Equity markets have enjoyed a strong start to the year despite a slight retracement this week, with the S&P 500 peaking last Friday 4.16% up year-to-date, and our preferred global equity funds having gained as much as 6.7% earlier this week.
Looking forward, we believe that earnings will be the key market influencer for the year ahead: In Monday’s Quarterly Newsletter, we highlighted that inflation-linked bonds have already priced in a sub-2% inflation number for the US by year-end, while economists have reached broad consensus that there will be a global slowdown during the calendar year. We construe these two major market influencers as Known Knowns that have, to a large extent, already been priced into equity market valuations. Indeed, the rebound of 9.5% in the S&P 500 from its 2022 lows reached in October, to its level of 3 898 yesterday, came off the back of the fact that markets are already looking through the likely 25bps US rate hikes over the next few months, to a chance that rates might even fall by the end of 2023.
Going forward, we now expect that market participants will shift their focus to company fundamentals, and in particular the extent to which corporate earnings may have been negatively impacted by the decades-high monetary tightening policy that characterised 2022. It is noteworthy that a lag exists from the time of surging inflation and interest rate hikes, to the point where we are able to measure the impact that this has had on consumer spending patterns and corporate profitability. We refer to the current uncertainty around corporate earnings as the great Known Unknown, and believe that it will be the actual earnings releases together with forward earnings guidance that will play the dominant role in influencing both market volatility and direction during 2023.
On balance, we expect our equity portfolios to end the year higher than current levels, particularly because the very factors that counted against our active managers last year, should act as tailwinds for outperformance in 2023.
“There is a real disconnect between news flow on public companies and the value of the underlying businesses. The overwhelming majority of discussion is based on what may happen over the next year or so to create volatility in earnings, despite over 90% of intrinsic value depending on what happens after that.”
– Tony Coniaris, Partner and Co-Chairman at Harris Associates
Global News
- The International Monetary Fund may revise growth forecasts upwards for the second half of 2023, giving investors a nostalgic reminder of what was priced into markets three to six months previously. The potential for faster declines in inflation supports growth improvements later this year.
- Bonds have had a great start to the year, which is helping fuel an unprecedented debt-sale bonanza by governments and companies around the world of more than half a trillion dollars. The rally is being seen across most of the world with global bonds all over gaining 4.1% to start the year, the best performance in data stretching back to 1999.
- Overnight, the US hit its debt ceiling once again, which has led to Treasury to begin using a series of accounting maneuvers to ensure the federal government can keep paying its bills. There could well be a long fight over whether to increase the borrowing cap. Treasury Secretary Janet Yellen wrote to Congress, stating that she would begin using what is known as extraordinary measures to prevent the US from breaching its legal debt limit. She has asked lawmakers to raise or suspend the cap so that the government could continue meeting its financial obligations.
- Also in the United States, inflation is easing even while unemployment hits a 50-year low. This is despite the growing trend of job cuts that we are seeing in the tech sector. Job numbers need to be properly interpreted, as lower income earners have been hard hit by high inflation, with many having to take up second jobs.
- Cost of living price gains in Europe have declined, thanks – in part – to lower gas prices due to relatively mild winter. In December, inflation came in at 10.4% versus 11.1% in the previous month. Germany’s chancellor, Olaf Scholz, is certain that the country will avoid a recession this year, offering reassurance for Europe’s largest economy as it faces down Russia’s energy squeeze as it benefits from diversified gas supplies.
- However, Europe’s fight against inflation is likely to drag on for so long that it will tarnish the appeal of the region’s debt this year. The European Central Bank’s deposit rate will top 3.5% after another 1.5 percentage points of hikes, according to more than a third of 201 investors in the latest MLIV Pulse survey. An additional 15% see it heading to 4% or above, which would be a record level. This comes as the US seems closer to ending the rate hiking cycle than Europe, while those with home loans in the UK will be hard hit by rising payments.
- China has assured governments gathered at the annual WEF conference in Davos that it could return to its pre-pandemic growth trend this year after coronavirus infections passed their peak. This comes as it had one of its worst years of growth in decades in 2022, gaining only 3%. It also faces discontent from workers who are no longer needed due to its zero Covid policy as sectors such as covid testing have collapsed.
