2022 has come and gone. As I write this, I find it difficult to believe that we are already at the tail end of February. It would be fair to say that 2022 was an extremely challenging year.
Last year was the year that markets "paid the piper". This idiom describes a situation in which one has "to pay a debt or experience unfavourable consequences, especially when the payment or consequences are inevitable or a result of something one has enjoyed."
Newton's Third Law states that for every action, there is an equal and opposite reaction. After years of excess - global zero-interest rate policy (free money), stimulus, quantitative easing, massive government spending and balance sheet expansion (US National debt breached $32 trillion in 2022!), and over-zealous support of stock markets by central banks and governments alike - we finally saw the inevitable outcome in the form of inflation. Central banks were caught off guard and were forced to hike interest rates aggressively to try to bring inflation under control. Markets, which one could argue were already overvalued, sold off aggressively.
Throughout the year, markets sold off and started to display the typical characteristics of a bear market, namely heightened levels of pessimism and strong adverse reactions to any bad news. This is a dangerous phase for the markets as it is easy and, in some ways, understandable for investors to consider capitulating (selling out of the market to sit on the sidelines and reinvesting "when things improve"). This is where a good wealth manager has a pivotal role to play. Suppose an investor's portfolio has been structured correctly, factoring in things like risk tolerance, liquidity and income needs; the investor should be able to sit tight and wait for the next phase of the market: recovery.
We have been telling clients, and we started to see it from October of last year - when the market is in a state of enhanced pessimism (as we saw running into the last quarter of 2022), it only requires news to start turning in a more positive direction than that which has been priced in - and the reaction can be swift and significant. In October, US CPI numbers came in slightly better than expected, and global markets bounced by 7% in a single day. This movement was equal to the previous three years' worth of returns on the MSCI World Index. In January, we saw local markets bounce by 10%, while global markets moved by 7%. These are big moves that investors cannot afford to miss, and the discipline of staying committed to investment strategies is critical.
A topical question is whether the world will go into recession because of the aggressive interest rate increases we have seen, with many investors believing that markets will struggle as a result. Markets are forward-looking pricing machines, and the possibility of slowing GDP numbers and corporate earnings is already "priced in". The key will be whether what we see is better or worse than what the market expects.
Given the uncertainty, there is a case to be made for a cautiously optimistic approach over the next 18 months: Inflation is likely to moderate quickly this year off the back of a lower oil price (which is around 30% lower than its peak last year); lower shipping rates (indicating a normalisation of supply chains as well as lower demand) are evident; and a reopening of China as it abandons its zero-Covid goal and associated lockdowns (improving global supply and helping global demand in the medium term). We also see a resilient US job market, which is positive for the economic outlook. As markets gain confidence in the belief that inflation is under control and the tightening cycle is ending, market participants will reassess their assumptions and start pricing in an economic recovery and a falling interest rate scenario. This reassessment is not to say that volatility is a thing of the past. There will be bumps along the road. However, there is a case supporting a constructive view on markets in the medium term.
On the local front, the picture is concerning, with the political wranglings that we saw last year highlighting the keyman risk that South Africa faces. Markets reacted extremely negatively to the prospect of the President's resignation following the Phala Phala scandal. While he survived, markets lack confidence in what may come after Ramaphosa. Given the likelihood of a second term as President of South Africa, two scenarios can play out from here. The first is that he is emboldened and aggressively enacts his reform agenda given that he no longer needs to worry about re-election. Alternatively, the party-before-country dynamic continues to play out, and is further exacerbated by concessions that were made to garner the support to get a second term in office.
The Eskom debacle remains an existential risk to South Africa's economic fortunes. The South African Reserve Bank downgraded its growth expectations for the country from anaemic levels to, quite frankly, pathetic levels. The impact this will have on employment, tax collection, social dynamics and the attraction of investment is nothing short of disastrous. Broadly speaking, emerging markets saw their currencies strengthen in January as risk appetite returned to markets. However, South Africa decoupled from its peers, with the ZAR weakening during the month. It's difficult to conclude that something other than the political and Eskom-related risk we see is negatively impacting our fortunes from a currency and economic perspective.
Whether South Africa can navigate this storm remains to be seen. What is undeniable, though, is that we face elevated risks which need to be addressed within the confines of portfolio construction. While the ZAR may strengthen through the year as risk appetite returns to markets, offshore diversification is essential to protect against the risks we see. We strongly advise you to engage with your Wealth Manager to discuss this.