Tiptoeing into 2022


By Debra Slabber, Portfolio Specialist at
Morningstar Investment Management SA

In the US, 2021 ranked as the ninth-lowest peak-to-trough drawdown in a calendar year out of the past 94 years of data. That’s quite a feat, seeing as 2021 was by no means a dull year – global bonds bottomed out, we saw the Evergrande debacle unfold, Chinese tech stocks slumped and then the contagion of it all to emerging markets. Fast forward four months into 2022 and we are back to a period where market volatility and uncertainty are the order of the day and to say that 2022 has been volatile would probably be somewhat of an understatement.

Investors are navigating their way through a time when it feels like everything is going up (and not necessarily in a good way) – inflation, interest rates, the oil price and geopolitical tension to name a few. Understandably, clients are asking “where to from here?”.

If we look at the various asset class returns over the first quarter (year-to-date) of 2022 there are a few stand out points:

  1. Local is lekker – for a change

Over the first three months of the year, we saw global equities fall by 13% in rands (5% in USD) versus South African equities that are up 4% in rands. That is a 17%-rand differential in performance in just three months. There has been a lot of positive news coming out of South Africa recently. South African manufacturing sentiment rose to the highest level in almost 23 years, the national state of disaster ended after 750 days, Moody’s revised South Africa’s outlook to “stable” from “negative” (stating that our fiscal position has “markedly recovered“) and the South African Reserve Bank (SARS) broke a revenue record and collected more than R1.5-trillion net tax revenue (a 25.1% increase from the previous year).

Energy supply disruptions in Russia and Ukraine (due to the current conflict), combined with sanctions and boycotts against Russia have caused the price of energy and commodities (namely oil and gas) to soar.

The rise in commodity prices has impacted our local commodity counters and the S.A. Resources sector has been a beneficiary of these higher prices (up close to 19% on a year-to-date basis). Favourable terms of trade have also been the main reason why the rand has been so strong when compared to other emerging market currencies (see graph below), and a large part of the volatility of our currency is a result of commodity price volatility.

While some of the easy money in local equities may well have been made by now, we are still seeing good value in select shares and areas of the market like resources and financials.

2. Volatility continues in fixed income

Fixed income managers did not have an easy year in 2021. What had appeared to be a stable (and dare we say “boring” asset class) was no more, as 2021 saw fixed income assets experience a lot of volatility. This has continued in 2022 and over the past quarter, global bonds experienced its worst drawdown on record and US bonds had the worst quarter since the Civil War in the 1980s[1].

Global inflation was expected to ease as economies started recovering from the pandemic but rising energy and food prices (due to supply disruptions in Russia and Ukraine) have continued to drive global inflation higher. Given that adjusting interest rates is one of the few mechanisms to curb inflation, central banks globally may look to increase and/or continue increasing interest rates in the near term.

This may alarm bond investors since market interest rates and bond prices typically have an inverse relationship (in other words, they move in opposite directions), meaning higher interest rates generally cause bond prices to fall. With that being said – for bond investors, this is short-term pain for long-term gain. Higher yields mean higher future returns. While rising interest rates will cause bond values to decrease in the short term, eventually, the declines will be more than offset as bonds mature and can be reinvested for higher yields.

South African Bonds is an asset class we have had our eye on for quite some time. Our government bonds are offering investors a yield of around 9.5%. Compare this to cash where you can get 4% in the bank and inflation is currently 5,7% (and on the rise). Simply put, you are being offered a real yield of over 3,5% from S.A. Government bonds versus an almost negative 2% real yield from cash. Yes, government bonds are more volatile than money market instruments when looked at in isolation, however, when held in a portfolio with equities and foreign assets, S.A. government bonds offer a healthy yield and potential for capital gains should yields decline from here.

3. In global markets, the tide has turned

The MSCI World Index is down about -14% year-to-date (as at 31 March 2022, in rand terms). Value shares and unloved sectors of the market (such as energy and UK equities) certainly rallied and have been solid contributors to portfolio performance (as can be seen in the graph below). On the other hand, we have also witnessed previously high-flying areas of the market – such as growth stocks and technology companies – come under pressure.

Being overweight in emerging markets was a detractor from performance over the past 12 months as well as the past quarter. Sentiment towards emerging markets turned sour towards the end of 2021 when the Omicron variant was discovered in conjunction with the Chinese implementing new regulations that had a material impact on certain sectors.

Emerging markets are some of the more attractive regions in our investable universe and although we acknowledge the volatility this asset class as well as emerging market currencies can bring, we need to remember that emerging markets are heterogeneous and we are still seeing good pockets of opportunity in this sector of the market.

We believe a small, dedicated allocation to emerging market equities in more aggressive portfolios is appropriate.

The importance of building robust portfolios

Given the current market backdrop, there is a lot of uncertainty that investors face both in local and global markets as we navigate 2022. The most powerful protection against market volatility and uncertainty is diversification within portfolios.

Staying invested

You will recall that we wrote “Taking stock and reflecting on the year that was” at the end of 2021. Even though it feels like the world has been turned on its head (again!) with a second black swan event in just two years and lots of uncertainty within markets, the basic principles of investing remain constant.

Markets are and will always be complex. There is a constant oscillation between euphoria and depression and/or celebrating positives and obsessing over negatives. Markets are inherently unpredictable over the short term and driven by factors no machine or person can predict accurately.

Take the long view on your investments and ensure your portfolio is diversified to withstand bursts of volatility that may be experienced in the short term and accept that you will find very little advantage in trying to predict the future from one day to the next. Patience, perseverance, good savings habits, and a good sense of value will help you reach your financial goals.

[1] Source: The Wall Street Journal; Sam Goldfarb, “Bond Market Suffers Worst Quarter in Decades”. Data as at 31 March 2022.