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Another Lehman Brothers? Luckily not!

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

Welcome to the world of banking crises, where there is a consistent flow of money and the stability of a shaky Jenga tower! Here, banks can go from being the pillars of the economy to crumbling ruins faster than you can say “subprime mortgage”. So, grab your wallets and hold on tight as we unpack the events that unfolded in March.

Banking crises have a long history, with notable events including the Great Depression in the 1930s, Latin America in the 1980s, Japan and South-East Asia in the 1990s, and, of course, the Global Financial Crisis (GFC) in 2008. These financial fiascos have been like a bad penny over the years that will just not go away. They have been caused by a range of factors, including inflation, unhealthy monetary policy, poor banking practices, and a lack of regulation, to name but a few. They have led to significant economic downturns, widespread unemployment, and poverty, but have also led to reforms and changes in the banking industry to prevent future crises. Despite previous efforts to increase oversight, the current banking fiasco, once again, highlights the need for ongoing vigilance in the financial sector.

The most recent events started with the startup-focussed lender, Silicon Valley Bank (SVB) Financial Group, previously the sixteenth largest bank in the United States (US), which became the largest bank to fail since the GFC in 2008. The reason for the recent collapse was owing to the US Federal Reserve’s (Fed’s) aggressive interest rate hikes over the last year, which crippled financial conditions in the startup environment in which SVB was a notable player. Unfortunately, other banks, such as Signature and Silvergate, followed suit as a potential bank run threatened the stability of the overall banking system. Financial markets initially contracted by 4% but, by the end of the month, when the dust had settled, markets made up more than the initial loss.

Investors may be excused for mistaking the SVB banking fiasco for the Lehman Brothers and the GFC. But even though there are similarities, there are also substantial differences. For one, the GFC was triggered by a combination of a housing bubble, subprime mortgages, a lack of regulation, and oversight problems. In contrast, the current fiasco has been caused primarily by the COVID-19 pandemic, the associated economic downturn, and the structural shift in monetary policy. Furthermore, there is the severity of the impact to consider. The GFC was a global event that led to a significant downturn in the global economy. The current fiasco, while serious, has been largely limited to the US. It has also been well contained by the US Fed, US Treasury, and the Federal Deposit Insurance Corporation, who have offered to provide support where needed. Hence, the recovery and optimism in stock markets.

Locally, despite the impact of load shedding, downgrades, and our recent greylisting, South African banks have been able to weather the ongoing global sell-off extremely well as they were already well capitalised with high levels of liquidity. Additionally, South African banks have some of the best reputations among global banks. In fact, First National Bank was recently awarded the strongest banking brand in the world, closely followed by Capitec Bank. Overall, there are risks and challenges, but the South African banking system is strong and well regulated.

It is because of reasons like these that we continue to favour South African and emerging market equities, especially at a time when developed markets appear shaky. Emerging markets are only now starting their growth engines.

United we stand, divided we fall

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

South Africa (SA) is in a peculiar place. For the first time, in a long time, the ruling party might not remain in power. Since the African National Congress came into power in 1994 many South Africans have started to question the party and their policies. Very few, if any, of the promises that were made almost three decades ago, have come to fruition. Weak, unaccountable leaders have left millions of South Africans wanting and there is simply no more room for excuses. Unfortunately, the prevailing economic policies that have taken root in our politics are insufficient. Although these policies were necessary for social upliftment, they have proven to be insufficient for economic upliftment, that is for long-term sustainable economic growth and job creation.

To create a growth environment where income rises rapidly, and unemployment falls at a similar pace, centralising power can help, although too much of it can lead to more corruption and state capture. But centralising power can only work if it is paired with right-leaning economic policies that create wealth. These policies include effective spending on infrastructure, education, and healthcare, and making it as easy as possible to do business in a country. Ease of doing business includes allowing citizens to contract freely with one another without hindrance or interference, making it easy to hire and fire employees, but also making it easy to start, finance, and sustain businesses. China, and possibly even Saudi Arabia, proved this. But when centralising power is paired with left-leaning social policies that focus more on wealth redistribution, governments fall short. SA has proven this time and again. What we have been left with is a country where citizens are socially free but economically imprisoned. We can vote, but half the population lives in poverty.

It is, however, important to understand that redistributive policies are not necessarily less effective, their outcomes are just vastly different from wealth-creative policies. Right-leaning, wealth-creative economic policies lead to economic freedom (high income and low unemployment), whereas left-leaning, redistributive policies lead to social freedom. Wealth-creative economic policies are the only policies that have been proven to generate a return on investment that is greater than their cost because their rate of return is higher. A good example is effective spending on primary and secondary education. What this does is that it rapidly increases the productivity in a country, this not only fills the skills shortage and makes employees more employable, but also gives citizens the basic tools they need to start their own businesses. Redistributive social policies can help to bring social equality, but because they often do not allocate resources effectively, their rate of return is too low to cover their cost, which ends up reducing the potential and relative size of an economy. This is one of the main reasons why we have record-high levels of unemployment. A simple example: Black economic empowerment (BEE) was effective in allowing more social development and inclusion. But because BEE allowed many candidates to receive jobs they might not have been the best, most productive fit for, inefficiencies entered and reduced the overall potential and size of the economy in the long term. BEE should have been a short-term solution that would later have been substituted with effective government spending, support, and the execution of education.

