Investors in SA and across the world were spoiled with better-than-expected returns in 2021, but we had better brace ourselves for some bumps in 2022, says Alwyn van der Merwe, director of investments at Sanlam Private Wealth.
US equities are up 14% for the year to date, the French CAC 40 index is up over 21% in US dollar terms over the same period, and the JSE Top 40 index is up 15.5%, even after last week’s sell-off on news of a new Covid-19 variant that is expected to put a crimp in the global recovery.
Leading the charge for US equities are tech stocks such as Apple, Alphabet (Google’s holding company), Microsoft and Tesla, with year-to-date gains of between 48% and 65%.
Unlike in 2020 when commodity stocks and Naspers/Prosus accounted for most of the upward momentum on the JSE, this year it was industrial stocks, with notable re-ratings for Richemont (up 82% so far this year), Investec (up 116%) and MTN (160%).
The re-rating of local stocks
MTN enjoyed a substantial re-rating after previously being dogged by its legal troubles in Nigeria. Investec split off its investment arm Ninety One, which gave investors a more focused exposure to its banking assets. “Investec’s share price was always rather cheap, and traded at price-to-book value which was well below its European and UK peers,” says Van der Merwe. “It was clear that interest rates would go up in Europe and the UK, which would drive up Investec’s profitability. That led to a re-rating, which coincided with a turnaround in the operating performance in previously lagging divisions within the bank.”
Richemont was never particularly cheap, but was a major beneficiary of changing spending patterns as a result of Covid. “One of the changes we witnessed as a result of Covid was that people spent less on travel and more on luxury items such as jewellery, and this worked to the benefit of Richemont and others operating in this segment of the market. It was inevitable that Richemont would experience a re-rating. The question is, is this sustainable? That remains to be seen. One would expect spending to return to some kind of normal pattern in the future, but for the moment this is great news for Richemont,” says Van der Merwe.
At the start of 2021, US government bonds were yielding 0.91%, but as the year progressed, yields shifted higher to around 1.7% as the spectre of inflation reared its head, resulting in capital depreciation for bonds. Oil prices have shot up 60% in US dollar terms for the year so far, while gold is slightly down.
“Risky assets such as equities and commodities did well in 2021,” says Van der Merwe. “The same cannot be said for less risky assets such as gold and government bonds. At Sanlam Private Wealth we expected local equities to return about 12% for the year, which was slightly below the 15.5% achieved so far for the year. We expected single-digit returns for global equities, and again we were a bit conservative. The global economic recovery was stronger than we expected, and this accounts for the better-than-expected returns from global equities, particularly in the IT sector.”
Despite a better-than-expected recovery in the first half of 2021, cracks started to appear in the second half, and these will become more pronounced going into 2022.
Following material price increases in commodities and supply-side bottlenecks, inflation emerged as the single biggest economic concern both globally and in SA.
SA’s producer inflation for October 2021 came in at just over 8%, while personal consumption expenditure inflation in the US, which excludes energy and food, is currently nudging 4.2%. That is likely to drive economic policy going forward. The one policy tool the US Federal Reserve has to counter the inflationary threat is interest rates, and the prospect of higher interest rates in 2022 may strangle the post-Covid growth momentum. There is now talk of stagflation – no or little growth accompanied by rising inflation.
How did Sanlam Private Wealth position its portfolios in 2021?
“We have many different mandates, with discretion across asset classes and geographies,” says Van der Merwe. “We carry a full weight in SA equities, with 45% to 50% exposure to domestic equities, and a rather full exposure to global equities at 15% to 20% with the remainder of the 30% offshore exposure largely invested in alternative assets. Offshore exposure is limited to a maximum of 30% as per retirement fund regulations.
“Our exposure to equities overall is about 70%, against the maximum allowable limit of 75% under SA retirement regulations. As the year progressed, we trimmed global equities and I think this was a good call. We parked some of the proceeds of these sales into US dollar cash, and some of it went into assets uncorrelated with equities.”
What are the key economic and financial variables likely to drive financial markets in 2022?
“The biggest risk for financial assets is that valuations are high as we enter 2022, which means the market is sensitive to headwinds or disruptions, such as higher inflation, or another Covid wave or perhaps a major bankruptcy,” says Van der Merwe. “Reactions to bad news like this could be magnified as a result. Valuations are high in the US, less so in SA, and there are significant risks of high inflation and aggressive policy response from regulators.”
One factor that has changed in the course of 2021 is that investors are less prone to overreact on bad news about the virus. “You can see this in the East where people are still very mobile even though infection rates are going up. From an investment point of view, asset prices are expensive, so investors have to adjust their expectations lower. We have been spoiled with returns of 14% or 15%, and this is simply unsustainable.”
The bottom line: thanks for the great returns in 2021, but prepare for some potential bumps in 2022.
Brought to you by Sanlam Private Wealth.
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