Q2 has been somewhat uneventful. Effects of previous events have continued to characterise the most recent quarter with the war in Ukraine, inflation, and interest rates continuing to make headlines globally. Locally, load shedding continued which impacted economic growth, and the currency.
We identified three major themes which impacted our clients’ portfolios over the past quarter:
Enthusiasm over Artificial Intelligence (AI) boosted technology stocks.
As analysts began to consider how artificial intelligence (AI) could benefit technology stocks, mega-cap stocks in the US saw a surge in attention. This AI-fuelled boom helped the Nasdaq, a technology-heavy US index, rally by 39% in the first half of the year.
The broad-based market did not enjoy nearly the same spurt, despite helping drive most global equity markets higher. The broader US market, excluding the largest stocks, showed only low positive growth in the first half of the year.
Whilst AI will impact the fortunes of many different sectors, not all will be positive. The market has likely been too exuberant in the short term, and it is difficult to assess the immediate outcome of AI for many companies.
Source: Bloomberg
If history is anything to go by, the US market is likely to become less dominated by a handful of specific companies. The few outperformers will likely fall back, or the broader-based market will catch up.
The chart below shows the concentration levels of the top seven stocks over the last 50 years.
Source: Bateleur Capital
Global inflation and interest rates dominate discussions
Central banks around the world raised interest rates to combat rising prices. Their determination to keep inflation in check - even in the face of a banking crisis last quarter – surprised even the market.
In the graph below, we show the increase in short-term interest rates in developed markets over the past year. For years these markets offered barely positive yields on bank accounts and short-term deposits. But with rates currently around 5-6%, keeping funds in the money market makes sense for investors in these countries.
The higher rates in developed markets also attracted fund flows away from emerging markets, like South Africa. However, towards the end of the quarter, funds started flowing back into the South African bond market. This was largely due to our interest rates being nearly double that offered by developed markets.
Source: Bloomberg
Despite interest rates increasing, economic activity remained robust, with the US jobs market remaining buoyant. Financial markets seem to believe that central banks and governments will be able to balance the tension between fighting inflation and not triggering an economic recession. Watching markets in the coming quarters may feel like watching Wimbledon from the umpire’s seat – look to the right to see what interest rates are doing and then to the left to the economy. This is an uneasy transition period.
After quarter end, US inflation surprised on the downside, reaching 3% - the lowest figure in two years. Core inflation moderated to 4.8%.
The market seems to have been lulled into a possibly false sense of security about the risks posed by our current moment in history. The volatility index (an indicator of uncertainty and fear) showcases levels last seen before the pandemic.
Source: PortfolioMetrix
South Africa continued to score own goals
In general, emerging markets languished over the past quarter. However, South Africa was one of the worst-performing financial markets due to the continued deterioration of the country’s power situation. Foreign investors have also repriced South African risk in light of the given loadshedding, the sour perception of our political stance towards Russia in the Ukraine war, and the endless other own goals.
The Rand continued to weaken through April and May, reaching record low levels against the major trading currencies.
Source: PortfolioMetrix
SA inflation continued its downward trend, slowing to 6.3% in May (6.8% in April). Core inflation came in lower at 5.2%. This gives the SA Reserve Bank (SARB) a degree of comfort as they look to contain inflation yet balance out the impact of real rates against a backdrop of weak economic conditions.
Towards the end of the quarter, news flow brightened somewhat: loadshedding subsided, the government’s position on Russia became less confusing and President Ramaphosa was cleared of wrongdoing by the Public Prosecutor in the Phala Phala saga. This led to a retracement of the Rand to end the quarter at R18.85/$, and more positive market conditions.
The most important question to ask, however, is whether concerns about South Africa have been more than priced into local assets.
What has happened in financial markets?
Source: PortfolioMetrix
Local markets showed little movement in the past quarter. Local equities were barely positive at 0.7% growth, whilst the bond market declined by 1.5%. Within the equity market though, resources and financial shares showed significant divergence with a 6% fall and rise respectively. Given the Rand’s weakness during the quarter (declined by 6.5% against the US Dollar), one would have expected a good performance from resources. However, lower output by mining companies, concerns over Chinese economic growth, and lack lustre precious metal prices all contributed to lower resource share prices. The decline should also be seen in the light of the long-term outperformance of resources shares on the JSE – over the past five years, these shares showed growth of 15% per year.
After a dismal 2022 for global equities (down 18%), the first half of the year was surprisingly good. Global equities returned nearly 14% in the first half of the year. Local equity, on the other hand, declined by almost 5% in US Dollar terms - partly because of the depreciation of the Rand relative to the US Dollar this year.
Given the recent Rand weakness, the currency now looks undervalued. We would caution against knee-jerk reactions to this weakness. The currency has a history of severe downturns, followed by long periods of retreat, as we saw after Nenegate and the pandemic. In the long term, the Rand tends to weaken by the difference between local and global inflation.
Most investors, even market experts, would not have thought that the first half of the year would be this good for global markets given the tough environment. However, the year to date has once again illustrated that markets live in the future and not the present. Market participants are already celebrating the end of the global interest rate hiking cycle and are looking forward to rates declining. This is the nature of financial markets.
At present, global companies face tough times. They are still reeling from the impact of higher prices last year due to global supply problems, labour cost increases, and generally tough economic conditions.
When markets party too hard and too early – meaning long before economic conditions start to change - we can expect a reality check. Perhaps we should prepare ourselves for a hangover sometime in the second half of this year. But we should never arrange our affairs according to our short-term predictions. Rather stick to the proven asset allocation strategies which have inflation-beating long-term returns.
It was Oscar Wilde who said, “To expect the unexpected show a thoroughly modern intellect.”
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