The answer, however, is not in either/or, but in both/and, because focussing too much on either wealth-creative or redistributive policies cannot lead to a sustainable outcome. Similarly, the answer is not in government, but in public-private relationships. No political party has the proven track record of most corporations in SA, therefore, it is a shame that government has been unwilling to learn more from them. United we stand, divided we fall.

“Binge-drinking alcoholics” or astute stewards of capital?

Dr Francois Stofberg
Managing Director: Efficient Private Clients, with Specialist Input From Renier Van Zyl

Ray Dalio, a billionaire hedge fund manager, once described politicians who continuously raise the debt ceiling in the United States (US) as “a bunch of alcoholics who write laws to enforce drinking limits”. And to no one’s surprise, the US has, once again, reached the point where they need to increase the debt ceiling.

In January, the US hit its $31.4 trillion debt ceiling and, essentially, set itself up for D-Day (Default Day) a few months later. Janet Yellen, Head of the US Treasury, had to inform House Speaker, Kevin McCarthy, that Treasury was taking measures to ensure that government will be able to keep on paying its bills. Over the next three months, McCarthy will have the near-impossible task of uniting two deeply divided parties, especially in terms of who is to blame for the current debt crisis. What is certain is that, with the looming 2024 elections, neither of the parties will let the other off the hook.

But how did the US get to this point? The US’ national debt has been growing for decades, owing to wars, economic downturns, and major policy initiatives. Two significant periods of debt growth occurred between 1940 and 1950, and between 1980 and 1990, when the US borrowed heavily to finance its war efforts and to support the economy. However, the most significant increase in US debt occurred after 2000, primarily owing to the Global Financial Crisis and the COVID-19 pandemic. During this period, low interest rates and government’s belief that they could pay back the debt later encouraged increased spending, which far exceeded their income. In fact, 2001 was the last time that the US government’s revenue exceeded its spending.

It seems an easy solution to continuously raise the debt ceiling without any repercussions but there is a point where it becomes more difficult, owing to higher interest rates. For example, this year the interest payment on US debt is estimated to total $395.5 billion, which is more than government will spend on primary and secondary education. Once the debt limit is reached, Treasury cannot sell any more bonds or securities to pay off the debt from previous deficits, which will result in a default of some sort. A default would severely damage the US government’s credit rating and erode confidence in the US bond market. This, in turn, will cause investors to panic-sell, which can lead to a financial crisis. However, it is important to note that the US has never defaulted on their debt before, and we doubt it will happen soon.

There are steps that the US government can take to avoid defaulting on its debt. Democrats and Republicans can agree to raise the debt ceiling again. Additionally, government can use some of the funds in its Exchange Stabilisation Fund to pay down its debt and it can even reduce some of its wasteful spending. Furthermore, government could consider increasing revenue through tax reforms, such as increasing taxes on high-income earners. Overall, a combination of responsible spending and tax reform can help the US government to avoid a default and to maintain its financial stability.

Even though the US government’s debt levels are a symptom of a bigger problem, it will need to take significant actions to address this problem to avert a fallout in the short term that can shake the entire global financial system. What is certain is that the US will almost certainly raise the debt ceiling again in the future, which will simply result in the debt bomb being kicked further down the road.

A recession in the US and its benefits for SA

Dr Francois Stofberg
Managing Director: Efficient Private Clients

Research by the world’s largest financial institutions seems to support our view that the monetary policy tightening cycle in the United States (US) is approaching its third stage, an economic downturn. We have been expecting this for quite some time and have made the necessary changes to our investment strategies. Usually, when the US sneezes, the rest of the world catches a cold but, in today’s context, an economic downturn in the US will provide the necessary relief to many emerging markets and their currencies. Investors can, therefore, expect a persistently strong equity market in South Africa (SA) and a much stronger rand over the next 12 to 18 months.

The first stage of the monetary policy tightening cycle in the US occurred when markets recognised that the helicopter money provided by the US government produced a spending and inflation overshoot. Markets, consequently, started to price in the upcoming tightening cycle and central banks followed suit with rapid interest rate increases. The second stage occurred as tightening progressed, inflation peaked, and soon started to decline whilst the US economy avoided a more substantial economic contraction. Markets started to price in a soft landing, inflation would be back at 2% within months, and the US Federal Reserve would be able to start cutting interest rates. But, given the current conditions and cause-and-effect relationships, we will, most likely, not see the soft landing that markets have priced in, but an economic downturn; let us not scare everyone and call it what it is, a contraction or a recession.

