Two experts unpack the economic climate and summarise how equities can be valued in such an environment.
As countries realise that inflation is linked to the shortfalls of globalisation, the world may see more “slowbalisation” and “sticky inflation,” according to two experts at Citadel.
"Slowbalisation occurs when countries start diversifying their supply from single to multiple trading partners, and local manufacturers. Although this strategy helps countries to secure supply, it will exacerbate high inflation in the short term, because countries will no longer look for the cheapest supply of goods. Add that to the other current drivers of inflation, such as global rising fuel and food prices, goods will become more expensive. This suggests that inflation is going to be sticky for a long time,” says Citadel’s Chief Economist, Maarten Ackerman.
While the situation may seem dire, systemic changes may offer good opportunities for investors, he says. “Desperation leads to innovation, if you know where to look. The COVID-19 vaccine race accelerated medical investments, and current diversification away from coal is accelerating global green energy investments. Locally, a large retail company is doubling its spend with local clothing manufacturers, creating 5 000 new local jobs,” adds Ackerman.
CONSUMER CONFIDENCE DIPS BELOW PANDEMIC AND BANKING CRISIS LEVELS
“Rising prices of food, energy, petrol and mortgage repayments are eating into disposable incomes and savings. Although a recession may not be immediately imminent, thanks to good employment numbers and still reasonable consumer spending, economies will not be able to count on these alone to hold off a recession,” says Ackerman.
Currently, consumer confidence is below levels seen during the COVID-19 pandemic, the European Banking Crisis in 2013 or even the financial crisis of 2008. This is a major red flag for consumer-based economies and might affect consumer spending negatively as people fear for the future. Inflation is driving this lack of confidence and central banks urgently need to get it under control.
“Inflation will start to decline in 2022 but will remain well above central bank targets. We expect we’ll have to manage above-average inflation, of about 3.5%, for the next three years. This is a result of the supply issues that will take time to resolve,” says Ackerman.
VALUING EQUITIES IN THE CURRENT ECONOMIC CLIMATE
Economies around the world are in a state of flux while equity markets have been extremely volatile. In this environment, investors have been struggling to determine the correct value of stocks.
Nishlen Govender, Portfolio Manager at Citadel, explains that a marketplace is generally good at gauging the fair price of something, but this becomes trickier when that value is based on future, unknown information rather than readily available data.
“There has been a dramatic sell-off of equities in the first half of the year, which is largely attributable to the ‘risk-free rate’ (the rate of interest set by central banks) in a variety of countries increasing as central banks tried to curb the pressure of inflation,” says Govender.
“The rate of return is what investors expect over what they would get at a bank or from the risk-free rate. It validates the risk they assume when investing in a company. The market sets this rate of return as part of its market pricing. The equity risk premium reflects the expectation of equity market participants of future events. Thus, if the market expects interest rates to increase in future, but those increases have not happened yet, we could see share prices fall, in anticipation of higher rates,” explains Govender.
When valuing stocks at an approximate value, Govender combines his expertise with technology to create a discounted cash flow process.
Simply stated, if you take a view on something happening, that is outside what is known by the market, you could be rewarded for it, as the market only prices in known information. Excellent investors spend a lot of time considering the future to try and stay ahead of the market; however, markets are full of surprises. The best investors are never right 100% of the time – they simply aim to be more right than wrong,” concludes Govender.