With higher interest rates and tighter monetary policy dampening confidence throughout 2022, major indices ended a turbulent year in negative territory, despite the fact that markets bounced back strongly in the fourth quarter. That recovery has continued into the first quarter of 2023 with a 7.5% increase in the S&P 500, a 16.8% surge in the Nasdaq, and a 7.9% increase in the MSCI World Index having given investors reason to be more optimistic for the year ahead.
Despite the positive returns, performance has been choppy for the first stretch of 2023 as markets seesawed throughout the quarter on the back of investors trying to second-guess the Fed’s intentions. Many speculators seem to be betting that central banks worldwide are starting to tame inflation—but it remains unclear whether rising prices are really abating fast enough.
Crises at several US banks—Silicon Valley Bank (SVB), First Republic, Silvergate and Signature Bank—as well as Swiss-headquartered Credit Suisse—were the source of much of the volatility during March. Regulators and banking peers moved quickly to restore confidence in the banking sector, ensuring that the events were a blip rather than a systemic crisis.
Paradoxically, these events helped to boost markets during the first quarter. Markets are now pricing in a gentler interest rate curve than previously for the rest of 2023 and are daring to hope for a soft landing for the global economy. Softer oil prices, even with war still raging in Ukraine, will assist in reducing inflation pressures.
Tuning out of the short-term noise
Yet the danger remains that inflation will remain persistent and that the Fed might not get prices under control without some pain in the market. With labour unrest across Europe, populist parties and leaders on the rise worldwide, geopolitical tensions between the West and China, and a trend towards deglobalisation, many other uncertainties are – and will remain – in play.
As always, we are taking a longer term view on the markets, rather than trying to anticipate short-term movements. Our quality approach focuses on businesses with strong underlying cashflows and consistent earnings that are relatively independent of economic burdens. In our article about investing versus speculating, we look at how a steady and defendable approach enables investors to win in the longer term.
One of the changes we have made in recent months is including a 4% allocation to quality Chinese companies in our Global Accumulator Fund. We feel that traditional funds and benchmarks are structurally underweight in Chinese exposure and believe that the valuations of Chinese quality stocks are starting to look more attractive. China can’t be ignored because of its size and growth, but we remain cautious, for reasons we outline in this article.
South Africa — the rand gets a respite
Turning to South Africa, the JSE ALSI delivered a return of 6% in rand for the quarter, but a more modest 1.16% as measured in US dollars. The South African rand ended the three-month period 4.5% weaker at around R17.78 to the US dollar, after having fallen to as low as R18.72 in early March. The rand’s subsequent recovery was assisted by the stabilisation of the month’s banking crisis in the US, together with a 50bps hike in the repo rate by the SARB, which was double what the market had been anticipating.
Our currency models suggest that the rand is still trading at a 5.4% discount to fair value. If the Fed pauses interest rate hikes in the coming months, accompanied by a return to a risk-on environment by investors, the rand may well strengthen in the months ahead. Nonetheless, the local currency remains vulnerable to both external and internal shocks.
With recent financial results from retailers and telecoms companies reflecting deep pain from load shedding, we maintain our conviction that there are better investment opportunities offshore than in South Africa. We see little reason to be optimistic that the picture will change in the medium term, with the ANC continuing to put the party’s interests above those of the state.
Even if the ANC slips below 50% in the 2024 elections, we are unlikely to see a government with the appetite to implement the economic reforms the country needs so desperately. One of the potential outcomes is a replication at national level of the paralysis and chaos seen in coalition governments in the major metros. Another is a corrupt and potentially authoritarian alliance between the ANC and EFF.
One of the questions many of our clients are asking is about our exposure to bonds. While South African bonds are delivering above-inflation yields in the short term, our analysis shows that long-term bonds provide similar returns to shorter duration fixed income funds over time, but add significant volatility in the process. As such, we believe that for most clients, fixed-income funds remain a more compelling solution in providing an element of stability without sacrificing long-term returns.
