Investment Perspectives – Opportunities amidst volatile conditions

Equity markets rebounded in the fourth quarter of 2022, ending a particularly volatile year.

Global markets became relatively upbeat heading towards year-end after China relaxed its pandemic restrictions, alongside peaking global inflation. Falling gas prices in Europe also improved the outlook in the region, while US economic growth proved resilient.

In South Africa, the JSE rallied despite persistent severe loadshedding, which weighed on sentiment. Eskom CEO, Andre de Ruyter, resigning was a further indictment of the institution’s formidable challenges. On a positive note, President Cyril Ramaphosa was re-elected as leader of the ANC, after being on the verge of stepping down in the wake of the “farmgate” scandal.

Market performance
The South African equity market (FTSE/JSE Capped SWIX) was down in December (-2.8%) but still managed to end the year positively (+4.4%), capped by a strong fourth quarter overall (+12.2%). Gains in the quarter were broad-based with resources (+17.6%), industrials (17.0%) and financials (+13.9%) all rising meaningfully as global risk appetite improved.

Foreign equity (MSCI All Country Index) also ended higher this quarter, although dollar weakness dampened returns when measured in rands (+3.9%). Despite the bounce, foreign equities still ended the year sharply lower (-13.0%), negatively affected by inflation-driven, macroeconomic concerns and geopolitical uncertainties.

Outside of equities, interest-sensitive asset classes, such as domestic property (+18.2%) and nominal and inflation-linked bonds (+5.7% and +2.0% respectively) also rallied this quarter, unperturbed by the November interest rate hike. Foreign property and bonds were little changed (+1.2% and -1.7% respectively). Foreign bonds suffered a particularly poor calendar year performance (-12.9%), in line with equities, hurt by the significant rise in interest rates.

Portfolio performance
The portfolios had a reasonably good year under the circumstances. Our specialist SA equity strategy, the PPS Equity Fund, performed well, and multi-asset funds with material SA equity exposure benefitted as a result. The PPS Balanced Fund of Funds stood out, as did two funds from our partnership range: the PPS Managed Fund (36One) and the PPS Stable Growth Fund (Laurium).

Disappointingly, our specialist foreign equity strategy, PPS Global Equity Fund (Capital Group), lagged the foreign equity index in 2022 and was a detractor in portfolios that hold foreign equity.

Portfolio Positioning
We downgraded SA equity in our tactical asset allocation house view framework from “overweight” to “neutral” toward the end of the fourth quarter. With the SA equity market having rallied 20% off its lows, it was an attractive opportunity to continue along the measured path of de-risking into what we believe will be a challenging period ahead.

We also took the opportunity to slightly increase our foreign equity “underweight”. Although foreign equity valuations are now less frothy, our current macroeconomic outlook calls for continued caution.

Taking the above into account, the portfolios are now slightly underweight growth assets, which we believe is appropriate given that major global economies are facing the high likelihood of a recession during the next year or so.

We acknowledge that there are strong arguments in favour of either a bullish or bearish outcome playing out. The main argument for a potential bull case is premised on the consensus view of only a mild technical recession playing out (or even a “soft landing”/ no recession scenario). It also assumes the US Fed proactively cuts rates swiftly in response to cooling inflation. We are not convinced of either of these.

Firstly, consensus is usually wrong, and in this case, we believe that consensus is overly optimistic and that risks remain skewed to the downside, with the full economic impact of restrictive financial conditions not yet being felt. And secondly, even if consensus turns out right, then markets have not yet come to terms with the foreboding corporate earnings recession.

The bear case view, on the other hand, is premised on the high likelihood of a full-blown recession in the US at the very least, filtering through to the rest of the globe, at a time when geopolitical risk (particularly Russia and China) remains high. Furthermore, our sense is the market might be incorrectly pricing in that policy rates will soon decline.

With corporate profit margins having only just started to compress, earnings risk casts a shadow over the potential for bond yield compression to underpin the equity market’s current rating. And while we acknowledge that market sentiment may have capitulated, there is no evidence that capital market flows have, too. To make matters worse, flows no longer have the support of the “TINA” (i.e., “There Is No Alternative”) undercurrent.

What to expect in 2023
As we look ahead, one is inclined to be hopeful at the start of this new year, especially after the difficult 2022. This could indeed be rewarded over the near term given how far the pendulum has swung toward pessimism. In any event, with investors still jittery, the risk of continued heightened volatility remains high.

In this context, our somewhat cautious view attempts to look beyond the very near term and is being expressed across the portfolios by staying relatively close to strategic asset allocations across the funds, rather than making bold calls for now. In general, the portfolios currently hold enough growth assets to be able to participate should markets rally from here, and not too much in the event of further declines.