Investment Perspectives – Q4 2023
What were some highlights from the quarter?
Financial markets had a strong final quarter of 2023, driven by optimism that steadily declining inflation meant the interest rate cycle had most likely peaked. US Federal Reserve rhetoric in December cemented this belief, with the “dovish pivot” further supporting interest sensitive assets.
Geopolitical tension was high emanating from the war in Gaza, stoking fears of broader contagion amid the humanitarian crisis. South Africa seeks to charge Israel with genocide at the International Court of Justice in The Hague.
Loadshedding eased over December, with Kusile Unit 5 coming back online at year end. Record high “out of service” levels saw loadshedding swiftly resume in the first week of January however, despite very low demand at the time.
How did the markets perform?
The South African equity market (FTSE/JSE Capped SWIX TR) spent most of 2023 inside January’s trading range, eventually ending the year up 7.9%. The Index was held up by Financials and Industrials (up 21.8% and 17.3%, respectively) but Resources fell sharply (down 15.4%) as platinum shares and Sasol came under pressure.
The SA market’s entire return for the year was achieved in the fourth quarter (up 8.2%), with banking and gold shares extending their rallies. Although SA bonds (FTSE/JSE All Bond Index TR) delivered a similar return to equities this quarter (up 8.1%) they outperformed for the full year (up 9.7% vs 7.9%), despite higher interest rates.
Foreign equity (up 7.8% for the quarter) had a stellar year, with the MSCI ACWI TR climbing 31.3% in rands, boosted by the stronger dollar (7.5% appreciation against the rand). US equities were the main driver, fueled by technology stocks. Foreign bonds continued their recovery this quarter (up 4.9%), following the protracted sell-off in US Treasuries to 2007 levels, with the FTSE World Government Bond Index eventually ending the year up 13.1% in rands.
How has the economic outlook evolved?
Financial markets were propped up by better-than-expected global macroeconomic data this year, most notably growth and inflation. The pace of global economic growth is currently below average, with the IMF projecting 3.0% for 2023 (and 2.9% in 2024), with US resilience compensating for weakness in Europe. High inflation has proven transitory after all, and has been falling rapidly in most countries, prompting the much-anticipated Fed “pivot” at the end of the quarter.
In December, Federal Reserve Chairman, Jerome Powell, capitulated by announcing that further rate hikes no longer seemed necessary. The market’s interpretation of this and based on the Fed’s summary of economic projections is that the interest rate cycle has peaked, and we can expect cuts later this year. This is potentially the cue for other central banks to become more dovish as 2024 unfolds. The market expects the Fed Funds Rate to decline from 5.25% at present to 4% in December.
The prospect of monetary policy becoming less restrictive is welcome, alleviating fears of a potential significant slowdown in economic growth. Fear of a US recession was elevated in 2023, with leading indicators suggesting a contraction. Signs, such as the inverted US yield curve, are still present but unlike in previous cycles, might be less reliable in the context of the recent years’ economic shocks.
Outside of the brief US banking crisis scare in March, and intermittent Chinese property market concerns, economies by and large appear to have taken higher rates in their stride. The macro backdrop was supported by fiscal stimulus from some policymakers, while consumers in the US have benefitted from having previously fixed their mortgages at low levels. On the surface it appears economies might now be better equipped to withstand more normal levels of interest compared to the last decade.
The IMF expects South African economic growth of 0.9% in 2023 to accelerate to 1.8% in 2024. Loadshedding has been a major headwind for growth, but this is expected to pose less of a burden going forward, with many consumers and businesses having taken measures to reduce their reliance on Eskom. Transnet is another State-Owned Entity undermining economic growth, given the state of the freight rail and ports networks on which our exports are heavily reliant.
In keeping with the global trend, domestic inflation moderated to 5.5% at the end November, from 6.9% in January. Reuters polls predict continued disinflation over 2024, with CPI ending the year at 4.6%, fractionally above the SARB’s targeted level. The Repo Policy Rate is expected to decline from 8.25% at present to around 7.5% by year-end, still 0.5% above the SARB’s steady state neutral level, and therefore arguably still mildly restrictive.
How are portfolios positioned?
We remained somewhat cautious in 2023, visible through our slight underweight positioning in foreign equity for most of the year. Our main concern was the rapid ascent of interest rates from ultra-low to pre-GFC levels, which we believe presented skewed downside potential for both the economy and equity markets. In the past, acute tightness has almost always led to some degree of economic weakness or a serious financial accident of some sort but, so far, this time has been different.
