The final quarter concluded a calendar year in which most investors in funds with longer-term investment horizons saw their savings increase by double-digit nominal returns, resulting in above-average real returns.
The US equity market continued to appreciate strongly, despite higher-than-average valuations, additional disruptions caused by the emergence of the Omicron variant and the highest US inflation rate in 40 years. Even with the disruptive effects of the pandemic making comparisons somewhat tricky, corporate results during the quarter impressed, as reported earnings for constituents of the MSCI All Countries World Index grew by more than 25% versus the corresponding period in 2020. With consensus analysts’ estimates pricing the Index on a multiple of 18 times forward earnings at the year-end, global equity valuations remain towards the top end of the range that has prevailed over the past thirty years.
While not even the most enthusiastic of bulls could convince us that the market is cheap, implied price/ earnings to growth (PEG) ratio of less than one does go a long way to justifying the view that, by the same token, it is by no means unattractive. Importantly, away from the highest rated US market, which dominates and skews the Index’s metrics by virtue of its 60+% weighting, valuations are far less demanding (albeit with commensurately lower growth estimates in some cases).
Despite the generous earnings growth results, we caution investors to moderate their return expectations for 2022. There is a risk that equities may have a worse relative year ahead given the elevated levels of exuberance evident in market prices. Higher inflation makes it more likely that central banks will continue to raise interest rates and tighten monetary conditions.
While US equities performed well in 2021, lifting the global indices upwards, emerging market equities disappointed. The most significant detractor from performance in this asset class was the souring of investor sentiment towards China in response to multiple regulatory interventions aimed at rebalancing the economy in favour of the broader society, coupled with the impact of increasing tension between the world’s two major powers. The silver lining of the recent underperformance of offshore-listed Chinese companies is that the prospects of superior future returns from high-quality businesses with attractive growth prospects and undemanding valuations have increased.
Domestically, the economy slowed in recent months as the post-lockdown pent-up demand worked its way through the system and as employment levels continued to lag the economic recovery.
SA equities and property outclassed their emerging market peers by ending the year up 29% and 36% respectively. The ZAR has depreciated by 8.0% against the US$ in 2021, making it the worst performing BRICS currency for the year. This was largely driven by foreign selling of SA assets, adding to the pressure on inflation with the rising cost of imported goods.
SA government bonds were the top-performing sovereign debt market in the world last year and continue to offer attractive yields, especially at the long end of the yield curve. While policy interest rates are likely to increase this year, short-term interest rates remain low, and we continue to caution that investors in income funds should expect more muted returns going forward. Global bonds declined in US dollar terms in 2021 and the asset class remains unattractive in our view.
The debates in our team to manage risks and opportunities in the new year will include the following:
- Inflation, the interest rate outlook in the US and Emerging Markets which will dominate risk asset behavior
- Equity themes of growth stocks vs. value stocks will be an ongoing debate – we remain exposed to both styles with a larger tilt to quality growth stocks. In a potential lower return market, more focus will be on dividends and the consistency of quality stocks.
- Will “Greenflation” continue to drive a global policy U-turn when it comes to the green energy transition. The world is certainly not ready to implement green energy, therefore the exposure to oil/coal in our portfolios will be an ongoing debate
- Will China bounce back and open up the taps while everyone else is reigning in liquidity? We believe they will do anything in their power to support their local economy with disciplined liquidity stimulus
- The commodity cycle. We are encouraged by recent global PMI data and especially the numbers from the ASEAN economies that have been ravaged by COVID and are critical for global manufacturing supply chains and demand is rising.
- COVID – people will demand their lives back in 2022 and this may influence economic growth positively.
- How attractive are SA risk assets as an investment destination? Without a well-executed reform narrative, we remain at the mercy of the global commodity cycle. In a low or no-growth environment our managers will continue to hunt for businesses that can gain market share or benefit from self-help, acquisitions or restructuring. From an analyst’s perspective Investec report that earnings growth of 13% for the Capped SWIX Index is possible with a dividend yield of 4.4%. SA equities, on a 10.8x 12m forward P/E, are trading significantly below their long-term average of 12.5x but we still question where the marginal buyer comes from as foreigners remain absent.
Our portfolios remain well exposed to risk assets in SA and offshore markets and our absolute return mindset will ensure that we have sufficient ‘insurance’ in place to manage volatility in portfolios.
Head of Portfolio Management
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