- Goldman Sachs’ earnings fell by nearly 70% in the last quarter of 2022, which represents a steeper decline than its peers as it set aside more money to cover bad loans. The company has long been a stalwart of the US banking sector.
- Microsoft is preparing to cut 10,000 jobs and is set to take a $1.2 billion charge as a result thereof. In fact, between Microsoft and Amazon.com, two of the world’s biggest companies, 28,000 jobs could be lost. In today’s news, Google is the latest tech giant to announce a significant reduction in its headcount with an intention to slash 12,000 jobs. This is to offset slowing sales and a possible recession.
- As at Thursday’s close the S&P 500 was 2.5% down for the week.
Local News
- South Africa is seeking a new $1 billion loan from the World Bank as it wants to take advantage of cheaper finance from international institutions over the next three years rather than approaching financial markets at a volatile time.
- Interest rates may be approaching their peak despite inflation surging to its highest level since the end of the global financial crisis in 2009, rising to 6.9% last year from 4.5% in 2021, but there is still bad news ahead as the cost of living is set to increase further. Nedbank’s economic unit forecasts a hike of at least 50 basis points (bps) in the first quarter of the year – split equally between January and March meetings – with the prime lending rate likely to peak at 11%. South Africans, however, seem to have more disposable income, according to an Altron index. The interest rate decision will be released next Thursday.
- According to economists in a Bloomberg survey, there is a 45% chance of the SA economy slipping into recession this year. They predict inflation will only near the midpoint of the central bank’s target range in the fourth quarter, before accelerating again into 2024.
- As the country continues to be besiged by loadshedding, which is only expected to end in the next year-and-a-half, it has already signed contracts with French and German development finance agencies for €600 million (R11 billion) of low-interest loans. Last November, it agreed to a $8.5 billion (R146 billion) Just Energy Transition Investment Plan, which provides concessional finance to move away from fossil fuels. Barbara Creecy, Minister of Environment, Forestry and Fisheries, has stated that countries such as Italy and India have imposed medium-term deadlines on South Africa to transition away from coal, failing which they will refuse to accept our exports.
- One must seriously question why Eskom applied for a massive tariff hike of 32%, to which Nersa approved an increase of 18.65%. Opposition political parties are now scheduled to challenge Nersa’s decision in court. In our view, Eskom’s existing business model is likely to remain in a death spiral caused by persistent load shedding and declining demand as customers (including municipalities), turn to alternative energy sources and providers. Compounding Eskom’s woes is the ever-increasing level in its debtor’s book caused by non-paying customers. We should consider that Eskom’s operating losses would better be reduced by bold management interventions to drastically reduce operational inefficiencies and eliminate corruption, in preference to hiking tariffs at more than double the prevailing inflation rate.
- Mining output declined 9% in the year to November, while the automotive industry’s significant contribution to the economy is likely to go backwards in 2023 as stage six loadshedding continues. The vehicle sector contributed 4.3% to South Africa’s GDP last year and accounted for 17.3% of its manufacturing output in 2021, while mining accounted for 8.7% of the economy two years ago.
- Railway provider Transnet seems to be in just as much trouble as Eskom, after being hollowed out for years by state capture. It is weighed down by debt and with hundreds of broken locomotives it cannot keep all of its freight trains running. The lack of ability to get coal to the ports has resulted in the money earned from coal exports, declining by R80 billion.
- The banking sector is expected to provide a bullish performance this year as the financial institutions head into their reporting cycle. This is despite higher interest rates, which are putting a strain on consumers’ disposable cash. Banks are expected to have a manageable increase in credit impairments.
- Technology services group EOH seeks to raise R600 million through a rights issue to ease a debt burden currently costing more than R200 million a year in finance charges, in a test of shareholder faith. EOH is trying to restore its reputation after featuring prominently in the Zondo reports into state capture.
- As at the time of writing, the rand was 2.1% weaker for the week and the ALSI was 0.3% lower.
Sources: Dynasty, Daily Maverick, Bloomberg, BusinessLIVE, BBC, News24, Sky News, The Economist, Reuters, TechCentral, Moneyweb, New York Times, MyBroadband, UBS, etc.
