It is hard not to have a sense of apprehension going into 2022. Interest rates in SA are trending up from a 50-year low as we enter an upward cycle. Inflation in big markets is at levels not seen for 30 years. Central banks in the biggest economies are beginning to unwind unprecedented levels of liquidity as they turn towards dealing with inflation. There is no playbook for this phase as we’ve never had central bank balance sheets as swollen with printed money as we do now.
The unwind is happening in a global economy that has had more than a fair share of external shocks thanks mostly to Covid-19 (though Chinese property earthquakes can be big contributors too). Equity markets are at or near historic levels implying that investors are confident that company profitability is going to be strong. Business confidence is positive in all big markets. This is the right kind of environment to be attempting to wind back an experiment in flooding the world with money to fight off a Covid-19-induced recession.
My sense is that investors are less certain than it appears. We are learning as we go, leading to a skittishness that could amplify volatility if something unexpected happens. Markets exhibit a “volatility skew” in that they tend to be more volatile going down than going up, and we’ve had a long period of consistent upward movement. That means most measures are showing a lower risk market that can lead investors into undefensive portfolios that seem safe in the rear-view mirror. But those more forward-looking are likely to turn attention to long-shunned value stocks. Already this year value stocks have outperformed growth stocks in the US by a five percentage point margin as Covid-19 era favourite tech stocks take a hammering.
The problem for investors in SA is that the developed market liquidity unwind will have real consequences for emerging markets. US Federal Reserve balance sheet expansion has proven to increase flows to emerging markets as the extra money goes in search of yield. As this unwinds, we can expect flows to reverse as US yields creep up and become more attractive. Domestic monetary policy in countries such as SA must respond, increasing rates to remain attractive while also dampening imported inflation. We have not previously faced a situation of global central bank liquidity being withdrawn and we don’t really know how it will play out for countries like SA. The one historic episode that may provide some guidance is the emerging markets crisis of the late 1990s, in which hot money rushed out of emerging markets leaving chaos in its wake, and interest rates that hit 25.5% in SA. We certainly hope that is not a model for what might happen now, but the reality is that there is no obvious policy path to walk to counteract developed market liquidity withdrawal.
Of course, investing is a long-term game. You should be thinking about the 10-year view rather than any single year. The Fed balance sheet has doubled in size since Covid-19 to fight the economic shock it could have been, with remarkable success. The Fed will not tip the world into economic chaos now, so withdrawal will be gradual, and we may see it ebb and flow in response to economic conditions.
I am inclined to make the most boring of predictions: stock prices will start to reflect the economic fundamentals of companies. Of course, this is a prediction that is safely always going to be true — the real question is “when?” I expect that wise money this year will be focused on the profits and dividends that companies are actually delivering (the fundamentals), so we will see a continued rerating of low-risk stocks relative to high-risk stocks. These are going to be affected by the economic ructions caused by a changing monetary policy environment, but the only way to keep your head while others are losing theirs is by keeping an eye on how companies are doing on the bottom line.
In SA we will have had plenty of other kinds of ructions to deal with, not least political. We are now in the year in which the ANC will be deciding on its next leader, which will make for a lot of scary headlines, as we’ve already seen. But investors must remember our stock market has little to do with domestic politics, being far more driven by global economic factors.
Inflation, driven by global supply chain shifts and investment in green economy infrastructure, will be good for commodities and therefore many SA-listed stocks. As we go into 2022, with an eye always on the 10-year view, I will take the opportunity to keep looking at who is generating profits sustainably, while ignoring the flows of liquidity that are going to be buffeting all sides.
• Theobald is chair of Intellidex. This column first appeared in Business Day.
