Defend Truth


Investors have nowhere to shelter from ferocious global bear market


Born in Cape Town, Natale Labia lives in Milan, Italy, and writes on the economy and finance. Partner of private equity firm Lionhead Capital Partners. MBA from Università Bocconi. Supports Juventus.

Thus far in 2022, both bonds and equities, the two main asset classes of global markets, have been decimated. Furthermore, with inflation climbing, interest rates rising, economic growth slowing and ferocious wars ongoing, the markets do not look like they are about to get any easier. It is unclear as to where investors might be able to take shelter.

Year-to-date in 2022 the main global equity benchmark, the MCSI World, has dropped more than 8%, largely a consequence of rising interest rates, stubbornly high inflation and geopolitical uncertainties. However, the traditional safe haven of the bond market has been hit almost as hard, with the Bloomberg Aggregate Bond Index similarly down more than 6%.

It is rare that these two asset classes are so highly correlated. Usually one or the other acts as a hedge; falling equity markets have historically been associated with yields moving lower (bond yields move inversely to prices) owing to concerns about economic growth, as investors seek a haven in fixed income. This has made the standard 60/40 portfolio, balanced in those percentages between equities and bonds respectively, exhibit lower volatility and more consistent returns than pure equities.

Just about all savers, via various pension funds or off-the-shelf investment products, are in some way exposed to classic 60/40 portfolios. These have indeed served investors well, with Goldman Sachs estimating that over the past 10 years such a portfolio has returned an average of 11% a year.

However, what is highly unusual about this market is that the widely anticipated economic slowdown in the US and Europe is being accompanied by inflation running the highest it has been in four decades, a dynamic that is hurting bonds and equities alike. The war in Ukraine is exacerbating what would have been an extremely challenging year for investing regardless. Defence spending and soaring commodity prices are worsening inflation while depressing aggregate demand.

Markets could potentially be at the beginning of a major correction and about to enter a secular and protracted bear market. Despite the recent sell-off, global equity markets remain close to all-time highs, with valuations still looking stretched. Should the global economy start to meaningfully slow down or even tip into recession, future earnings will be hit harder than expected.

Similarly, interest rates on benchmark bonds such as 10- year treasuries are still historically low, currently yielding around 2.8%. With some strategists seeing the 10-year bond yielding 4% by 2023, the potential for capital loss in both equities and bonds is profound. Asset management firm Vanguard has warned that returns from the standard 60/40 portfolio over the next 20 years are likely to be less than half what they have been over the past two decades.

SA markets have thus far been sheltered from the worst. Thanks to soaring commodity prices the JSE is broadly flat thus far in 2022, an extraordinary result that puts the South African index solidly ahead of all major developed world markets. South African bonds too have been fairly resilient, only around 20bps weaker this year, with the domestic 10-year trading at around 10%. The rand, meanwhile, continues to be extraordinarily strong. At around R14.7 to the US dollar the currency is effectively flat against the greenback from levels seen in late 2017.

Given what is happening internationally, South Africans would be well placed to use this current moment of market resilience to be more defensive. But what does defensive look like in 2022? Investing in a time of slowing economic growth and accelerating inflation is extremely tough. According to the paper The Best Strategies for Inflationary Times by researchers from hedge fund Man Group and Duke University, both equities and bonds have historically shown dismal performances in periods of rising prices. The annualised real return on US stocks averaged -7% during eight such periods since World War 2. Real estate too has offered negative real returns.

The one asset class that does tend to outperform in times of inflation is commodities. However, investors hoping to buy into commodities now could be a bit late. The Bloomberg Commodity Index has already risen 48% in the past 12 months and has more than doubled since its March 2020 low, which would indicate that the stagflation trade in commodities has largely all been priced in.

Arguably, the rally could have further to run, with the index still standing at little more than half of its pre-financial crisis high, but that would be highly contingent on single commodity-specific dynamics. With a slowing global economy, and particular worries about several demand drivers of rare materials such as China, it is unclear how much higher these prices could go. Iron ore and other base metals are particularly exposed, being almost entirely dependent on resilient global economic growth. Platinum group metals also look like they might have peaked. Gold, however, is a standout underperformer, up only 9% in the past year, which could mean further potential upside.

The paper concludes by saying that investors could do well to seek alternative asset classes for returns during inflation. Art, wine and rare stamps have all retained value and even outperformed in times of rising prices, showing returns of between 5% and 9%. Confronted with a secular bear market, at least investors would have something attractive to look at and enjoyable to drink while inflation erodes the value of their savings. DM168

This story first appeared in our weekly Daily Maverick 168 newspaper which is available for R25 at Pick n Pay, Exclusive Books and airport bookstores. For your nearest stockist, please click here.


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