Equity market corrections are certainly not unusual and are both more frequent and less severe than market crashes. The Nirvana, of course, is when markets move up steadily, such as the period between October 2016 and January 2018 when the S&P experienced positive returns for fifteen consecutive months, leading to a cumulative return of 36% in dollars.
From September 2021, increased volatility has characterised markets, with the catalyst being steadily rising inflation in the US, culminating in a 40-year high of 7% for December 2021. Higher inflation is now widely accepted as being less transitory, and investment firms have anxiously anticipated the policy responses from the Federal Reserve and other leading central banks, believing the banks are “behind the curve” in terms of rate hikes.
The big story for investors thus far in January 2022, and indeed for this week, has been the steady decline in markets. For example, as at yesterday’s close, the MSCI was down 4.1% year-to-date with the Nasdaq down 9.5%. In addition, in what is referred to as “The Great Rotation”, there has been a sell-off in heavyweight tech and growth stocks into value plays, leading to a huge divergence in the index performances of these two investment styles.
How can the current equity market correction and stock rotation be explained? The primary reason is an increased opportunity cost. When interest rates are at zero, investors are not foregoing any yield to be invested in equities and, in particular, the high growth sectors where dividend yields may be extremely low or even deferred. In anticipation that four rate hikes may take place during 2022, markets are “front running” this opportunity cost, with investors searching for immediate yield outside of the mega cap tech stocks, which form a large weighting in the S&P.
Our view is that the quality companies on which we focus are not overvalued and thus less sensitive to rate increases and market corrections over the medium to longer term, notwithstanding the short-term volatility.
Meanwhile, on the SA front, the JSE has surprisingly bucked the global trend, achieving a record high of 76 233 yesterday and representing a year-to-date return at that point of 3.4% in rand terms. This was accompanied by a surge in the rand over the same period, which increases the return of this index to 8.9% when measured in dollars, as compared to the MSCI at -4.1% outlined above.
Our research this week shows that the general trend of emerging markets is positive 3.5%, with emerging market currencies gaining alongside the rand. We believe persistent rand strength is unsustainable due to several factors, including tepid economic growth, domestic inflationary pressures, deteriorating SA fundamentals, and an uncertain political landscape. These same factors would also have a major bearing on the future performance of the JSE relative to its global counterparts.
“The key thing will be whether we see a pause in market interest rate expectations after weeks of aggressively pricing in more hikes and balance sheet reduction.”
– Craig Erlam, OANDA analyst
Global News
- New York Times columnist, Paul Krugman, believes most of the profit margins reflected by big US companies, like shippers, own crucial assets at a time of supply chain bottlenecks. He argues: “It’s possible that some companies are using general inflation as an excuse to hike prices, abusing their monopoly power in ways that might have provoked a backlash in normal times.” The Biden administration and its allies are not claiming otherwise and are trying to toughen up antitrust policy in their fight against inflation. There is much controversy over this policy, as well as concerns as to how it will be practically implemented and enforced.
- This comes as Bloomberg reports that global inflation is ending a period of cheap electricity, giving a fresh jolt of uncertainty to global energy markets battered by one supply crisis after another. Relentless price declines over the past decade made renewables the cheapest sources of electricity in much of the world. In the past year, though, prices for solar panels have surged more than 50%. Wind turbines are up 13%, and battery prices are rising for the first time ever.
- Investec argues that few factors have the potential to shape 2022 like the path of global inflation. The prevailing view is that the current uptick in prices is due largely to a surge in pent-up demand as economies rebound, combined with supply shortages, while capacity that was mothballed during lockdowns is reinstated. But if inflation proves more permanent than transitory, interest rate hikes will follow, potentially throwing markets into turmoil.
- In the evolution of a major geopolitical risk, US Secretary of State, Antony Blinken, has cautioned that Russia could launch a new attack on Ukraine at short notice, but Washington will pursue diplomacy if it can. America has promised severe sanctions against Russia in the event of a new invasion. The Kremlin said tension around Ukraine was increasing and it is still waiting for a written US response to its sweeping demands for security guarantees from the West.
- Surging demand, fading Omicron fears, and OPEC+’s inability to ramp up output have underpinned an incredible rally in oil prices. Global benchmark Brent crude has jumped 25% to around $88 a barrel since the end of November. Goldman Sachs Group said this week it sees prices reaching $100 in the third quarter as consumption climbs.
- Long-standing concerns about China’s ageing population returned to the headlines this week as official statistics showed the country’s birth rate plummeted in 2021 to the lowest since modern records began in 1949. But China’s ageing society and looming worker shortages are widespread trends across the developed world. Like so many other economic statistics, Covid-19 may have distorted these relatively slow-moving trends only temporarily. Read more here.
