CIARAN RYAN: Volatility is back. It returned with a vengeance in the past few weeks with the S&P 500 index plunging more than 9% since the start of the year, and the tech-heavy Nasdaq is down nearly 15%. Given this heightened volatility, investors must ensure their portfolios are well diversified, and they need to be aware of the possible rotation from growth to value.
Investors could also be tempted to chase the highs and the lows of the market but, due to the heightened volatility expected, a clear guide map is needed. To help us find out where we are on the investment map, let’s welcome Adriaan Pask, chief investment officer at PSG Wealth.
Hi, Adriaan. I think we can all agree that the past two years were particularly eventful, what with the outbreak of Covid, the market crash and the subsequent recovery. What in your view were some of the big lessons for investors in 2021?
ADRIAAN PASK: Hi Ciaran, and thank you very much for having me. Yes, a very eventful period for markets. It’s been nerve-wracking for investors over this period. I think if we reflect now that things have settled down quite a bit from a recovery perspective, as you mentioned in your introduction, the Nasdaq has been quite volatile, but nothing like we saw in 2020 and the selloff there.
What the crisis, as well as the subsequent recovery, has taught us is that things are always volatile when you talk about equity investment; there’s an inherent cyclicality in markets and you should be in a position where you can take advantage of it. So, it’s not necessarily taking advantage in the form of market timing, really, but it is being more measured, being more tactical as those opportunities present themselves.
It’s always easy to say, ‘We’ll just buy that when the market collapses and there are opportunities there’, but when you’ve got fears around a sustainable world recovery things aren’t always as simple as that.
The second thing is research, obviously. There we find a lot of our comfort in our processes where, if you’ve done your work and you know what the company’s worth, and you are reasonably certain that they won’t be compromised long term and they will survive, it’s just a case of thinking long term, keeping your eye on the prize; then those opportunities become a little more apparent, even though conditions are quite tough.
I think the other lesson through this whole process has been to remember that, even though you might have the view that some asset classes might be expensive – in our case, we’ve been fairly negative on US bonds for a while, during the crisis period they accelerated, actually – it just goes to show that, even though you’ve got a fairly good idea of where you want to be, you still need to maintain that diversified portfolio just in case something happens [such as] a Covid crisis or [something] similar.
CIARAN RYAN: Right. You touched on the bond market, and there’s a lot of talk about inflation. What, in your view, were some of the key macroeconomic drivers in the last two years?
ADRIAAN PASK: I think it’s exactly right. Inflation and interest rates are really two sides of the same coin. Last year’s talk was very much about where inflation is going; is it transitory, is it going to be more sticky? We’ve seen how the Fed has also flip-flopped with the inflation rate coming out at 7%. But I think this year, without a doubt, that narrative is going to evolve. We are not talking about whether inflation is going to come or it’s here; it is a risk and it needs to be addressed.
So, we are talking about interest-rate hikes this year and the only question is how the market currently perceives them and where the error might be.
Currently, funnily enough, both in South Africa and in the US, the market’s pricing in three hikes. I think in the US’s case there’s every possibility that it might be more aggressive than that, because we’ve seen inflation numbers come out more aggressively than expected as well. So that’s something to keep a very close eye on.
In South Africa, I think we are a little more sheltered in the sense that our bond yields are already quite high. It seems they’ve priced in a lot, let’s call it, more fiscal risks for South Africa. But in doing that they’ve also created some margin of safety should we see interest-rate hikes. So maybe [things are] less dire on that front.
Another important macroeconomic outcome from last year was obviously the rebasement of the GDP measures. There were really two key tailwinds for us in South Africa last year; one was the higher commodity prices, which really helped quite a bit in terms of tax revenue and helped the fiscus quite a bit. And then, by rebasing the GDP numbers, we actually expected debt to GDP to go to 80/90/100%. Instead, with the income being elevated and the GDP being restated, we moved our debt-to-GDP number from roughly 80% to roughly 70%, which is, strangely enough, below the OECD average debt-to-GDP ratio, because many of these developed economies are carrying quite a lot of debt on the back of the stimulus from 2020/2021. So that’s key.
Maybe the last one that I can mention that I think is important is China’s economic growth strategy. We were getting a little bit nervous last year; everybody’s moving towards a tightening cycle. Commodities have done quite well, but if China is continuing to tighten and the growth is under pressure, then that’s obviously a concern. But, obviously they’ve now surprised us with multiple rate cuts. So, it looks like we might have more demand out of China for a while to come. That will obviously also have an important impact on commodity prices and how well emerging markets that are producers of those commodities fare on a fiscal front as well.
