In the book “Managing in a VUCA world”, Oliver Mack and Anshuman Khare describe the VUCA phenomenon as an environment marked by Volatility, Uncertainty, Complexity and Ambiguity. There is undoubtedly no better and befitting manner to describe the world over the last few years. From the US-China trade spats, to COVID-19 waves and vaccinations, to the recent invasion of Ukraine by Russia, geopolitical, social, and economic uncertainty have somehow become the new normal. The crucial question is how all of this has affected markets and more importantly, client portfolios.
In 2021 global equities (+32.36%) delivered a sterling performance as accommodative monetary policy remained supportive for the most part of the year, continuing to present tailwinds for high-flying US technology stocks. In addition, the continuation of COVID-19 waves and successive lockdown measures resulted in continued easy monetary and fiscal policies which seemed to have favoured stocks and in particular technology stocks at the expense of more cyclical consumer discretionary and personal services. However, cyclical stocks managed to gain some ground as vaccination efforts increased across the globe while notable upward moves in the oil price were also supportive. Important to remember is the fact that returns in developed markets have been very concentrated, driven by a handful of US large-cap technology stocks which are currently trading at heightened valuations.
While easing policies led to a massive equity rally, this in turn led to increased demand and along with lockdown measures and supply chain issues, inflation started to rise. As a result, monetary policies turned and are becoming more hawkish, leading to growth stocks struggling and volatility increasing in general. In emerging markets, Chinese equities were the biggest elephant in the room following a regulatory crackdown on technology and private education sectors.
On the other hand, Chinese property also saw headwinds after the Evergrande debacle, dampening sentiment across major emerging markets. As a result, GEM equities delivered lacklustre returns of 5.89% in 2021. In fixed income, developed market bonds remained out of favour as the risk-reward profile continued to be uncompelling due to negative real yields. As 2022 started, volatility made a strong comeback to levels last seen in November 2021 (during the breakout of the Omicron variant) – mainly due to global monetary policy uncertainty surrounding the magnitude and speed of tightening. Subsequently, geopolitical tensions between Russia and Ukraine further worsened sentiment. Growth pockets of the market have started the year 2022 on a backfoot, unsettled by higher inflation and the imminent interest rate hiking cycle, coupled with high valuations. Meanwhile, value areas of the market have handsomely benefitted in this environment, mainly financials and energy.
The local economy continued to benefit from tailwinds driven by the boom in commodity prices which impacted the fiscus positively through revenue overruns and a subsequent current account surplus. This was supportive to the rand while also improving the debt-to-GDP metric. While it was not all doom and gloom, structural challenges around unemployment and political instability remain key headwinds for future growth as seen in the July unrest. Business confidence was in contraction territory but higher than pre-COVID levels while consumer confidence remained firmly negative and manufacturing activity was robust. Inflation ticked up to the ceiling of the target band of 3%-6%, leading the SARB to hike interest rates by 0.25% to 4% by the end of 2021.
On the market front, SA equities (+29.23%) had a sterling 2021, thanks to the rally in commodities which were highly supportive for the resource sector. Apart from resources, SA Inc stocks, financials and small caps made notable moves to the upside as investors continued to take advantage of attractive valuations locally. Interestingly, even the decline of JSE heavyweight, Naspers (-17%), could not avert the rally in local equities such as MTN (+184%), Investec (+153%) and Sasol (93%) which took the crown as the best performing large-cap stocks on the JSE in 2021. Funds that had a decent exposure to SA equities, and in particular smaller, domestic stocks, delivered strong annual returns.
Local market volatility has been particularly friendly over the year, spiking sporadically at points of new COVID-19 variant outbreaks but settling down subsequently. After gaining 8.40%, local bonds remain attractive, given the real yields on offer, especially on the back end of the curve where yields are in excess of 10%. Over the last two months of 2022, while global markets have seen a rout, local markets stacked up well, supported by the increased global demand for commodities. The recent spike in the oil price may, however, bode ill for local inflation outcomes but the strength of the rand should be supportive.
While global volatility has seen a notable increase in the last two months, it remains far from COVID-19 levels, however it does reflect a risk-off environment as monetary policy and geopolitical uncertainty continue to prevail. Elevated valuations of global equities and the concentrated nature of their source of returns remains a key risk currently and this was seen in the last two months where US growth pockets of the market sold-off quite aggressively.
As clients and investors continue to embark on ways to navigate the VUCA world we are in, it’s never been more beneficial to build a balanced, diversified portfolio that blends different asset classes and investment styles. A new abbreviation of VUCA has emerged, as a means of navigating this initially- described “VUCA”, which is Vision, Understanding, Clarity and Agility. It’s important for clients to stick to their long-term Vision while Understanding the make-up of their portfolio, having Clarity of purpose and partnering with investment advisers to create investment portfolios that are Agile in taking advantage of multiple investment environments.