Over the past few years, there has been a series of what many have dubbed black swan events. These are events that are difficult to predict and come with negative consequences. Before a black swan event occurs, it is not only difficult to predict but also an unknowable event. Strictly speaking some of these may not be black swan, but there certainly is a lot of resemblance.
A few of these events on the global stage have included the Donald Trump presidential victory in the US and the Brexit vote in the UK in 2016, where most surveys and polls indicated that these were unlikely to impossible. These were on the back of the rise of populism and nationalist ideals over globalisation. Invariably this led to trade wars between the two largest global economies, the US and China.
After these events, we experienced a lot of volatility in the markets as fundamentals such as earnings growth for geographically diversified multinational companies were reassessed as well as margin revisions for global input cost structures.
In SA, we experienced the Nenegate saga, with three finance ministers in less than a week, and the state capture inquiry, initially launched by then public protector Thuli Madonsela — with the rand aggressively slipping.
In the midst of these activities, the Covid-19 pandemic hit — bringing the global economy to a halt. We navigated this environment, hoping for safe and speedy vaccine developments and containment of the virus. Locally, in the midst of Covid, we were downgraded to junk status by all three top credit ratings agencies, as debt levels rose to support our local economy.
We forgot about the geopolitical landscape and economic realities that existed before Covid. In hindsight, it is no surprise that after the reopening of the global economy one of the largest drivers of global markets has been geopolitical risks and that locally we continue to grow below economic potential with an infrastructure and energy crisis.
The Russia-Ukraine crisis led to a global commodity shortage, which was already in deficit due to demand exceeding supply in the post-Covid recovery. Inflation moved from transitory to transitory for longer, to sticky but not structural, then to hopefully not structural. With the rise of interest rates, we have seen some confidence, liquidity and balance sheet issues in parts of the banking sector, particularly regional US banks. Meanwhile SA was greylisted, making us even less attractive from a capital allocation perspective.
How then does one look to invest in this environment of uncertainty? Over this period, when all these events were unfolding, both local and global markets have delivered high single-digit to low double-digit returns on an annualised basis over the past five to 10 years. We have experienced some volatility and excessive drawdowns, particularly as these risks have unfolded, but the long-term behaviour of markets is such that drawdowns are typically followed by bull market rallies that reward investors with double-digit investment returns that typically last longer than the drawdown periods.
Portfolio structure
Turbulent times are therefore not necessarily bad for long-term investors looking to grow their wealth in real terms. Timing the market is less important than the structure of your portfolio and whether it is well diversified with sufficient upside participation, your holding period and when you sell out of your portfolio.
In the recent earnings season in the US, we have carefully monitored the earnings releases of the counters. One of the shares in our global equity portfolio, JPMorgan, had a strong positive earnings release, with adjusted earnings surprising markets by double digits. It is a great quality counter with a strong balance sheet, sufficient liquidity and well positioned to not only withstand the high interest rate environment but also take advantage of the crisis within regional US banks. We recently bought it at attractive valuations with strong upside potential due to indiscriminate selling on the back of negative market sentiments.
On the local side, banks have also done reasonably well despite a tough macroeconomic backdrop. They have delivered high single-digit to low double-digit earnings growth over the year, though with some increases in impairments for Capitec. Though these have been attributed to provisioning practices, the high rate environment and normalisation after the Covid era, market participants have remained wary and will look to future earnings releases on whether this improves. The counter does, however, have a lower loan book relative to its competitors and is now trading at a discount relative to its history. Overall, despite the negative sentiment, the sector remains resilient.
When trying to time the markets, you find yourself either investing in a supportive economic environment at expensive valuations or attractive valuations in a tough economic backdrop. In trying to wait for the economic backdrop to improve, most investors lose out on the subsequent rallies as markets tend to move ahead of economic cycles.
It is therefore essential to identify the quality counters which have suffered due to negative sentiment but are expected to do well in the future from the companies that are value traps which will continue getting cheaper and cheaper — destroying shareholder value over time. Moreover, it is important to overlay the individual security selection with good portfolio management ensuring adequate position sizing, sector exposure, asset allocation and investment strategies that are built to withstand and take advantage of turbulent times.
• Smith is chief investment officer at Absa Global Investment Solutions, Stockbrokers & Portfolio Management.
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