Where do 2022’s uncertainties leave South Africans in 2023?

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CIARAN RYAN: Last year truly was a reality check for many investors. Investment themes that remained intact for decades quickly unravelled in 2022, forcing investors and numerous wealth managers to ditch traditionally considered safe-haven assets like US bonds and expensive growth shares.

Well, where does that leave South Africans as we kick off 2023 with so many uncertainties clouding the investment space?

Joining us to discuss this is Adriaan Pask, chief investment officer at PSG Wealth. Hi, Adriaan. We spoke just before Christmas last year, and in that discussion you highlighted the difficulties and opportunities in the investment space in 2022. Among the difficulties that you highlighted in our last conversation [was] the fact that there was very little in the way of safe havens with bonds and equities all on a down trend. Here we are a little over a month later; what were the events in 2022 that gave investors a reality check in your opinion?

ADRIAAN PASK: Hi, Ciaran. Thank you for having me, and thank you to the guys listening in. I think we started off the year quite well initially, until we went into [the] war period. So the war in Ukraine is a big surprise. I think it’s been a very, very long time since we’ve had a war that featured on a global scale and affected many people globally, and that was a bit of a wake-up call. I think we live in a world where times have modernised a lot and, for the majority of us, it is largely unthinkable to have a war that affects us globally.

Even going back to that period of time, many people were concerned that it could very easily spill into a Nato conflict and globally become something much, much bigger, with that amount of fear. Even though the likelihood of something like that happening is very small, those fears do tend to capture the minds of investors.

We did see that affect markets, and it just felt like a perfect storm together with what we saw in inflation numbers, which have been the highest since the late 1970s and early ’80s. And with that, unprecedented interest rate hikes, especially if you consider their pace. The last time we saw that was during the [former US Federal Reserve chair Paul] Volcker period in the late 1970s, and many investors who have been around, even professional investors, haven’t managed money through periods like that.

I think the one exception would be South African fund managers who are quite accustomed to higher inflation periods. I mean, we saw 7% inflation just in 2016, so it wasn’t a big adjustment for us. But I think for many investors globally, and even professional investors, that came as a big shock and a bit difficult to navigate.

Something else that we’ve discussed, really a consequence of the interest rate environment, was the sell-off in growth assets and in particular tech counters, which came as a shock as well, because I think many investors just thought that good businesses will never be under pressure – and I think we see that now. We are going through a phase where more and more businesses are announcing job cuts, etc. It clearly shows that there is significant pressure on growth expected, and [investors are] trying to manage costs as effectively as possible.

And I think maybe for South Africans, load shedding – I won’t harp on it because we read so much about it – was very, very painful through last year in particular, which impacts the sentiment locally.

But again, just back on the global level, maybe the last one was crypto assets. So even there we experienced some pain; [it’s] not really to our mind an investment asset for investors. It’s more for speculators. But it still just goes to show how broad-based the sell-off really was across different assets.

CIARAN RYAN: I guess there are a few other themes that did come up in 2022. Load shedding – we had more than 3 600 hours of load shedding. And yet the Alsi [All Share Index] did pretty well last year relative to the rest of the world. Can you just talk about some of the investment themes that struck you last year, particularly the ones that ran out of steam?

ADRIAAN PASK: Yes. We spoke briefly about the war and the energy crisis, and I think what we’ve seen over the last decade has been good intentions in terms of getting a better energy mix, especially in South Africa, but also globally. There has been a lot of pressure on dirty energy, fossil fuels, and to our minds at times somewhat unrealistic transitions into cleaner energy. These are massive infrastructure projects that take time and you need to be sensible and realistic as to how you can do this. There was a lot of capex just halted into those spaces, which meant that when we ran into an energy crisis we couldn’t make sufficient adjustments to release new energy. That meant that we needed to rely on these old fossil fuels to carry us through, which meant that the oil prices rallied, and many of the oil counters did reasonably well.

I think investors had to just come back to reality and understand that there [was] definitely more of a transition than a switch going to be flipped. As that happened, we saw things like the share price of Exxon, for example, an oil company in the US, the share prices were up 70% over the course of 2022. But if you look at something that could serve as a proxy for clean energy, something like Tesla was down 70%. Those are massive, massive differences. I think previously investors just shunned the oil companies and invested in the new-energy things, based purely on sentiment under the pretence that things would happen quite quickly. It just goes to show that you need to be a lot more pragmatic than that.

The other theme that ran out of steam was, for me, speculative assets, and the poster boy for that one would definitely be crypto.

So we saw a lot of speculation throughout. Just a few years back we saw spacs [special purpose acquisition companies], for example, come through a lot of new IPOs on US exchanges, and those things are characteristics of easy money, a lot of capital flowing through. We know that that was the case because there was a lot of fiscal support, a lot of monetary policy support, and those things came to an end. As that happened the appetite for speculative assets decreased. We’ve now seen how that can affect prices in those kinds of environments.

The other one that we also previously spoke of late last year was how people perceive good businesses to be good investments all the time. This comes back to, in particular – a good example would be the tech businesses. They are phenomenal businesses, but they’re not always unconditionally good investments, and sometimes they get very expensive. If you buy at higher levels you significantly decrease your possibility or probability of a good investment outcome there. So that I think also ran out of steam a bit. I think investors are a lot more cautious.

And, maybe lastly, a really big one is US government bonds that have always been perceived as the global risk-free asset class, and they have been in a bull market for 40 years. All of a sudden we see bonds sell off. I’ve no doubt that many offshore investors weren’t prepared for that, and we see it in some of the fund-manager results globally. I think most investors just expected that as equities would sell off you would get that diversification support through your government bonds – and that was not the case.