- At the same time, Investec says there are few things that US Democrats and Republicans agree on – other than China being wrong on almost everything. Yet one gets the sense that both camps felt a grudging admiration for the way Xi Jinping put Jack Ma, the founder of tech conglomerate Alibaba, back in his box when he got a little too ambitious. The sweeping regulations imposed by the Chinese government on their tech industry look to have both altruistic and ulterior motives. Many parents with screen-addicted children would agree that restricting gaming platforms is not an entirely bad idea, nor is making online learning content more affordable. But halting IPOs and banning celebrities from social media platforms seems a ham-fisted way to go about it.
- In company news, Swiss luxury goods group, Richemont, reported that strong demand for jewellery in the Americas and Middle East helped sales grow by a third in the three months to end-December, also boosted by a partial return of tourism spending. Group sales of €5.66 billion in Richemont’s third quarter were up 32% in constant currency terms year-on-year, and up 38% from 2019.
- In international news, major airlines rushed to rejig or cancel flights to the US ahead of a 5G wireless rollout on 19 January that has triggered safety concerns, despite two wireless carriers saying they will delay parts of the deployment. The Federal Aviation Administration warned that potential 5G interference could affect height readings that play a key role in bad-weather landings on some jets, and airlines say the Boeing 777 is among models initially in the spotlight.
- Russia’s central bank wants to ban crypto mining and trading because it feels that it is nothing more than a pyramid scheme. Bitcoin has shrugged this off. Its value, despite the news, rose 4.2% to $43,463 during New York trading hours. Russia houses about 10% of crypto mining activities.
Local News
- The South African Reserve Bank is likely to raise interest rates to 4% on 27 January as it continues its hiking cycle as consumer price inflation picks up, according to a Reuters poll on Wednesday. Statistics South Africa on 19 January reported that annual consumer price inflation, as measured by its consumer price index (CPI), rose to 5.9% in December, its biggest annual increase since March 2017 when the rate was 6.1%. Prices rose 0.6% month-on-month. CPI is forecast to average 4.8% this year, slow to 4.5% in 2023 and 4.4% in 2024, the poll shows. That’s around the midpoint of the Reserve Bank’s 3% to 6% target range.
- Business Day columnist, Peter Bruce, has argued that the ANC’s claims are like the pipelines it builds – full of holes. Describing the ruling party’s litany of missteps, he quotes President Cyril Ramaphosa as saying: “It is imperative that we build on the successes of the district development model to drive the revitalisation and stabilisation of local government.” Bruce adds: “He must think people are fools. Either that or he doesn’t care what he says.”
- Following the fire that damaged parliament at the beginning of the year, and the vandalism at the Constitutional Court, plus the Lindiwe Sisulu argument that the Constitution and judiciary are broken, a burglary took place at state capture whistle-blower, Themba Maseko’s, house. These seemingly unrelated events were then followed by a robbery at the home and office of former SARS executive, Johann van Loggerenberg, who was targeted in the early hours of Tuesday morning by criminals he believed might have an ulterior motive. We surmised in a News Flash earlier this month that repeated criminality against state institutions is a form of politically motived terrorism following the release of the first Zondo Commission Report, as well as in the lead-up to the December ANC elective conference. The strategy to undermine the reform efforts within the ANC will, in our view, be deliberately orchestrated and increasingly multi-faceted.
- The office sector is set to come under more pressure due to a hybrid work model, which includes working in the office and from home, as well as occupiers downsizing to smaller quarters. Landlords will need to be flexible as data from the SA Property Owners’ Association showed that vacancies climbed to 16% in the last three months of 2021, which is a percentage point above the previous record in 2003.
- Capitec’s share price dropped after it indicated that a proposed BBBEE transaction for staff was likely to dilute earnings. Shares in South Africa’s biggest retail lender by customer numbers fell 4% to close at R2 019 on 19 January. That still leaves the Stellenbosch-based lender with a market value of about R242.2 billion, making it the second biggest banking group in South Africa after FirstRand in terms of market capitalisation.
- Meanwhile, South Africa is reconsidering the national state of disaster as the rate of Covid-19 infections dips. This comes as several people have challenged the government on the use of state of disaster legislation to curb the spread of the virus. The National Coronavirus Command Council is set to brief cabinet on the issue.
- This comes as US biotech billionaire, Patrick Soon-Shiong, launched a plant that will produce one billion Covid-19 vaccine doses a year in Cape Town by 2025. This would make it the biggest such factory in Africa and could help the least vaccinated continent tackle the pandemic more aggressively.
Sources: Dynasty, News24, New York Times, BusinessLive, Reuters, Bloomberg, etc.