CIARAN RYAN: Going into 2022, what’s your take on South Africa’s prospects? Are we in a value trap, or are there opportunities for investors?
ADRIAAN PASK: Well, I think there are certainly some areas of the market that would be value traps, that look stressed – and they are justifiably rated lower from a PE [price-earnings] perspective. But I think on aggregate there are actually very good opportunities – real value and not really value traps. But again, you’ll have to be selective through that.
And then the other thing to remember, as I mentioned on the bond front, yields are quite high, and they’re pretty well sheltered from interest-rate hikes to come, because there’s so much risk priced into them already. If you look at our money-market rates, they are low, but they are still significantly higher than what you would experience offshore, for example.
We think that South African markets across equities as well as multi-asset portfolios have a very good chance of outperforming offshore peers. I don’t think that’s a common expectation, but we rely on the valuations and we think there’s a good opportunity in South Africa.
CIARAN RYAN: All right. That’s encouraging news for South Africans. So there still seem to be opportunities for investors here. But are there challenges that you are particularly concerned about?
ADRIAAN PASK: Yeah, I think there are many. I think most South Africans are incredibly well versed in all the challenges that South Africa as a country faces. We talk often about the public-sector wage bill, dysfunctional state-owned enterprises, unemployment – especially among the youth – corruption, the risk of social unrest. So, all these things are challenges South Africa [faces]. In many cases, these have been challenges that we’ve been trying to deal with for a while. So, it’s definitely not without risk.
The key is to understand how these things could potentially impact the investment prospects of the securities in a portfolio, if at all. There are quite a few of the listed entities on the JSE that aren’t really affected by those things directly; they have very little South Africa exposure.
On the bond front, I think last year there were still quite a few concerns around, yes. But there might even be a probability that bonds default and, behind their yields, sort of reflect that that risk is not zero.
Going back to our discussion on debt to GDP, things look relatively stable, especially if you start to compare us to some of the other countries. If you look at US bonds, for example, debt levels are completely through the roof and at the same time yields are incredibly low. So, it seems like the valuations of bonds are completely decoupled from the fundamental reality of the fiscal situation in the US, whereas at least in our market it seems to be accurately reflecting the risks in there. And again, it comes back to the point of having a sufficient margin of safety in those valuations, which we think is the case.
CIARAN RYAN: Okay. So we’ve been speaking about bond yields and inflation. Do you think these key market drivers that underpinned the market in 2021 are going to persist into 2022?
ADRIAAN PASK: Yeah, I think so. I think it’s maybe just a change in the narrative going forward. [As] I mentioned, interest rates and inflation are really two sides of the same coin. Where last year a lot of the talk was about inflation – is it going to stick around or will we see it rear its head? But this year I think we’ve evolved into understanding that it is here, it is a material risk, and interest-rate hikes are inevitable. So, I think in that sense, yes, the same discussions are on the table.
The other key thing is commodity prices – especially from a South African perspective, because that’s been one of the key drivers for fiscal stability as well as earnings on the JSE. If we see China continue to stimulate, that will assist credit extension in China, as well as commodity prices globally. That could be quite positive.
And the other key thing is that obviously sentiment is critical if we talk about equities over the short term. There are still many, many challenges being faced in South Africa and we can expect that volatility will creep in as we see turbulence in our political environment, and on the economic front still a lot of uncertainty around policy reform and whether we are on the right path.
So, if you compare where our situation sits relative to the US, from a volatility perspective, I think volatility in the US is set to be quite high this year. We’ve already seen what happened in the early weeks of the year, and I think that’s a precursor for what we can expect for the year going forward.
CIARAN RYAN: A final question, Adriaan. What can investors expect in 2022?
ADRIAAN PASK: As I mentioned, volatility. It’s going to be substantial, especially in offshore markets. And then in South Africa a quite-similar situation. As always, we have volatile markets as an emerging market country. We anticipate a rotation from growth to value. I think investors are going to become more sensitive to how much growth they price into the investments they make. Investors need to be aware of possible rotation from growth to value. I think that on the growth front investors will start to price in less growth than they did historically, especially over the preceding two years. At the same time, investors will also start to become more price-sensitive in terms of how much they’re willing to pay for stocks and assume future growth.
That’s why in our view the rotation from growth to value seems likely for 2022.
CIARAN RYAN: Adriaan Pask, we’re going to leave it there. Thank you very much for coming up. That was Adriaan Pask, chief investment officer at PSG Wealth.
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