If you look at global equity industries, they were down roughly 18% and in that environment you would have traditionally expected your government bonds to be up, and buffer some of your losses. But they were actually down 17%; global developed-market bonds. That’s material because it makes it very difficult for asset managers to diversify their portfolios, and we’ve definitely seen weaker results out of the fund management industry, especially in the US.

CIARAN RYAN: It’s interesting that you mentioned how Exxon appreciated 70% while Tesla went in the opposite direction. So the big sell-off in the tech stocks sort of correlated with what was happening in the crypto market. Are these themes likely to drift over into 2023? What are the themes that you are looking out for this year?

ADRIAAN PASK: I think some of them are likely to continue. I can’t see, for example, a massive uptick in in the appetite for speculative assets all of a sudden. It’s just not that kind of environment. Typically what happens when investors wake up to certain themes, it takes some time to turn that around again. I think investors have become more cautious around how they consider investment prospects, even in good businesses.

But I think for this year what’s going to make it really, really interesting is that I think there’s a bit of a twilight here for us ahead in the sense that, if you look at something like commodities excluding gold, there’s been a lot of structural underinvestment and diminishing inventories that underpin support for higher prices. But at the same time we are heading for a recession, and that’s really well known. Every single indicator that you consider signals that we will experience a US recession. So it’s very difficult to see how commodity prices could be higher in that environment. Although the long-term story is very much supportive for commodity prices, over the medium term there would be diminished demand, just based on the recession. And as growth fears escalate, you’ll see some pressure there.

The same could be said for things like US equities. Valuations are actually quite high still, which means that we don’t favour that area of the market, but we know during a recession that will be favoured again. The same [goes] for the dollar, that the dollar is something that feels to us just excessively expensive given the fiscal backdrop in the US. Yet we know it is a safe-haven asset and typically when there’s a recession it does quite well.

So how you navigate that is really interesting. You can decide to try and time it perfectly, and be long those assets for a while, until they run their course – and then change your theme into the longer term. Many players avoid that situation because there’s obviously a lot of risk in getting the timing right there, and you can rather look through the recession and get your positioning right longer term. So be short US dollar, favour your commodities. But that’s going to be a really, really tough ride potentially for fund managers and investors.

So, to make a long story short, I think the key theme for the year is going to be continued uncertainty as to how to navigate the situation, which brings with it heightened volatility. It’s going to be very interesting to see how that plays out.

I think the one benefit that we do see on the horizon, however, is that Fed rate hikes will likely peak this year. So that’s the other more certain thing. Again, it brings some uncertainty because you have a recession, but then you see interest rate peaks and maybe investors become a little more optimistic around that.

But these macro calls are so, so difficult to get your head around at times, because you can see the implications of various things and, depending on your mindset and your time horizon, you can interpret them entirely differently. For us, I think we’ve reverted to considering these things and being pragmatic, aware of the risks. But ultimately valuations will carry you through to the end.

So don’t be too worried about how sentiment might change. Often investors, when they try to get this right, get it completely wrong – whereas, if you follow valuations over time, you have a much better chance of actually getting your strategy right and getting good results for clients.

CIARAN RYAN: You’ve touched on one of the big themes that everybody seems to be discussing, and that’s recession for this year, certainly out of the US, and of course if it happens in the US it’s going to happen around the world.

But [there is] also the peak interest rate cycle. Now there is a time lag, isn’t there, between peak interest rates and economic recovery. So are we really looking at a year where there’s not going to be very much vibrant economic activity? We’re probably going to have to wait till 2024. What’s your view on that?

ADRIAAN PASK: Again, a very interesting question because there’s typically, as you mentioned, a delay between interest rate hikes that are effected in the economy and when they actually show you the impact of those changes.

So, for example, the changes that we saw even late last year are unlikely to have any impact on the economy – even this year. It does more for sentiment, but in terms of inflation coming down, we’ll only see that maybe later this year, if we’re lucky, or potentially only next year. I think that’s what also makes it so difficult for the policymakers because it might feel like you’re under a lot of pressure and you’re behind the curve and you should be increasing or cutting. But you don’t really know because you haven’t seen the effects of the last sets of changes that you made over the last three or four quarters. So that’s really difficult.

But I do think the halting in interest rate hikes, as well as low inflation numbers, will get investors into a mindset where they are potentially looking for more opportunities. But there is a risk that you are too early.

One of the things that we also previously spoke of is the risk to profit margins for US firms, and earnings consensus expectations. Both of those remain quite elevated, so there could be another let down in markets this year. But then hopefully when you go through these tough periods, they always set the tone for the next bull market to come. So it’s one of those difficult things. You need to take the pain in order to get ready for the next cycle, and what we try to do is to take as little pain as possible. You can’t ever avoid all of it, but then be ready to participate in the opportunities when they present themselves during these shock periods.

But I think it’s very difficult to see how exactly this year will pan out. There are so many variables in play, as I mentioned, and how investors position themselves will be key.

I think the things that we need to keep in mind – I’ve mentioned these briefly before – are to be really pragmatic in how you assess the situation, distinguish very carefully between what is short term and maybe less important versus things that are longer-term drivers and will add more value to your investment process over time. It comes back to the component of following valuations. I think that’s sort of what we are aiming at for 2024, because it is definitely going to be an uncertain year on either side.

CIARAN RYAN: Yes, we look forward to following this story with you as the year goes. It’s certainly going to be a nerve-wracking and potentially very interesting year for investors. So I want to thank you, Adriaan Pask, chief investment officer at PSG Wealth.

Brought to you by PSG Wealth.

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