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Maintaining an equity bias and following diversification principles provide the foundation for building strong investment portfolios. - David F. Swensen, CIO, Yale and philanthropist
MARKETS REMAINED UNDER PRESSURE
The tough market conditions experienced in the first half of 2022 continued in the third quarter. Globally, equities (-26%), bonds (-20%), property (-29%) and gold (-9%) have all declined in dollar terms over the past nine months. After a strong start, the rand also succumbed to the rampant dollar, declining 12% year to date. Even in the very few areas where price moves were upwards, volatility levels were elevated. While the dollar oil price increased by 13% since the start of the year, it declined by 23% over the third quarter. We are on track to experience only the fourth year in US market history where both equities and bonds produced negative returns. The last time this happened was in 1969.
Given these outcomes, even investors with great fortitude may be asking themselves whether the foundational investment principles of maintaining an equity bias and managing risk through diversification between asset classes, industry sectors and geographies are still the appropriate approach to protect their wealth over the long term.
The key argument for holding the line is that lower prices result in undemanding valuation levels, which is typically consistent with much better prospective returns. In the three years after 1969, a portfolio invested in 60% US equites and 40% US bonds delivered a cumulative dollar return of 37%. This pattern repeated post 1931 and 1941, the only other years where both equity and bond returns were negative, when cumulative three-year returns were 32% and 47%, respectively.
As we report in this quarter’s fund commentaries, our analysts continue to find many examples of attractive valuation opportunities created by the indiscriminate dislocation in asset prices in response to a tougher-than-expected macroeconomic cycle and a deteriorating geopolitical environment. This holds true across both South African (SA) and global markets, and across asset classes, with the gap between current market prices and our assessment of long-term fair value at levels not seen since the Global Financial Crisis (GFC) in the late 2000s. The performance of the Coronation Global Optimum Growth Fund, our aggressive worldwide flexible portfolio, during this period confirms how undemanding valuations eventually support better returns. After a decline of 25% in 2008, the peak of the GFC, the Fund produced a cumulative return of 255% over the subsequent five years.
More SA companies are using these attractive valuation levels to perform share buybacks. This is a widely misunderstood but attractive form of capital allocation, as Neville Chester explains in his article.
Finally, Christo Lineveldt provides an interesting perspective on how being able to embrace market volatility is the unavoidable price of reaping the long-term rewards of owning equities. In his article, he explains why the journey wouldn’t necessarily be any smoother even if you had perfect foresight.
Market sentiment was not all negative over the past three months. An example of how quickly negative sentiment can turn positive can be found in strong share price recovery in emerging market e-commerce players such as Brazil’s Mercado Libre and Korea’s Coupang, as reported by our emerging markets team in their very comprehensive commentary.
More broadly, the belief that inflation had peaked fueled a brief moment of optimism in July, which led to a double-digit rally in equity markets. The hope of the optimists was dashed at the Jackson Hole summit, where central bankers made it clear that they are prepared to fight inflation with tighter monetary policy, even at the expense of significantly lower economic growth. While US inflation did indeed moderate in subsequent months, it declined at a slower pace than the market anticipated.
Higher interest rates are increasingly creating tensions. Economist Marie Antelme focuses on how high inflation met with tighter monetary policy is creating pressures in societies around the world, motivating some politicians to provide more fiscal support. The problem is that more government largesse will likely lead to even tighter money, which further increases recessionary risks. High government debt levels and the increasing cost of funding this debt as interest rates go up will further strain the relationship between politicians and central banks. The strong dollar is also creating strains in international relationships, as it exerts contractionary pressures on other economies that have no choice but to import dollar-priced commodities, goods and services. While central bankers’ resolve to keep inflation expectations anchored remain resolute for now, the debate is starting to shift to how much further tightening can be absorbed before it becomes counter-productive.
Economies cannot grow without adequate capital investment. As Marie reports, South Africa can achieve 4%-5% annual GDP growth if investment levels increase by around 10% of GDP. The elephant in the room remains the urgent need for investing in new power generating capacity, with the bulk of Eskom’s existing coal-fired power stations due to be retired over the next decade. Mauro Longano reviews government’s recently announced energy plans, which include the expectation of the development of an additional 14 gigawatt of private sector funded and operated supply. Over time, this should be supportive of higher domestic growth. Unfortunately, given the complexities and lead times, his analysis also concludes that loadshedding will still be with us for years to come.
On a related note, we asked analyst Henk Groenewald to report on global infrastructure investment opportunities and to explain why our global funds are invested in North American railroads and French company Vinci, a global infrastructure giant. He sets out why we believe these are attractive assets to own in an uncertain and high-inflation world.
Coronation won first place for gender reporting by JSE-listed companies at the 10th annual Accenture Gender Mainstreaming Awards. This award is a recognition of many years of work to improve gender diversity at board level and to develop a pipeline of senior female employees. It also highlights the impact of the broader diversity and inclusion initiatives we have embarked on over the years.
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