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Don’t blame the war!

May 25, 2022 | General, Market & The Economy | 0 comments

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If you are concerned that the war is causing stocks to drop, here is the full story.

In our review meetings we listen carefully to the questions our clients ask. Generally, if one client is asking that question, chances are it is top of mind for many others. Currently, most meetings end in conversations about the war in Ukraine and the impact this will have on investments. Over the past few months it has become evident that many are genuinely fearful about this situation and the economic repercussions of the war.

What if the Russians are intent on going further? What if they cut off gas to Germany? What if Putin presses the nuclear button?

As financial planners we do not have concrete answers to these questions. Nobody does. However, what we do know, is that the war in Ukraine is not the main reason stock markets have fallen. The primary cause for the market coming off sharply since the beginning of the year is that 350 million Americans are facing 8-10% inflation for the first time in 30 years. This is a massive economic – and potentially social – issue that they will need to deal with.

Inflation started to rise during the pandemic as governments (first China and then the US) announced massive infrastructure spending. This drove up commodity prices around the world, a massive boost for South Africa, that unexpectedly filled SARS’ pockets. Then car and computer microchips faced challenging supply issues, followed by general chaos in the shipping industry and shipping lines, as containers ended up in the wrong ports, on the wrong side of the world, at the wrong time of year.

Then, in the run up to the election, Donald Trump announced massive stimulus packages, which President Biden then added to. They effectively printed money and placed it in the hands of US consumers, who happily went out and either bought goods or invested on the stock market or crypto currencies, all of which ended up at dizzying heights by December 2021.

Recently, outbreaks of Covid-19 in China have disrupted the recovering supply chain. The oil price is at an unsustainable level of $130 and food prices are spiking due to Ukraine being a massive producer of wheat and sunflower oil. On top of this, India has experienced record temperatures that may cause their wheat crops to fail, indicating that they may have to import wheat.

The Federal Reserve (the US central bank) believed these were short term inflationary issues that would be resolved within a year, i.e. by 2022. They signalled to the market that they would increase interest rates to slow the economy and the consumer down. Ultimately higher interest rates will lower inflationary pressure. This process is now underway, however it has had a massive effect on stock markets globally.

Since the 2008 financial crisis, governments and central banks have implemented massive stimulus packages and lowered interest rates. Now they need to normalise interest rates again. In the interim, stock markets have risen based on the premise that interest rates will stay low for a long time.

The Federal Reserve has now made it abundantly clear that interest rates are going to go up for the foreseeable future. However, it needs to be careful about how quickly – and to what extent – it does this, as it is very easy to move too rapidly and tip the country into a recession.

How does this affect you?

Stock markets have sold off a great deal since January 2022:

S&P 500 (US Market) $ -17%
JSE (R) – 6.5%
Emerging markets $ -17%

A Great Rotation of Portfolios? Why have portfolios gone down?

Firstly, international portfolios have done spectacularly well since coming out of Covid-19, overshooting the mark. Local portfolios have also shown excellent returns over the past 18 months up to 31 December 2021, after seven years of relatively poor returns.

Secondly, good asset managers are now seeing markets differently. The interesting thing about asset managers is their ability to relook at portfolios from one day to the next. They are able to take into account changing circumstances and ask themselves honest questions like: are there better companies for me to hold in the portfolio than the ones I currently do?

Currently, the answer to that is a resounding “yes”. The environment has changed, holdings in companies (like tech businesses) that benefitted from low interest rates are being reduced and businesses like banks and medical companies that benefit from higher interest rates are being upweighted.

As you can imagine, with all of this change, asset managers are very busy restructuring their portfolios, trying to take advantage of the opportunities that present themselves.

What have Veritas and our research teams been doing?

Over time, we have been introducing more of what we call value / contrarian-style managers. This has worked well for the past four months, even though they have been unloved for about eight years and supposedly been left behind. Growth managers, all of whom gave spectacular returns over the past few years have, as expected, been punished the most. Quality managers, who buy blue chip stocks, have had a great run for the past 12 years, but will now start to revert to the mean, as will the index, which is full of tech stocks.

Unfortunately, we do not know when the war in Ukraine will end. We do know that in time the supply chain issues will be sorted out and the oil price will retreat below $100. We know that interest rates will continue to climb and we hope that central bankers implement these interest rate increases appropriately. This means that inflation will again be brought back under control. However, the situation could become very serious in developing countries, as it may affect people’s ability to eat and live in the short term.

South African shares appear well-priced relative to international markets. Even though the lights are not working, the analysts believe that you may get better returns from local equity over the next ten years than you will from holding offshore equity in dollars.



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