Reflecting on the year that was…
While 2023 produced some surprise events, a few were not entirely unexpected. We found some of the most notable events to be:
- the deteriorating global geopolitical environment, particularly in the Middle East, where there remains a high risk of contagion. The Ukraine-Russia war continued unabated during this past year. Tensions between the US and China, whilst currently under control, revealed an even deeper divide between the two super-powers than as witnessed at the start of the year.
- the US 10-year bond reached a yield of 4.75%, a level last seen prior to the global financial crisis.
- the sooner-than-expected normalisation of inflation. Signs have been emerging to indicate that inflation is seemingly under control, implying that interest rates may begin declining in 2024.
- the inability of the Chinese economy to grow above 5%, despite coming from a very low, Covid-impacted base. The Chinese property crisis deepened with large bankruptcies recorded during the past year.
- on the positive side, there were further advancements in technology. This was evidenced by material strides in the democratization and pervasiveness of generative AI through free-to-use tools such as Open AI’s ChatGPT. The rapid adoption of AI resulted in a five-fold increase in expected profits of specialist AI hardware and software company Nvidia.
- another sector benefitting from innovation was biotech and the pharmaceutical industry and here expected profits of Novo Nordisk’s tripled (over three years) attributable to the success of the medication, semaglutide, that appears to be delivering material success in treating diabetes and obesity.
- the 32% decline in the platinum group metals (PGM) basket price and resultant collapse of the PGM mining sector’s share prices.
Domestically in South Africa,
- record levels of loadshedding were experienced which impacted the profitability of several companies.
- the decline of Transnet Rail’s volumes and its weakened financial position, culminating in a state-backed bail out.
- the Rand’s circa 15% weakness relative to its EM peers and the meagre 3.5% return from the JSE Capped SWIX, despite attractive domestic company valuations going into the year.
It feels like history is becoming a less reliable indicator
As we review the events that transpired these past 12 months, we cannot help but wonder to what extent were these surprises vs more foreseeable events. Were there warning signs? Which of these trends will continue in 2024 and beyond?
These are questions that we as investors continually ask ourselves. One of the essential features of our job is the requirement to assess whether a trend in play is structural or cyclical, or both. During this current golden age of disruption and rapid technology adoption, it feels like history can appear to be a far less reliable indicator than it used to be. Due to the high forecast risk, the ability to predict regime changes is by no means a perfect endeavour. The heuristics that were essential for our survival to date either seem to lead now to excessive optimism, extreme pessimism or denial and burying of heads in the sand. As we prepare for 2024 and beyond, therefore, we must consider a range of tools and matrices to assist our decision making to counter these potential behaviours.
“…it’s essential to assess whether a trend is structural, cyclical or both.“
Understanding the market cycle can help investors
Regardless of whether we think that structural changes are afoot or not, we always need to assess where we are in a market cycle. To help us determine this, we have adopted from respected investor, Howard Marks’ Mastering the Market Cycle, the following core questions which assist us in this determination:
- Where are we in the economic cycle: are we more likely to enter a period of accelerating or decelerating growth?
- Are monetary conditions tightening or loosening?
- Is fiscal policy expansionary or restrictive?
- What is the mood of investor psychology: are investors responding from greed or fear or euphoria or despair?
- Are valuations stretched or attractive?
- What is the market’s attitude towards risk: is there complacency or risk aversion?
Economic and financial data point to a two-speed market environment
As we assess the current cycle, it strikes us that there are some contradictory signals.
For example, whilst there are signposts that the economic cycle is slowing, namely weak credit growth and rising credit defaults, there are also other indicators such as robust employment growth that point to some resilience. We do question whether the growth in fixed rate borrowing during the decade of low interest rate environment means that the transmission effect of interest rates is significantly impaired. So, while the US is consolidating, in China the recovery remains elusive, whilst Europe looks to be headed for a recession.
In assessing investor psychology, the S&P500 is trading near its all-time high and at a 20% premium to the 20-year Price/Earnings mean. This is due to a two-speed market: the technology sector vs everything else. In contrast to the US, the FTSE100 is trading at its lowest P/E multiple outside of the global financial crisis era. We can find many counters that are trading on high single digit dividend yields. The South African market has many similarities with the UK.
“…indicators such as robust employment growth point to some resilience.”
Generating alpha from market mis-pricing
These contradictory signals lead us to believe that due to the two-speed market that has evolved in recent years, returns are likely to reflect this. It is our view after a decade or more of it being a great time for markets, and a worse time for stock-pickers we are now shifting to a period that will be a stock-picker’s market whilst the market’s beta is signalling disappointing returns. Even amongst technology shares, unlike in the boom earlier in the decade, we have noted that there is differentiation. It was purely the “Magnificent Seven” (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla) drove returns this past year. Without these seven counters, the S&P 500’s 20% return would have been a mere 8%. In contrast, there are some other “tech” counters, such as (Tencent, Alibaba and PayPal) whose returns did not cross the zero line in 2023.
It is not just Chinese tech stocks that are priced attractively. Even for counters that are exposed to the Artificial Intelligence mega-trend, there are companies that play in the supplier value chain that are well placed to benefit from the trend, but are priced more reasonably (e.g. TSMC, Samsung and Micron). The South African market is also showing indications of being more of a stock-picker’s market. Consider the 2023 performance of the following companies that are in the same sectors:
- Goldfields +72% vs AngloGold +1%
- BHP+17% vs Anglo American -34%
- Mondi +22% vs Sappi -18%
- Standard Bank +15% vs ABSA-20%
Portfolio management is risk management
Whilst we have little perfect foresight of the market mood that will prevail in 2024, we know that the “pendulum of investor sentiment” seldom stays in equilibrium as currently seems to be the case. The mood will either be one of excitement or depression. The contradictory signals indicate the prevailing uncertain environment.
Our priorities for the year ahead remain unchanged no matter the season or mood – to preserve client capital and take advantage of the stock-picking opportunities that Mr Market’s moods present to us.
Here’s wishing us all a positive 2024!
Article was written on 19 December 2023; final returns may differ from the ones referred to in the article