We trust this communication will provide you an overview of current market conditions, what to expect, how this is likely to influence and impact your investments. We also provide insight in respect of our investment philosophy and methodology and how you can make all the difference. As always, we want to keep things personal.
Market Overview:
June was a brutal month for global equities, capping the worst first half of a year since the launch of the MSCI All Country World Index in 1987. In the case of the US, the first-half performance of the S&P500 has not been this bad since 1962.
The MSCI All Country World Growth Index lost 8.5% in June and 27% in the first half of the year.
Asset Class Performance
From a country point of view, the US market remains the most important as it makes up around 60% of global benchmarks. The S&P500 lost 8.3% in June and 20% since the start of 2022. Other indices fared even worse. The Russell 2000 Index of smaller companies has lost 24% this year while the tech and growth-heavy Nasdaq lost 30%.
Emerging markets were also negative in June. For the six months to end June, the MSCI Emerging Markets Index is down 17.5%, the 3rd worst first half since the launch of the index, behind only 2008 and 1998.
The international bond market returns for the first half are among the worst on record.
South African assets were cheaper at the start of the year. Cheap investments don’t escape market sell-offs, but they often fall less since there is less hot air that needs to come out. The exchange rate has also softened some of the blows of declining global markets.
In terms of local equities, the FTSE/JSE ALSI lost 6.5% in June, 12.7% over the last quarter (Apr-June) and 10% since the start of 2022.
South African long bond yields have risen since the start of the year and therefore the All-Bond Index has delivered a negative return of 2% this year.
The rand is only slightly weaker against the dollar since January, but it is down 14% compared to a year ago, providing local investors with some respite. The rand only depreciated around 1% against the pound and the euro over the past 12 months.
Given the depth of the decline and the murky macro backdrop, it seems unlikely that the first-half losses will be reversed in the second half. Recovery could take time but will happen eventually.
Equity markets move up and down over the short term, but the longer-term trend is always upwards.
How did we get here?
The unprecedented amount of accommodative fiscal and monetary policy (low interest rates/cheap money) applied by central banks since March 2020 (COVID) had the desired result in keeping the wheels of the economy turning but effectively they have kicked the can down the road.
As the world reopened for business there was always an expectation that inflation would rise, this unfortunately has recently been exacerbated by the shortage of goods, low inventory levels in a growing demand environment which has reverberated all the way down the supply chain. China’s zero tolerance covid policy, resulting in significant lockdowns over the last few months, has aggravated the situation.
To add fuel to the inflation fire was the invasion of Ukraine by Russia and the resultant sanctions. Energy prices and other commodity prices have spiked on fears of reduced global supply as Russia, a major supplier of gas to Europe has been removed from the equation.
With rampant inflation, central banks have had to quickly revise their approach to “normalising” monetary policy. For a long time, the US Federal Reserve held the view that inflation was “transitory” and that there was no need for an urgent and dramatic policy response. As inflation has persisted and grown well beyond expectations, there’s been urgency to tame inflation with the US Fed, Bank of England and European Central Bank all hiking interest rates.
Inflation currently sits at 9% in the UK, 8.6% in the US and 8.1% in the Euro zone. Historical inflation in these developed markets is roughly 2%.
There are some signs that inflationary pressures are easing. Commodity prices are off their recent peaks, supply chains are unclogging, and consumer demand seems to be shifting from durables to services. China is declaring victory over Covid (for now), meaning that its massive productive capacity can return to running at full steam.
The net result is that while overall inflation could start declining in the months ahead in developed countries, it will likely remain elevated for the second half of the year.
Why interest rates matter to markets
As interest rates rise the cost of borrowing increases. This leads to higher operational costs for companies, in many cases it impacts a company’s ability to pass on inflation to the consumer, ultimately squeezing their future (profit) margins. Costs that are passed onto the consumer through inflated prices for goods and services, leads to lower consumer demand which further impacts a company’s profits. From a valuation perspective, a company’s “predicted” future earnings growth is compromised which will have a negative influence on the share price.
