Investonline 1st Quarter 2023 Market Outlook

Going into 2023, investment markets continue to face many uncertainties, many of which we will evaluate. Despite these uncertainties, most importantly, global markets are not expensive and are offering attractive pockets of value.

Global MSCI Index P/E Ratio

Although more short-term volatility is anticipated in 2023, the positive is that investors will find attractive entry points during the year, which will benefit them materially into the future.

In our 1Q 2023 Market Outlook, we highlight the key events that shaped 2022 markets, the opportunities, and risks for 2023, the outlook for SA, the Rand and investment markets, and how best to position your investments in 2023.

2022 markets were driven by three main events

The main factors that led to the JSE and global equity markets declining as much as 15% and 25% during the year, included:

Russia’s invasion of Ukraine.  In addition to the terrible human tragedy and suffering, Russian investments have been written down to zero in portfolios and the conflict has resulted in global food shortages, energy prices spiking and a renewed disruption in East/West relations.

Inflation rising higher and longer than expected. This was accelerated by the Ukraine war, but the uncertainty of the global inflation outlook is fuelling market volatility.

China’s business rule changes and COVID mismanagement. A loss in global investor confidence and a slowdown in the Chinese economy led to the Chinese market declining as much as 40% in 2022.

Global market risks facing 2023

A global economic recession takes place and lasts longer than expected. The World Bank has reduced its 2023 GDP growth forecast to 1.7% from 3.0% in June 2022. Developed countries are only expected to grow 0.8%, which includes a recession (2 consecutive quarters of negative GDP growth). However, the risk is that economic and investment analysts are notorious for underestimating the magnitude of economic related declines.

Global inflation remains at elevated levels (around 4%). The US and Europe’s inflation has declined to 6.5% and 9.2% from peaks of 9.1% and 11.1% respectively. US core inflation (excluding energy and food) has reduced to 5.7% after peaking at 6.6%. The risk is that core US inflation remains elevated around 4% as it is supported by a firm US job market, resulting in higher interest rates being maintained for longer than expected.

The Ukraine war escalates with other countries getting directly involved. With Russia’s failings and an irrational Putin desperate to maintain power, an outcome to this war is impossible to predict.

China continues its COVID mismanagement and implements further restrictive business policies. This could fuel another year of disappointing economic growth with overall negative global consequences.

SA’s future remains precarious

ANC to drive a positive campaign for the 2024 election. With a serious risk of the ANC losing its majority in 2024, we expect to see the party drive a positive narrative to rebuilding SA with an agenda to recoup votes. This is assisted by Ramaphosa having more support from the ANC’s top six, which is likely to see a positive cabinet reshuffle and some nation building announcements to boost morale.

Eskom is a black hole. With the resignation of the CEO and more loadshedding, the electricity outlook continues to deteriorate. Although there is a credible plan to replace capacity, SA could be in a “dark space” for the next two years, before the expected new capacity comes online. This is extremely negative for economic growth.

Political uncertainty remains the key problem for SA. Other than a long list of failings, Ramaphosa’s Phala Phala saga is likely to have long-lasting negative effects on the country given its fragile politics. The bottom line is that SA needs the private sector, both locally and internationally, to invest in the country to produce growth. This will not happen within an unstable political environment and with a dysfunctional government.

SA GDP growth is at risk of declining. GDP growth consensus forecasts for 2023 and 2024 are 1.2% and 1.8% respectively. We believe there is more downside risk to GDP in 2023 as it will be a very difficult year for the SA consumer. The prime overdraft interest rate has risen to 10.5% from 7.0% and inflation is up to 7.5% from 3% in 2021. Although inflation appears to have peaked at 7.5%, the market is forecasting at least a further 0.25% increase in interest rates.

SA inflation and interest rate expectations

With our very low economic growth rate, the unemployment rate is unable to improve, leading to further socio-economic strains. The SA economy needs to grow at 4%+ to reduce unemployment.

There are some positives:

• The rebuilding of some government institutions is taking place, such as SARS, NPA and Eskom
• Many arrests for corruption have taken place with asset forfeitures in the R billions
• State capture is being throttled
• Ramaphosa has a far more supportive newly elected ANC top 6 to work with
• Policy has changed to allow private electricity supply
• There’s a credible plan to replace Eskom’s ailing generators by 2030
• Eskom’s debt has been reduced and a more credible board has been installed
• The R200bn+ resources windfall taxes over the last two years have averted a debt crisis for now, lowering our debt to GDP to 71% from a projected 90% after COVID
• 3Q 2022 GDP growth of 1.6% surprised on the upside, due to strong agricultural and service growth
• Relative to other emerging market countries, SA appears relatively stable

SA equities are cheap

JSE All Share Index P/E

SA equities are at a 20-year historically low valuation, obviously due to the dismal outlook for the country (GDP growth expected to remain below 2% for the next five years and the risk of spiralling debt). But the opportunity is that too much negativity is priced into SA shares, and any hint of positivity and an eventual resurgence of global emerging markets, should drive up equities dramatically.

