SA Markets: Impressive resilience and pockets of opportunity as fad assets collapse
Albert Botha, Head of Fixed Income at Ashburton Investments
South Africans are used to being the ones catching a cold when the world sneezes.
They tend to see Rand depreciation, inflation, and asset class tumbles as a matter of course in times of crises. This was true in 2020, 2008 and 2001 – and in many cycles before.
Yet 2022 was different.
While things are tough at home, they have not yet risen to the level of crises. Yes, asset prices are sluggish, but we are still far from the lows we experienced in prior economic contagion events. As of writing, the JSE All Bond Index (ALBI) is up 3% and the Capped SWIX Total Return sits at +4% for the year.
The maximum drawdown for these in 2022, from peak to trough was -7.75% and -14% respectively. A portfolio comprising 60% equities and 40% bonds would have had a max drawdown of 9% in 2022. Compare that to March 2020 where the max drawdown on bonds were 19.30% and equities were down a whopping 37.88%. A 60/40 portfolio would have been down around -30% at that time.
The Rand is another example.
It is still trading significantly stronger than the highs of above R19/USD we saw in April 2020. And this selloff has been relatively tame compared to 2001 and 2008.
By almost every metric we can see that South Africa has been spared the worst effects of this recent economic and market downturn – at least so far.
Yet most South African investors are blissfully unaware of the severity of the current global circumstances. There are many ways one can demonstrate this, but let’s start with some of the darlings of the last cycle.
Crypto and NFTs are terms that become synonymous with massive overnight wealth. “Have fun staying poor” was their motto. The recent spate of bankruptcies and frauds in this space is indicative of a broader malaise in the industry and one can find dozens of coins/currencies that are down 99.9% or more in 2022. Justin Bieber bought an NFT for $1.3m, which is now worth only $69k – taking a 95% loss in the process. Tom Brady and Gisele Bundchen meanwhile invested $650m into the now bankrupt FTX – they are expected to lose everything.
These stories of wealth destruction are mind-blowing, but even if you confine yourself to the reputable segment of the market, Bitcoin and Ethereum, each are down 66% and 70% year to date respectively.
The counter that these are “not real markets” and that “everyone knew this would happen” rings hollow in the face of the total capital in the space. At its peak, crypto was worth over $3 trillion – or roughly the same size as the market cap of the bottom 200 companies on the S&P 500 combined.
Cathie Wood and her once celebrated Ark Invest fund is another great example. As one of the market favorites back in 2020, she saw massive inflows following her great performance of 61.9% per year for the 3 years leading up to February 2021. Since then, the fund is down -77%. Now Cathie, one might argue, was a tech momentum player and this market broke even the large companies in the space – Netflix and Meta were both down more than 75% at some point. This point is valid, but the devastation was not limited to tech equities or crypto.
Within the fixed income markets, we have seen similar moves.
The backdrop to this has been global inflation the likes of which we have not seen in 40 years, alongside a fed hiking cycle that is similarly extreme. From the depths of March 2020, where the US 10-year bond traded at 0.35%, rates have maintained an almost uninterrupted upward march, topping out practically 4% higher at 4.335% in October 2022. This alongside rising credit spreads have led to the Barclays US Aggregate Index to drop 18.4% from its peak in August 2020 to October 2022 – a bear market in bonds lasting more than 2 years.
Yet even this astounding move in investment grade bonds pales next to the events that almost broke the UK pension fund system.
Being faced with rising rates and inflation, the short lived Truss government announced policies that led the UK Gilt market into a tailspin. It eventually resulted in the intervention by the Bank of England (BOE) and the resignation of the Prime minister and her Cabinet, echoing the South African experience with Des van Rooyen over the weekend back in December 2015.
The reason for this extreme political backlash becomes clear when one considers the moves of the UK 2061 Gilt. Within the last 12 months the bond had a price drawdown of 74% (December 2021 – September 2022). A 74% loss in a bond guaranteed by a government rated 8 notches higher than our own. In many ways, this epitomizes the extreme experiences of the last year. Tough underlying macro environment, poor policy and execution leading to a terrible market reaction.
So where to from here?
We have since seen a reduction in global inflation and expect further falls. Inflation is rolling over, or expected to, everywhere – but we are not there yet. The next potential issue is that inflation may remain “sticky”. This is where we see inflation dropping, but less than expected and not to the ultimate extent where the Federal Reserve would want. While Fed Governor Powell would like to see inflation around 2%, market consensus currently has inflation falling to barely below 3% at any time in 2023.
This means that it is likely that the fed will hike to between 4.5 – 5% and maintain rates at those levels for an extended period of time. Earnings downgrades and a sluggish economy is very likely in our future and this combination of factors could result in equities continuing to be under pressure for a while.
Yet all is not lost.
The fact that most of the rate hiking cycle, yield increases, and inflation surprises are behind us allows for some positivity in certain market segments.
Morgan Stanley’s recent Global Insight piece calls 2023 “The year of Yield.” Buying US 2-year bonds at 4.5%, or a diversified USD EM Government Bond ETF at 8.5% is certainly attractive. In the local market bonds are trading between 10.5% – 11.5% with inflation likely to be below 4.5% by the middle of next year. This is a real forward yield of 6-7%. In addition, the local Repo rate is expected to keep on rising, leading to Money Market and Enhanced Yield funds returning between 2-4% above inflation over the next 12 months.
We are nowhere near the end of this inflation uncertainty and economic correction.
But it might be the end of the beginning.