We still see the potential for a near-term soft patch in US growth, though the timing is unclear. Irrespective, with rates cuts on the horizon, we are more comfortable that the odds of a serious downturn have lessened, and that any weakness would be relatively minor. We therefore increased the foreign equity allocation across portfolios during the fourth quarter. We are currently neutral foreign and local equity in our tactical asset allocation house view, while acknowledging that valuations in SA are more favourable than offshore.
Most of our underlying SA equity managers unfortunately lagged the market in 2023, impacted by stock selection within the banks and resources sectors. The intentional high conviction construction of PPS Equity means near-term underperformance is inevitable from time to time, but we believe is an essential element of positioning for meaningful long-term outperformance. This quarter we introduced a fourth manager, 36One, into the local equity strategy, enhancing the underlying manager mix.
Outside of equity, we also upweighted foreign bonds during the quarter, as the 10-year US treasury yield topped 5%. Bonds have endured a historic sell-off to 2007 levels and after not owning direct exposure in portfolios for many years, we are now overweight in relevant portfolios. The opportunity set has broadened with rates and bond yields now higher. As a result, portfolios are now more diversified than in previous years, and managers have more choice in general.
We remain neutral SA bonds, having downgraded the asset class late in April, on fiscal risk concerns. Subsequently the “Lady R” saga brought about unwelcome volatility during implementation, while bonds have since strengthened.
Looking Forward…
Looking ahead, we expect some surprises to no doubt materialise in 2024, but we are confident that the portfolios are well-positioned. Last year was a reasonable year for absolute returns across the range, despite SA equity disappointing and the foreign equity market having been narrowly driven. Relative performance lagged in some areas, where portfolios or their underlying managers were defensively positioned, but solutions remain robust.
We remain wary of placing too much reliance on our ability to forecast the macro-outlook. Most expected economic pain in 2023, however this failed to play out, with disinflation and desynchronization being the more dominant themes. This year, interest rate policy normalization could become the main theme, which could prove bullish for markets. For now, it remains to be seen whether the Fed has indeed, against all odds, managed to engineer a soft landing, and how much of this is already priced in.
What were some highlights from the quarter?
Financial markets had a strong final quarter of 2023, driven by optimism that steadily declining inflation meant the interest rate cycle had most likely peaked. US Federal Reserve rhetoric in December cemented this belief, with the “dovish pivot” further supporting interest sensitive assets.
Geopolitical tension was high emanating from the war in Gaza, stoking fears of broader contagion amid the humanitarian crisis. South Africa seeks to charge Israel with genocide at the International Court of Justice in The Hague.
Loadshedding eased over December, with Kusile Unit 5 coming back online at year end. Record high “out of service” levels saw loadshedding swiftly resume in the first week of January however, despite very low demand at the time.
How did the markets perform?
The South African equity market (FTSE/JSE Capped SWIX TR) spent most of 2023 inside January’s trading range, eventually ending the year up 7.9%. The Index was held up by Financials and Industrials (up 21.8% and 17.3%, respectively) but Resources fell sharply (down 15.4%) as platinum shares and Sasol came under pressure.
The SA market’s entire return for the year was achieved in the fourth quarter (up 8.2%), with banking and gold shares extending their rallies. Although SA bonds (FTSE/JSE All Bond Index TR) delivered a similar return to equities this quarter (up 8.1%) they outperformed for the full year (up 9.7% vs 7.9%), despite higher interest rates.
Foreign equity (up 7.8% for the quarter) had a stellar year, with the MSCI ACWI TR climbing 31.3% in rands, boosted by the stronger dollar (7.5% appreciation against the rand). US equities were the main driver, fueled by technology stocks. Foreign bonds continued their recovery this quarter (up 4.9%), following the protracted sell-off in US Treasuries to 2007 levels, with the FTSE World Government Bond Index eventually ending the year up 13.1% in rands.
How has the economic outlook evolved?
Financial markets were propped up by better-than-expected global macroeconomic data this year, most notably growth and inflation. The pace of global economic growth is currently below average, with the IMF projecting 3.0% for 2023 (and 2.9% in 2024), with US resilience compensating for weakness in Europe. High inflation has proven transitory after all, and has been falling rapidly in most countries, prompting the much-anticipated Fed “pivot” at the end of the quarter.
