CIARAN RYAN: It’s almost a year since the great Covid sell-off. The JSE dropped 30% in a matter of days and it looked for a time that we were being herded off to a dark place. But then, lo and behold, over the next few months stock prices not only returned to their previous highs, they then sailed past them. It was the same story in the US and European markets. We’re looking back at what must rate as one of the strangest years for financial markets in living memory, and at what we can expect in the year ahead.
Joining us to discuss this is Adriaan Pask, chief investment officer at PSG Wealth. Welcome Adriaan. Just cast your mind back a year and remind us what happened in the first quarter of 2020. That was when we first started hearing about cases of Covid-19 coming out of China. What was the state of the market back then?
ADRIAAN PASK: I think it’s fair to say the markets were in tatters at that point in time. That first quarter was quite painful. And if you think back, the speed at which that decline took place was truly frightening. I recall, from just being in the office, you could see on the screens kinds of close on 10% [declines] a day taking place.
Obviously, there was a lot of panic in markets. I think that was just after January, when we saw there were 19 countries with confirmed Covid-19 cases. The stats that came up in terms of tests that were completed showed fewer than 10 000, and 200 people had died. But it was largely contained under a Wuhan lockdown. Countries did start to enforce some travel bans at the time, but I think everybody was still largely uncertain as to exactly what the impact could be. People were talking about supply chains at the time that would be disrupted, but analysts were still figuring out exactly what the impact would be. With something like a pandemic or a virus it’s so unknown – you just don’t know at what speed it can move.
So I think in that case the market assumed the worst, and just sold it off as quickly as possible. But that being said, and maybe it was the record for the fastest sell-off, but it also broke records for one of the quickest January recoveries. So, a very interesting period in markets.
But I think the most material thing for our South African listeners would be the fact that emerging markets were particularly hard-hit by the whole event. We saw a lot of capital outflow from emerging markets. It was the whole risk-off scenario trade, where capital tends to flow out of emerging markets, and emerging market currencies tend to suffer quite a bit. Then you see a lot of capital flowing into gold and US treasuries and the dollar as the typical safe-haven assets.
CIARAN RYAN: Okay. So, fast forward a year, here we are in the early part of 2021. Are you surprised that markets rebounded the way they did, and where do we stand in the cycle right now, in your opinion?
ADRIAAN PASK: That’s a very interesting question. I think if you consider the damage that the pandemic has caused and the scale of the lockdowns, particularly in South Africa, it’s almost hard to imagine why the markets would make a full recovery from there, but that’s exactly what we see.
There are many markets around the world reaching new highs at the moment. But the lesson there is the old adage in markets: “Never fight the Fed.” I think that’s exactly what happened here. The amount of stimulus was unprecedented. We know that markets like capital [going] into economies. I think unfortunately what you do see on a practical note is that a lot of that capital is not actually reaching the economy. It still sits in the savings pool of the individuals.
So I think there’s still some pent-up spending that must go into the economy, and not for the same reason. That’s why equities are still performing quite well in anticipation of not only actual benefit coming from previous stimulus, but also more stimulus on the cards.
CIARAN RYAN: When you look at previous market crashes, how does the past year compare to history? It almost seems what happened during that Covid crash last year is a non-event. It just occurred for a brief period of time, and it corrected itself almost immediately.
ADRIAAN PASK: That’s the other thing. People liken it to the corrections that the world experienced in the 1930s under the Great Depression. But those were lingering recessions of a very different nature, and the bear markets tended to return. They were very stubborn bear markets as well, and a lot of damage, a lot of wide-scale poverty followed from there.
So I think this time is very different. They say those are the words you should never use in markets, but I do think this recession and stimulus plan are unprecedented. We mentioned earlier the speed at which it took place – both in terms of decline and recovery, and the stimulus itself is just astonishing.
The one thing that worries us more now is the levels of debt being created on the back of this. Essentially debt is borrowing from the future. So what’s happening to earnings down the line, and what’s happening to interest-rate policy down the line, is something that we need to look at. But it seems like everybody for the time being is looking at the stimulus and saying we’re going to see earnings increase, and equities will do well.
I think at the same time what we do see is other asset classes, bonds, actually yielding great yields or returns. So equities have become by default a very attractive alternative.
And also, with the amount of money that’s in circulation, inflation could be a problem. Again, then you need real assets like equities to protect you.
Those elements are quite different from what we’ve seen in some of the earlier pullbacks in markets. It’s not always the case that there’s so much stimulus that follows. You would see similar behaviour in terms of gold and US bonds being favoured, but in terms of the equity rally this soon, it is quite unique.
CIARAN RYAN: Let’s talk about equities. The rally has been quite astonishing, but is it still attractive? I guess that would be a very qualified question because there would be some equities that may be looking attractive and others not. Just give us your sense of where we are in current equity valuations.
ADRIAAN PASK: I think that’s the key question. If you look back, I think there’s been a very long period of value underperforming – again largely unprecedented. And I think that stimulus has something to do with that as well. But eventually that also ends. So that transition from momentum-type equities or growth-type equities into value equities is really, really important. We do see quite a polarised equity market in the US in particular. Some of the mega-cap stocks are trading at high valuations, but then some of those balance sheets look okay, so they will at least survive.
So I think the question is whether you want to survive or make returns.
I don’t necessarily think great returns are on the cards for all of them, but definitely the majority will survive just based on balance-sheet strength – and they are quite cash-generative as well.
But at the same time, I think the opportunity really sits elsewhere. Even in the US market there are quite a few sectors that have been oversold that are offering value; but even beyond the US there’s more opportunity. So I think what we have seen more recently is capital flowing into emerging markets. People often talk of gold being a good hedge against inflation, but if you look at the research, nothing is a better hedge than international equity. So, from a US perspective or US-investor perspective, we can understand why they would be interested in the emerging market equity side.
Given that our valuations were depressed before Covid, and with Covid they were just further pushed down, this recent rally doesn’t really surprise me. I think there’s definitely more scope for reratings on the South African exchange in particular, and I would be wary of the US in general.
It’s also a time to think very carefully around your typical passive investments, because we know that the indices are quite concentrated at the moment and there is valuation risk. So those are maybe the things that we can keep in mind.
CIARAN RYAN: Okay. Final question. What should investors take note of as they review their portfolio for the years ahead? Here I’m talking about maybe taking a medium-term view rather than a 12-month view. What should they be looking at and maybe be a little bit worried about?
ADRIAAN PASK: I think one of the key themes that does come out is the sentiment around “cash is trash”. Interest rates are very, very low at the moment and inflation is not high; it’s around the 3.5% mark. At the same time there is risk of inflation picking up with a level of stimulus coming in.
So I think cash is something that should be avoided unless it’s there for a very specific purpose in terms of meeting income requirements in the short term. But for the medium term, I think there’s an inflation risk in cash. You’re highly unlikely to generate a real return after costs and taxes.
At the same time, if you look at our bond market, it see ms attractive. Yes, there are many issues, and our state finances aren’t in great shape, so investors need to be careful. But there is yield pickup on even short-dated bonds – significantly more than on cash. And, from an equity perspective, I think our local valuations look good and there are opportunities abroad as well.
I think it’s a very good time to focus on growth assets as opposed to more defensive-type assets, and that should be the key thing.
CIARAN RYAN: That was Adriaan Pask, chief investment officer at PSG Wealth.
Brought to you by PSG Wealth.