Positive 2022 investment returns to be supported by the continued global opening
As we enter the 3rd year post the onset of the COVID pandemic, it appears that 2022 will be less restrictive and life will be more normal as we learn to live with the virus. This is despite probable further COVID variants emerging over time.
Globally, COVID is being dealt with more rationally and collectively
Although global COVID infections are currently at record highs of 2.3m per day, the daily death rate has declined to 6200 per day, off a high of 17000 per day in Jan 2021. The decline is due to vaccine rollouts and better treatments.
As COVID has disrupted the world’s economy significantly, investors have grappled with many unknowns resulting in very volatile markets over the past two years. Despite multiple COVID variants, the world is learning to deal with the effects of the virus more rationally and more collectively. This should result in a smoother and more sustainable opening of global economies in 2022, which should have a positive effect on economic growth and consumer sentiment. This should be an important underpin to more stable investment markets in the year ahead, despite the risk of rising interest rates.
The main investment risk remains rising inflation and central bank policy adjustments
The massive injection of stimulus ($16T) by developed countries’ central banks from the onset of COVID is the reason that global markets recovered quickly and have risen abnormally (17% annually) from pre the pandemic.
But, as economies recovered and inflation soared (6.8% in USA), the stimulus is being unwound through reduced government bond purchases and rising interest rates. The tide has turned, and the effects could be negative for markets. However, central banks are very aware of this and appear to be very sensitive and prudent in their money tightening strategy. The question is: can global growth be sustained with moderate inflation to support a calm unwinding of the massive COVID debt stimulus? Currently, markets are approving.
Main global issues
Is global Inflation transitory or persistent? – It has spiked to 6.8% in the USA driven largely by supply-chain disruptions. Currently, investment markets are indicating that global inflation is transitory.
Central bank policy adjustments – Will central banks adjust to sensitively manage the balance between rising inflation and increasing interest rates? This could result in negative real interest rates for some time, which would be positive for equities.
Geopolitical tensions – Putin’s shenanigans need to be reined in by the West before an unwanted war takes place. The widening wealth gap remains a major problem, which questions the merits of democratic versus authoritarian systems.
Technology monopolies restricted – The likes of Facebook, Google and Amazon remain under the spotlight as governments grapple with how to loosen their market dominance.
China’s growth prospects – With the collapse of major property developer Evergrande, fears are being renewed around sustainable growth and the fragility of China’s massive private debt. But the government is very aware of the risks and are supporting constant growth into the future. Questions remain around the substance of the sustained growth.
Crypto currencies – Although we believe they are here to stay, we will not recommend an investment in them as we do not understand the underlying price being paid (value). Once we find a comprehensive valuation methodology for Bitcoin or any other Crypto currencies, we will be able to make an informed decision.
Key SA issues
SA politics go from bad to worse
The ANC has a disruptive undercurrent which appears to be worsening with a second Ramaphosa term not being a certainty.
With The ANC losing the national majority in municipal elections, coalition governing is being attempted, but we hold little hope for improvement as it can only lead to more conflict and mismanagement.
The NPA is in disarray, highlighted by its head of the Investigating Directorate resigning. Subsequent probes into slow progress and lack of capacity are being revealed.
The Zondo report has scathing corruption and state capture evidence, but the jury is out as to whether the government will follow up decisively and prosecute appropriately. Unfortunately, under the ANC, there is an obvious conflict of interest, plus a lack of capacity to succeed.
SA in need of structural reforms not austerity measures
The debt burden has been temporarily eased with the fortuitous commodity boom raising an unexpected R128bn revenue and reducing our debt to 70% from 80% of GDP.
Fitch, the ratings agency, changed the outlook on the country’s BB- rating from negative to stable. This is on the back of our reduced debt and other agencies may follow.
The new Finance Minister continues to push an austerity agenda to control spiralling debt, but without meaningful structural growth reforms, we will not reverse the high unemployment rate and stimulate much needed economic growth.
The riots in July slowed 3rd quarter GDP growth to 3% (year-on-year) and should reduce full year GDP growth to 5.1% from previously forecast 5.5%. But minor growth forecasts of 1.8% and 1.6% for 2022 and 2023 are a major concern.
Unemployment stands at 34.9% and with the expanded definition – including people who were available for work but not looking for a job – now stands at 46.6%. This is the country’s biggest problem and without significant growth (+4%), unemployment cannot be reversed.
Eskom remains a major concern with fragile operations, internal corruption, sabotage, and the need to raise electricity prices 20% in 2022.
Inflation rose further to 5.5% in November, resulting in the market anticipating interest rates to rise 2% this year.
The fully vaccination rate is 27%, which is a problem as it hinders attaining a national ‘herd immunity’. This could further restrict the country’s economic recovery.
The Rand is set to weaken further
In 2021, the Rand was supported by a most abnormal trade surplus, driven by very high commodity prices, which peaked in 2021 and have since started to decline. As can be seen from the graph below, the trade balance is very volatile and a return to a deficit is inevitable, which will be negative for the Rand.
The key headwind for the Rand is the country’s looming debt trap as structural changes are not implemented to stimulate material growth of +4%. We believe the fundamental value of the Rand to the US Dollar is 17.60, derived from a purchasing power parity (PPP) of 14.1 plus a 25% risk premium, which represents SA’s weak economic outlook (2022 and 2023 GDP 1.8% and 1.6%) and lack of growth implementation skills.
Prosperity’s risk management remains impeccable
The Prosperity Worldwide Flexible Fund of Funds is our proprietary unit trust fund, which is conservatively managed with an emphasis on capital preservation. Since inception (Sep 2014) the fund has returned an average 9% (net of fees) per annum. The fund is well suited for investors that want offshore exposure and a steady investment return.
2022 investments returns should be moderate and more stable
Globally, equity indices valuations are high, but when stripping out sky-high FAANG (Facebook, Amazon, Apple, Netflix, and Google (Alphabet)) shares, overall valuations are marginally higher than their 20-year averages, 1-year forward P/E s of 17x vs 15x average.
Although investment markets indicate inflation is transitory, we believe there is a sense of caution going into 2022, given relatively high valuations and rising interest rates.
Sector selection is key favouring more defensive and value-based equities as opposed to expensive growth (FAANG) sectors that are highly vulnerable to interest rate increases.
Local equities are still attractive especially in the “SA Inc.” space and longer dated bonds are relatively cheap.
Overall, we expect moderate (balanced) portfolios to produce double digit growth in 2022.
Although SA interest rates are starting to rise slowly, they should stay relatively low for the next two years, which is positive for equities but negative for interest earners. Therefore, including a measured portion of equity risk into your portfolio is essential to achieving after-tax returns above inflation.
A balanced (local /offshore) and diversified positioning is important to mitigate the risks of a weakening Rand and rising offshore interest rates that may negatively affect high valuation sectors, such as technology.
It’s critical to ensure that your investment portfolio is properly balanced and adjusted to suit your personal risk profile to achieve your goals.