Foreign investment flows in SA equities and bonds

Currently, SA equities and bonds are mainly driven by global events and resultant global money flows. Foreign investments have been negative on SA for the last five years, reducing their investment holdings, which has been a major headwind to positive investment returns. However, should foreign investment flows return to SA, this will be very positive for local equity and bond markets.

The Rand should stabilise in 2023

Over the past year, the Rand/Dollar spiked out to 18.4, which is above our fair value of 17.5. The R/$ weakening has partly been driven by a strong US Dollar, which strengthened as much as 18% during the year relative to other global currencies.

Our view is that the Rand will weaken over the long term due to SA’s weak economic outlook and its rising debt. However, in the shorter term (2023), we expect the Rand to be range bound at current levels. It is supported by global emerging market inflows and a positive government narrative in an attempt to repair the ANC.

The Prosperity Fund continues to produce solid, stable returns

In 2022, the Prosperity Worldwide Flexible Fund of Funds (managed by Investonline director, Nick Brummer) returned 9.1%, despite the MSCI World Index being down -12.2% and the JSE All Share Index only up 3.5%. Since inception (Sep 2014) the fund has returned an average 9.2% (net of fees) per annum.

In the Morningstar Ratings, year-to-date, the fund is ranked 3^rd out of 91 funds in its category: Multi-Asset Worldwide Flexible Funds.

The fund is conservatively managed with an emphasis on capital preservation. It is well suited for investors who want offshore exposure and a steady investment return.

The investment market playbook for 2023

Global inflation appears to have peaked, but it is unknown how long it will take to decrease back to target ranges of 2% to 3%.

US interest rates are currently 4.25% and are expected to peak at 5%, but their subsequent easing will depend on the pace of inflation declining.

Despite interest rate increases, the US economy is still growing at a reasonable 2% in 2022. However, it generally takes 8 to 12 months for higher interest rates to bite, and therefore, it’s highly likely a US and global recession will follow in 2023. Current market predictions are that a recession will be short lived.

The major unknown and often underestimated result is the recessionary effects on company earnings. Lower than expected company earnings is the biggest fundamental risk facing markets in 2023.

The question is, of the probable earnings decline, how much is already priced into market valuations, bearing in mind that investment markets are generally 18 months forward-looking.

This sets 2023 up for a stop – start year with more volatility.

The main investment theme for 2023

Many market commentators say 2023 is all about interest rate movements driving markets in the year.  But we believe it will be much more complicated, as it will be more about earnings and the ‘surprises’ (both up and down) as the global economic decline bites.

The biggest issue facing markets in 2023 is the effect that an economic recession will have on company earnings. Over my 30 years as an investment analyst, the market has always underestimated the negative effects of an economic slowdown. More pronounced this cycle, are the historically high company profit margins, which means earnings have further to fall when sales slow or decline.

Research has shown that a mild recession leads to a broad-based 10% decline in company earnings. Currently, the S&P 500 is still pricing in minor earnings growth in 2023, with the assumption of a soft landing, i.e., the US economy slows but doesn’t decline. This is based on interest rates peaking soon (US 5% by 2023 year-end) and the economy being able to absorb far higher interest rates.

Market Outlook

Although global equity valuations are near 20-year lows, P/E 15.7 vs 21 (20-year average), there are significant economic and earnings uncertainties in 2023, which are likely to lead to very volatile markets once again as company earnings surprise both on the up and downsides.

The secular move to value from growth shares should continue, with emerging markets, including SA, providing the more attractive growth areas.

Although tech shares are down 50%+ from their highs, it’s unlikely that a meaningful recovery will take place in the shorter term.

SA equity valuations are attractive and despite the woes of the country, a potentially positive narrative from the government, should see positive SA equity returns.

Review your Investment Strategy

Ensure that your investment portfolio is properly balanced and adjusted to suit your personal risk profile to achieve your goals and that your financial plan is up to date. It is critical to ensure that the risk you take in your investment portfolio matches your financial plan, especially when nearing or during retirement.