All of the aforementioned don’t make for an enticing equity market cocktail.
The equity market has seen many crises before and just this millennium the market has had to deal with the bursting of the dotcom bubble, 9/11, the Enron/accounting scandal, the SARS virus, the Global Financial Crisis, the Greek economy bailouts, the Donald Trump election shock, Brexit, global trade wars, the Zuma tenure, two finance ministers in two days debacle, persistent load-shedding, COVID lockdown’s, the Russian invasion of Ukraine and is now grappling with high inflation and fears of a recession is the US.
Investor behaviour
Over this period (21 years) the market has grown by 794%, that is an annualised pace of 10.47% p.a. Inflation was up 229% over the same period for an annualised inflation rate of 5.57% p.a., to leave real returns up 4.9% p.a. Adding an approximate 3% p.a. dividend yield gets you close to a real total return of almost 8% p.a. That’s a good return if one considers all that the world and the markets have had to digest over the period.
There is always the caveat that past returns are not indicative of future returns, but we have learned the principle that investing in the equity market with all its short-term volatility pays off with a long-term mentality. Crises come and go and impact the markets negatively for days, weeks, months and even years. Staying the course and not trying to time entry and exit points pays dividends (pun intended) and grows capital.
While market behaviour makes for a fascinating discussion (and source of debate), what is often overlooked is the extent to which investor behaviour determines the outcomes investors ultimately realise. Despite the best intentions, most investors are unprepared for the mildest bouts of volatility. It is easy to acknowledge that stocks are volatile in an unemotional and reasoned fashion when conditions are calm, but it is far more difficult to remind ourselves of this when markets plunge sharply during a crisis, as it did in March 2020. Confronted by clear evidence that they ‘got it wrong’ or their investment strategy does not ‘work’, investors are often quick to sell out of such positions, often hiding out in cash until things improve.
One well-documented problem with this kind of behaviour is that investors turn paper losses into real ones when doing so, and often miss out on a market rebound which also tends to happen unexpectedly in the case of market sell offs and crises.
What is less often talked about, is the tendency to overlook the investment manager’s philosophy when deciding what to do next. A manager’s investment philosophy will determine how they view the world, and where (and how) they will identify investment opportunities. Market sell-offs present opportunities to buy asset classes and individual shares at more attractive levels. Current valuations are now below longer-term averages for the main asset classes, and this bodes well for longer-term returns. They may already have factored prevailing market conditions into their outlook, and may, in fact, be exploiting market weakness to deliver future returns. One man’s loss is, after all, another’s buying opportunity. However, investment philosophies require sufficient time for views to come to fruition, as markets do not always recalibrate to align to expectations on demand.
As an investor, you are in control of how you react to market events. The scarier the headlines, the greater the temptation to abandon your investment strategy.
Remember that by the time you read about something in the news, it has already been discounted by markets. While the market punches were flying in the first half of the year it is important we stick to the plan of appropriate diversification, ignoring the volatility noise, and remaining patient.
How InvestLife is managing your money
Maximizing your wealth involves building and preserving your capital by incorporating and implementing the most appropriate strategies and/or solutions. This often has more influence on the growth of your portfolio than the underlying investment returns.
In addition to analysing your complete financial picture, we focus on what’s most important to you and customise your investments to align with your risk appetite.
In respect of structuring and managing your underlying investment, we employ both asset allocation and portfolio diversification, blending both active and passive strategies (funds) which display low correlation characteristics to compliment one another. This process is designed to mitigate risk factors from the broader market environment and generate real returns.
We outsource the tactical asset allocation decisions to our preferred multi asset investment managers who have the capabilities to analyze asset classes, sectors, mitigate any risks, and take advantage of opportunities that arise.
Our approach aligns your portfolio to you, your needs, your risk appetite, as well as your current financial position to help you achieve your medium and long-term goals.
The unpredictable nature of markets confirms why considered financial planning will always remain a valuable counterpart to skilled investment management.
While market behaviour tells one part of the story, it is often investor behaviour that has the bigger say in how the story ends.
