs at 1.96% per annum.
- Turning to alternative sources of renewable energy, the possibility of harnessing the power of the stars has moved a step closer to reality after scientists set a new record for the amount of energy released in a sustained fusion reaction. Researchers at the Joint European Torus in the UK generated 59 megajoules of heat, more than double the previous record of 21.7 megajoules set in 1997 by the same facility.
Local News
- Although the JSE is currently close to all-time highs, the private sector is stepping in where the state has failed. Sustained earnings growth cannot continue in a tepid economic environment with GDP set to average around 2% per annum for 2022 and 2023. Neither can we depend on a commodity super cycle to fund our fiscal deficits. As such, Dynasty does not necessarily subscribe to the SA “value play” currently offered by the FTSE/JSE, although this index should provide a hedge against rand weakness and higher inflation.
- RW Johnson argues that the ANC has embarked on a relentless programme of decay. “In that sense, the fire that destroyed Parliament was a crowning moment. Everything that we know about it – the sprinkler system that didn’t work; the CCTV system that went unmonitored by the police; the fact that the post of head of security for Parliament had been vacant for six years; that the building’s fire alarms only went off after the fire brigade had arrived – reeks of the key characteristics of the 1994 republic.”
- In a private sector initiative, former South African Post Office boss, Mark Barnes, has put forward a proposal for turning the post office into a national treasure. He argues that a public/private partnership would be ideal as there is a will, an energy and capacity (which borders on downright determined patriotism and a desire to succeed) within the mix that is the South African people. Read more here.
- Daily Maverick believes South Africa’s low growth over the past decade is attributable to one of three things. An external story – the end of the country’s growth and the fiscal consequences of the end of the commodity super cycle. A macro story – SA’s debt build-up and macroeconomic failures. A micro-economic story – the persistent loss of productivity in the economy and the investment slowdown triggered by micro-economic policies. Read more here.
- This comes as several economic indicators suggest South Africa is regressing under the ANC. Although GDP per capita grew from $2 497 in 2002 to $8 810 in 2011, it is now at approximately $5 600. Unemployment, inequality, crime, poor public health services, and a lack of policy certainty are all indicators of the country’s regression.
- On a positive note, Toyota SA CEO, Andrew Kirby, predicts that new vehicle sales will grow by at least 16.3% this year, lifting the market above pre-Covid levels and launching a period of sustained growth. Kirby, almost the only forecaster to come close to 2021’s 22% improvement (he predicted 21%), said 2022 growth would be even higher if the motor industry could overcome supply constraints.
- Standard Bank says five key African economies will face debt risks over the next two years as an era of extraordinary pandemic-induced stimulus and relief for poor nations ends. The bank named Ghana, Kenya, Angola, Ethiopia and Zambia as the “fragile five” of 18 countries covered in a recent report. The ratings agencies will no doubt remain vigilant in terms of SA’s debt metrics in a low growth environment.
- Meanwhile, justice minister, Ronald Lamola, is making headlines after last week’s chief justice interviews. The Judicial Service Commission interviews have resembled a Jerry Springer show in recent years, and last week’s episodes were no different, according to the Financial Mail. However, publicity may boost his profile at an important time as there is noise about his suitability to be the ANC’s deputy president. The controversy might also help South Africans make up their minds about exactly who Lamola is.
Sources: Dynasty, Bloomberg, Daily Maverick, Financial Mail, News24, AFP, The Guardian, Wall Street Journal, etc.
