Quality-style global equity managers typically deliver a more defensive return profile during periods of sharp market drawdowns. Quality companies are characterised as having low levels of leverage, strong balance sheets and cash flow generation, together with lower cyclicality of earnings, and, as such, our selected portfolios should have fared better than markets in general during 2022.
However, quality-style managers experienced significant headwinds in 2022 due to their philosophical avoidance of energy shares, which was the only S&P sector that delivered positive performance for the year.
In re-examining the case for the retention of quality-style managers, it is pleasing to note that despite the decline in share prices, the cash-flow generation of their underlying companies in general held up well last year. This factor bodes well for return prospects going forward. To quote Ninety One, “if valuation was the theme of 2022 and the widespread derating of equities the driver of returns, then earnings and balance sheets are likely to take centre stage again in 2023”.
Our own research supports this view: Since the intra-year trough of the S&P 500 on 12 October last year, our large-cap quality managers have outperformed the recovery in this index by on average 5.5% as at 26 January, with our small- and mid-cap quality manager having outperformed by around 21.8%.
In a broader context, the recovery of major equity market indices since the October low has been encouraging, with the MSCI and S&P 500 having rebounded by 17.9% and 13.5%, respectively.
In our News Flash header “Predictably Irrational” on 14 October, we included summary research by Dr Ariely on behavioural economics, which stated that “not only are humans irrational, but they’re irrational to the degree that it’s predictable”.
The rebound in quality-style management shows how important it is for our Investment Committee to recalibrate during times of relative underperformance, but to also avoid deviating from defendable philosophies (such as quality), unless changes can be motivated by the sound foundations of research and rationality.
“We believe, however, that investors will refocus their attention on business fundamentals in 2023 and worry less about whether stocks need to de-rate further. While there is still some time to run until the rate environment normalises, we believe that the value tailwind is beginning to run out.”
– Clyde Rossouw, Fund Manager – Ninety One Global Franchise Fund
Global News
- The outlook among global leaders at the World Economic Forum in Davos, Switzerland, in mid-January ranged from cautiously optimistic to unapologetically positive. Attendees interviewed by Bloomberg News during the proceedings talked about the reopening of China, the warmer-than-expected northern hemisphere winter which has helped keep energy prices down, and an absence of what was to be an expected surge in other commodity prices.
- The US economy grew at an annual rate of 2.9% in the fourth quarter of 2022, ending a year in which economic output slumped in the first half, triggering fears of a recession before sentiment swung the other way. The strong job market and cooling inflation allowed Americans to keep spending despite fears of a recession. However, the gross domestic product, adjusted for inflation was down slightly from a 3.2 percent growth rate in the third quarter.
- Housing demand in the US is also starting to show signs of recovery, with pending sales of US homes rising for the first time in more than a year, according to new data from Redfin Corp in a report released on Wednesday. Other measures of demand, including data on the brokerage’s customers requesting home tours and people contacting the company’s agents, are up from November.
- Federal Reserve officials are likely ready to slow interest-rate increases when they meet towards the end of this month. They probably will debate how much more softening in labour demand, spending and inflation they would need to see before pausing rate rises in the spring.
- Germany and France have stated that European businesses must unleash investments on a nearly unparalleled scale to not fall behind US and Chinese firms as countries overhaul their economies to make them more climate friendly.
- Over growing concerns that TikTok and its parent, ByteDance, could share information on US users with Chinese authorities, there is increasing noise in Congress to completely ban TikTok in the US. This raises the stakes for the Biden administration, which is in the late stages of reviewing the security risks of the popular social media app.
- Meanwhile, the US Justice Department has taken Alphabet’s Google to court, alleging it abused its dominance of the digital advertising business. It stated that Google should be forced to sell its ad manager suite, which accounts for 80% of its revenue. This is not the first time Google has been sued over such issues.
- Microsoft is making a “multiyear, multibillion-dollar” investment in OpenAI, the San Francisco artificial intelligence lab behind the experimental online chatbot ChatGPT. According to sources, the deal is likely to be worth $10 billion.
- Amsterdam-listed Prosus NV and its parent company Naspers are planning to cut their corporate workforces by 30%, becoming the latest global tech company to announce layoffs. These cuts will be made at corporate centres as well as hubs in Hong Kong, Amsterdam, and South Africa. Similarly, Spotify has announced that it will cut 6% of its workforce.
- As at Thursday’s close the S&P 500 was 2.2% up for the week.
Local News
- Peter Bruce, editor at large at Business Day and Financial Mail has argued that the ruling party’s fear of losing voters in next year’s elections may be the only hope of ending loadshedding. Calling Eskom’s board “suits,” he says that “the absence of electricity in our lives is suddenly an emergency as the next general election approaches.” Bruce adds that the plan to right the utility is now with government.
- The opposition is out in full force to use the lack of power to its benefit ahead of South Africans taking to the polls, having recently marched on Luthuli House. However, the ANC is likely to claim that it has bettered the lives of millions of people and deserves another chance at the helm. The City of Johannesburg is making its own plans to stop loadshedding, albeit at a cost of R400 million.
- The Reserve Bank this week slowed its rate hike trajectory, increasing rates by a lower-than-expected 25 basis points as food and fuel prices start to trend lower, indicating interest rates are near their peak. But the Reserve Bank remains worried about the considerable risk still attached to forecasts for average salaries, expectations of future inflation and a volatile rand. At the same time, the Bank of America has slashed its growth forecast for South Africa’s economy for the third time in just two months, citing persistent energy supply shortages.
- South Africa’s tourism industry is recovering from crippling lockdowns, despite tourist arrivals remaining lower than pre-pandemic levels. Overall income for the tourist accommodation industry increased by 28% in November compared with the same month in 2021.
- The latest TransUnion Consumer Pulse study for the fourth quarter shows that an almost endless increase in inflation as well as increasing financial pressures such as interest rate hikes, are forcing consumers to cut back on discretionary spending and prioritise debt repayments. Whilst two thirds of consumers are cutting back on luxuries such as going out, a third are battling to pay bills.
- The JSE’s remarkable performance of 10.7% for the month-to-date in January is in sharp contrast to a depressed economic outlook with GDP growth for 2023 now forecast at only 0.3%. Moreover, the FTSE/JSE has significantly outperformed its developed market peers since the start of the year, with the S&P 500 having gained 5.75% both as measured in ZAR. We view this as a short-term aberration and believe that any continued outperformance would be accompanied with high levels of risk in the face of an upcoming general election and ailing state-owned enterprises such as Eskom and Transnet.
- Sasol has inked three wind-power purchase deals as it moves towards renewable energy to meet its carbon emissions targets. It is partnering with French gas company Air Liquide to source 220MW of renewable power from two wind energy projects to be developed by Enel Green Power, a unit of Italy-based Enel. The two projects will supply power to Sasol’s Secunda site, where Air Liquide also has oxygen production operations.
- Rolling blackouts and price hikes are hitting companies, with chicken company Astral expecting to lose 90% of its first half earnings. Margins in this sector are already thin.
- As at the time of writing, the rand was 0.7% weaker for the week and the ALSI was 2% up.
Sources: Dynasty, Daily Maverick, Bloomberg, BusinessLIVE, BBC, News24, Sky News, The Economist, Reuters, TechCentral, Moneyweb, New York Times, MyBroadband, UBS, etc.
