In the past three weeks, there has been a discernible change in market sentiment worldwide. It is difficult, almost impossible to find optimistic opinions about where equity markets will go.
The tech-heavy Nasdaq index in the US is firmly in bear market territory, defined as a fall from its recent peak of more than 20%. The S&P 500 and Dow Jones industrial index, being broader market representations, fared slightly better, but even these two are down about 16% from their peaks.
And here in SA, the JSE all share index (Alsi) had fallen almost 13% from its early March peak by last week, placing it in correction mode, though it has recovered and is now only about 9% below its peak. Given the high concentration of commodity stocks in the JSE Alsi, there seems a fair chance that it won’t be affected quite as badly as the US indices but that is cold comfort when everything’s falling.
The main reasons for this current weakness appear to be the following:
- The realisation that inflation, and by extension interest rates, will rise farther and faster than originally expected. US inflation is sticking stubbornly above 8%. Recently, the Bank of England warned that UK inflation is likely to hit 10% by year-end.
- The Ukraine war and the growing perception that this conflict could last many more months, if not years. If that is indeed the case, supply shortages of energy, grains and other agricultural products will keep fuelling inflation.
- China’s slavish adherence to its Zero-Covid-19 policy. This is having the effect of further disrupting global supply chains already dislocated badly in about the first year of the Sars-CoV-2 pandemic. This is causing many countries to adopt an insourcing model for many supplies, which is proving to be inflationary.
It’s more than 40 years since the world has had inflation rates this high, and it took the best part of 20 years to contain that inflation. Older-generation politicians, economists and policymakers realise how sticky inflation can be once it gets a hold. They will thus be inclined to overreact to try cooling inflation and inflationary expectations. The net result of such zeal is likely to be stagflation, the deadly combination of economic stagnation and inflation.
The question is how to adapt to this bear market. It’s tempting to be a bear and hibernate until it’s all over but that’s not practical as it could take time. This is the time when financial advisers and portfolio managers really have to work for their fees. A passive approach, such as investing in broad exchange traded funds (ETFs), will guarantee losing money as the market falls. But there is no guarantee that an actively managed portfolio will do any better.
Investors need to sit down with advisers and examine critically if their portfolios as now constructed can adapt to the new world of a bear market. If they are still heavily invested in US tech stocks for example, they will already have taken a big knock, and there is probably more to come as interest rates rise and negatively affect future cash flows from these companies. But commodities may do well in a stagflation environment, especially if Russian companies continue to be heavily sanctioned by the West. And though bear markets have tended to be fairly short lived in recent times, this one has all the makings of greater longevity, as interest rates are forced up progressively in a bid to contain inflation.
But these are markets where real reputations are made and sustained. As Lou Mannheim says to Bud Fox in Wall Street the 1987 movie, “the quick-buck artists come and go with every bull market but the steady players make it through the bear markets”.
• Gilmour is an independent investment analyst with Salmour Research.
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