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Global and local investment markets are providing attractive entry points for long-term investments. Despite numerous uncertainties that are reflected by the bumpy start to the investment year, specific market areas are over discounting the negative effects of inflation and high interest rates.
2023 is proving to be another bumpy year
2023 is proving to be another bumpy year for investors as the JSE shot up 10% in Jan before declining in March to where the year started. This is the fourth year in a row that global equity markets have fluctuated significantly, which is an unusual length of time for this unyielding volatility. The main cause is the uncertainty created by the COVID economic collapse and subsequent abnormal monetary stimulus pumped into the economy. The effects of this are still with us as they contribute to global inflation.
Global inflation remains the biggest driver of investment markets
Global central banks are determined to throttle high inflation, but at what price? Even with a potential ensuing economic recession and consequential investment market adjustments.
US core inflation (excluding energy and food) pivoted at 6.6% in September last year and has declined to 5% in March, but it is still way above the Federal Reserve target of 2%. In Europe, core inflation hit a new high of 5.7% in March.
The issue is how long it will take for inflation to decline to 2%, despite a firm US economy, which grew 2.6% in 4Q 22 and has a strong labour market. Currently, US unemployment is low at 3.5% and wage growth is 4.2% versus their 50-year averages of 6.2% and 4% respectively.
US Interest Rates and Forecast
The current US interest rate cycle has seen the fastest increase in interest rates since the 1980s. Of concern is that the pace of increase could still shock the system and that these sharply higher rates are still going to bite. This is evidenced from cracks emerging in the banking systems in the US (SVB and First Republic) and Europe (Credit Suisse) with banks faltering.
Interest rate increases from first rate hike
History shows that when interest rates start declining, investment markets rally
Global investment markets remain optimistic expecting a soft economic landing with – at worst – a mild recession. Markets are 12 to 18 months forward-looking, meaning a lot of the economic slowdown effects are priced into investment markets.
In three of the last four interest rate hiking cycles, the US S&P 500 rose firmly in the ensuing 12 months after rates peaked. Only in 2000 (the IT bubble) did the market continue to decline.
The S&P 500 12 months before and after interest rates peaked
How does this all translate to investment returns?
The size of your investment returns is boosted by a lower (cheaper) entry point and the length of your investment horizon (enabling more risk taking and the benefits of compounding).
Global equity valuations are relatively cheap and below their twenty-year average, providing an attractive long-term entry point. But short-term (1-year) market predictions are very difficult, especially in this continuous, uncertain environment.
Global MSCI Index P/E Ratio
Global equity real returns average 7% per annum over the last 30 years. As a long-term investor, your probability of achieving these returns is enhanced by a below-average valuation entry point, where the market is currently sitting.
Global concerns unsettling markets
The souring of US and China relations is a concern, which appears to be fuelling a larger gap growing between West and East relationships or democratic and authoritarian governments. However, their strong economic interdependence is recognised and should ensure that ‘order’ prevails.
Civil unrest continues, which is mostly aggravated by the widening wealth gap, and ultimately is a threat to democracy.
The protracted Ukraine war and an “unthinkable” nuclear reaction persists. We believe and are hopeful that nuclear war is unlikely, but Putin is not to be underestimated.
SA equities are cheap despite political and economic woes
Despite SA’s economic and political woes, SA equities are cheap. Negative political sentiment and emerging market outflows are widening discounts, despite more than 70% of the JSE All Share’s company earnings being generated offshore with limited effects from the SA economy.
JSE All Share Index P/E
With SA nearing the peak of rising interest rates, equities are poised to re-rate over the next year.
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 investors 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.
But there are many economic headwinds
The SA Reserve Bank reduced their 2023 GDP growth forecast to 0.2%, citing loadshedding and logistics (Transnet) constraints impaired growth by 2%. Growth for 2024 and 2025 is forecast at a meagre 1.0% and 1.1%.
Inflation is expected to average 6% and interest rates should rise another 0.25% to a prime rate of 11.5%, the highest in the last 14 years.
SA’s crumbling infrastructure, electricity, rail, roads, water, sewerage, etc. leaves little hope for an economic recovery, without material private sector investment, which is highly unlikely with an ANC government.
Government remains dysfunctional without a cohesive strategy. The latest example is the public sector wage increase of 7.5%, which Treasury has rightfully refused to fund. This could be the fuel to the final major union battle. The reality is that fiscal consolidation (reducing government debt) cannot succeed without material economic growth.
The Rand should strengthen in the short-term
The Rand Dollar has remained volatile this year, rising from 16.7 to 18.6, as global inflation fears persist and SA’s economic and political woes heighten. Although we believe the Rand will weaken over the long-term due to SA’s weak economic outlook and its rising debt, we believe that the Rand is currently undervalued and is likely to strengthen in the short term as Emerging Markets return to favour.
Our Rand/Dollar fair value remains 17.5, which is a 25% risk premium above purchasing power parity of 14, due to SA’s weak economic outlook, rising debt and dysfunctional ANC government.
The Prosperity Fund continues to produce solid, stable returns
The Prosperity Worldwide Flexible Fund of Funds (managed by Investonline director, Nick Brummer) has returned an average annual return of 9% (net of fees) since inception (Sep 2014).
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.
Market outlook conclusion
Global and local investment markets are likely to remain volatile in 2023 as the negative effects of inflation and high interest rates filter through economies. However, some of these negative effects have been over-discounted in certain investment markets, particularly in developed markets (ex the USA), emerging and SA markets, and most value-orientated sectors.
These specific markets are providing attractive entry points for longer term investors and should be appropriately allocated in your investment portfolio.
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.
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