Global Market Overview
After a strong 2021, it has been a testing start to the year for equity markets. Spiralling inflation, concerns about central bank tightening and tensions in Eastern Europe drove the risk-off sentiment and led to a sharp increase in volatility. Disruptions to global supply chains due to the pandemic continue to cause shortages, driving up the prices of goods. US consumer inflation climbed to 7% year-on-year in December, its highest level since 1982 and economists now anticipate five interest rate hikes in 2022 as countermeasure. Federal funds futures are pricing in a 100% chance of a March rate hike, with an 89% probability of a 25-50 basis points increase. Developed market equities ended the month down -5.3% (MSCI World Index), although emerging markets outperformed, ending January down only -1.9%. Growth stocks trading on steep valuations came under increased selling pressure, particularly in sectors that had benefitted from changing consumer patterns during the pandemic.
Nearly all of the major indices declined in January, with most entering correction territory (a decline of -10% from recent highs). The S&P 500 fell by -5.9% in January, its largest monthly pullback since the beginning of the pandemic in March 2020. The Dow Jones closed -4.0% lower and the Nasdaq plummeted -10.1% month-on-month (MoM). UK equities significantly outperformed other developed markets, with the FTSE 100 ending +1.1% higher for the month. The index benefitted from the large weighting of commodity and financial stocks and relatively low exposure to technology stocks.
Germany’s DAX closed January -3.4% down, while France’s CAC Index fell by -3.0% MoM. Eurozone equities should benefit from further improvements in supply bottlenecks and a reacceleration in economic activity. December and January sentiment and economic activity data were surprisingly resilient against the backdrop of rising COVID-19 infections across the continent.
In Asia, Hong Kong’s Hang Seng Index was up +2.3% MoM, while the Shanghai Composite Index sank by -7.6% MoM. China’s economic and regulatory challenges have led to a significant sell-off in equities. In the past 12 months, Chinese equities were the worst performing equity market in the emerging markets.
Commodities continued to rally in January. Brent oil soared +17.3% to reach $90 a barrel for the first time since 2014, driven by falling oil stockpiles in the US and rising political tensions with Russia. Rising real rates weighed on gold, which lost -1.7% MoM, despite being regarded as a natural hedge against rising inflation, a weak equity market and geopolitical tensions.
In contrast to most of the major global equity markets, the JSE All Share Index managed to eke out a gain of +0.8% in January, which was driven primarily by the financial and commodity sectors. Even after last year’s gains, JSE share valuations remain well below those of emerging market peers, which increases their appeal to investors.
The rand strengthened by +3.7% against the US dollar during January. The SA Reserve Bank (SARB) hiked the repo rate to 4%, as was widely anticipated. Retail inflation reached its highest level since March 2017, with the consumer price index (CPI) coming in at 5.9% YoY. The SARB flagged upside risk to inflation, although headline inflation now averages out at 4.5% YoY, which is still in the middle of the SARB’s target band of between 3% – 6%.
While inflation has eroded the yields of developed market bonds, the high real (after-inflation) yields South African bonds offer are attractive not only relative to both developed and emerging peers, but also high against historical averages. These high real bond yields are discounting an elevated rand/inflation risk premium, along with significant country risk. Further negative sovereign credit rating action seems unlikely at present, given the rating agencies’ undemanding policy reform expectations.
Message from Kevin
An inflection point appears to be emerging, where further equity market losses are being offset by market participants buying at depressed share prices. The -10% market correction level, though arbitrary, is a psychologically significant one. Investors may start selling equities to protect their capital over the short term, or decide to buy the dip. Our view is to remain resilient and retain our existing positions.
The Iza Portfolios
The Iza Global Equity Fund eased -14.3% MoM, (GBP returns), while the Iza Global Balanced Fund declined by -11.4% (GBP returns) and the Stable Model Portfolio closed -5.7% (GBP returns). All of the underlying funds closed in negative territory, in line with market declines. Technology-heavy Scottish Mortgage Investment Trust, however, declined by -19% which weighed significantly on fund returns.
The equity market decline is corrective and short-term in nature. Following the great financial crisis, as the Federal Reserve started to taper quantitative easing programmes and hike interest rates over the 2010 to 2018 period, there were six instances in which the S&P 500 experienced declines exceeding -10%. Yet the index recovered each time and continued hitting new all-time highs.
The decline in the Iza funds’ returns is systemic and not indicative of a deterioration of the fundamental quality of the underlying investments held. Strong fundamental US economic growth drivers remain intact, which structurally underpin positive equity market returns. This includes wage growth, low unemployment, high household savings and high inflation. These growth drivers should fuel an equity market recovery in coming months. Recoveries are typically more gradual than market declines and the key is to remain invested.
Although we expect market volatility to persist as investors digest the Federal Reserve’s remarks, we remain confident that the fundamental factors that will drive a recovery remain solidly in place.