In December, Federal Reserve Chairman, Jerome Powell, capitulated by announcing that further rate hikes no longer seemed necessary. The market’s interpretation of this and based on the Fed’s summary of economic projections is that the interest rate cycle has peaked, and we can expect cuts later this year. This is potentially the cue for other central banks to become more dovish as 2024 unfolds. The market expects the Fed Funds Rate to decline from 5.25% at present to 4% in December.
The prospect of monetary policy becoming less restrictive is welcome, alleviating fears of a potential significant slowdown in economic growth. Fear of a US recession was elevated in 2023, with leading indicators suggesting a contraction. Signs, such as the inverted US yield curve, are still present but unlike in previous cycles, might be less reliable in the context of the recent years’ economic shocks.
Outside of the brief US banking crisis scare in March, and intermittent Chinese property market concerns, economies by and large appear to have taken higher rates in their stride. The macro backdrop was supported by fiscal stimulus from some policymakers, while consumers in the US have benefitted from having previously fixed their mortgages at low levels. On the surface it appears economies might now be better equipped to withstand more normal levels of interest compared to the last decade.
The IMF expects South African economic growth of 0.9% in 2023 to accelerate to 1.8% in 2024. Loadshedding has been a major headwind for growth, but this is expected to pose less of a burden going forward, with many consumers and businesses having taken measures to reduce their reliance on Eskom. Transnet is another State-Owned Entity undermining economic growth, given the state of the freight rail and ports networks on which our exports are heavily reliant.
In keeping with the global trend, domestic inflation moderated to 5.5% at the end November, from 6.9% in January. Reuters polls predict continued disinflation over 2024, with CPI ending the year at 4.6%, fractionally above the SARB’s targeted level. The Repo Policy Rate is expected to decline from 8.25% at present to around 7.5% by year-end, still 0.5% above the SARB’s steady state neutral level, and therefore arguably still mildly restrictive.
How are portfolios positioned?
We remained somewhat cautious in 2023, visible through our slight underweight positioning in foreign equity for most of the year. Our main concern was the rapid ascent of interest rates from ultra-low to pre-GFC levels, which we believe presented skewed downside potential for both the economy and equity markets. In the past, acute tightness has almost always led to some degree of economic weakness or a serious financial accident of some sort but, so far, this time has been different.
We still see the potential for a near-term soft patch in US growth, though the timing is unclear. Irrespective, with rates cuts on the horizon, we are more comfortable that the odds of a serious downturn have lessened, and that any weakness would be relatively minor. We therefore increased the foreign equity allocation across portfolios during the fourth quarter. We are currently neutral foreign and local equity in our tactical asset allocation house view, while acknowledging that valuations in SA are more favourable than offshore.
Most of our underlying SA equity managers unfortunately lagged the market in 2023, impacted by stock selection within the banks and resources sectors. The intentional high conviction construction of PPS Equity means near-term underperformance is inevitable from time to time, but we believe is an essential element of positioning for meaningful long-term outperformance. This quarter we introduced a fourth manager, 36One, into the local equity strategy, enhancing the underlying manager mix.
Outside of equity, we also upweighted foreign bonds during the quarter, as the 10-year US treasury yield topped 5%. Bonds have endured a historic sell-off to 2007 levels and after not owning direct exposure in portfolios for many years, we are now overweight in relevant portfolios. The opportunity set has broadened with rates and bond yields now higher. As a result, portfolios are now more diversified than in previous years, and managers have more choice in general.
We remain neutral SA bonds, having downgraded the asset class late in April, on fiscal risk concerns. Subsequently the “Lady R” saga brought about unwelcome volatility during implementation, while bonds have since strengthened.
Looking Forward…
Looking ahead, we expect some surprises to no doubt materialise in 2024, but we are confident that the portfolios are well-positioned. Last year was a reasonable year for absolute returns across the range, despite SA equity disappointing and the foreign equity market having been narrowly driven. Relative performance lagged in some areas, where portfolios or their underlying managers were defensively positioned, but solutions remain robust.
We remain wary of placing too much reliance on our ability to forecast the macro-outlook. Most expected economic pain in 2023, however this failed to play out, with disinflation and desynchronization being the more dominant themes. This year, interest rate policy normalization could become the main theme, which could prove bullish for markets. For now, it remains to be seen whether the Fed has indeed, against all odds, managed to engineer a soft landing, and how much of this is already priced in.
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https://www.pps.co.za/investment-perspectives-q4-2023