To get US inflation back down to 2%, wage growth rates need to be cut in half, from their current levels of around 5% to 2.5%. But, for this to happen, household spending must be cut in half, from its persistent levels of around 7% to 3.5%. For this to happen, unemployment needs to be increased by at least 2%. But, to increase unemployment, nominal gross domestic product growth needs to be driven materially below wage growth rates and profit margins need to be compressed enough to produce a 20% decline in earnings. For now, however, the strong labour market is keeping nominal spending too high to slow wages down, which is keeping household incomes too high, which, in turn, is keeping earnings too high. For this reason, a third stage in the tightening cycle, where interest rates remain high or even higher, is more likely. Persistently higher interest rates can then continue to cut into spending and earnings. The funding that companies receive from profits and credit has already started to turn negative, which will eventually cause them to stop hiring. This is an initial indication that we are close to the suggested downturn.

Another favourite indicator used to signal an economic downturn in the US is the diffusion index. This index tracks the divergence of spending on goods versus spending on services. Since 1960, in each of the six prior cases where the diffusion index was negative, there was a contraction in economic growth. Currently, nominal spending on services has grown at a rapid annualised rate of about 6%, whereas real and nominal demand for goods has been on a gradual decline. As a result, the diffusion index has turned negative for the seventh time since 1960. Because spending on services puts upward pressure on employment and wages, inflation will finally be tamed once the contraction does occur and spending is reduced sufficiently.

Investing offshore and the 2023 Budget

Dr Francois Stofberg
Managing Director: Efficient Private Clients

Two things stood out during February: The question around offshore investing, and the 2023 Budget in South Africa (SA).

Investing offshore
Research is clear when it comes to liquid assets: Clients should have global exposure between 40% and 60%. This figure, however, gets murky if one considers net asset value. A lot of this has to do with the benefits of diversification, as Nobel laureate Harry Markowitz proved in the 1950s. There are many more investable opportunities in the global markets than there are in SA, and by including these opportunities clients can achieve a better risk-adjusted return in their portfolios. But, because of a poor-performing rand, clients have been reluctant to take money offshore since May 2022. Before that, there was a moment when the rand reached R14.40 levels, but that was when global markets crashed, and investors were simply too scared to take advantage of such a strong-performing rand. We are confident that the rand should strengthen back to levels closer to R16.50, although it can easily strengthen beyond R15.50 levels. But this can take another year. So, what can clients do until then? We believe that there are one of three options (speak to your financial advisor to determine which option is best for you):

  1. Close their eyes and buy dollars at levels above R18.00. Unless there is no other alternative, we are not in favour of this. Clients will feel poorer when the rand eventually appreciates 10% to 15%.
  2. Hedge out their currency risk. This can be expensive but is more viable.
  3. Invest in other asset classes and/or markets until the rand is more favourable:
  • For risk-averse clients: The fixed-income market in SA is offering very attractive returns and the money is almost immediately available.
  • For balanced-type clients: A multi-asset or local balanced portfolio. We are very optimistic about emerging market returns over the short and medium term, especially fixed income in SA and investing in companies that profit from emerging market growth. However, clients must be aware that they can get stuck in these investments if markets go against them.
  • For risk-takers: Clients who are willing to take the risk can invest in the local equity market. SA plays into the emerging market story and, despite Eskom, we believe that the local market will deliver favourable results. But, again, clients can get stuck in the local equity market if we see a persistent drag.

2023 Budget
Our overall impression of the 2023 Budget is that the Minister of Finance did all he could with the broken tools he had at his disposal. There were no substantial announcements except for the comments made about Eskom. It seems as if the Minister is nudging the process towards privatisation, which is good news for South Africans. Concerning taxes, if these were increased, we would simply have seen more tax evasion because consumers would not be able to bear the load, and because we have long since passed the point of optimal tax collection on the Laffer curve. We do foresee a revenue risk in the upcoming years because we believe the Minister was too optimistic in his growth forecasts. As the economy and commodity cycle continue to slow down, revenues will also fall. We also foresee a risk to expenses. The largest item that government spends on is civil servant salaries and wages. Because next year is an election year, we doubt that government will be able to maintain a 3% increase. Also, it will be very difficult to stop the COVID grants that more than eight million South Africans have grown dependent on. More expenses mean more debt.

A definitive shift in SA’s long-term economic trajectory

Dr Francois Stofberg
Managing Director: Efficient Private Clients

It is undeniable that South Africa’s (SA’s) economy is in a poor state. But evidence suggests that the rate of deterioration has slowed down considerably. In fact, a strong case can be made to show that the rate of improvement is greater than the rate of deterioration. And, if that is the case, the long-term trajectory is towards a flourishing rather than towards a withering economy, an economy where employment income and life expectancies increase rather than decrease. It is, however, important to understand that a cancerous economy does not get healthy overnight: Monetary and credit cycles, as well as internal cycles of conflict, take many decades to play out. Unfortunately, while many things are looking dire, too many South Africans fixate on the immediate and miss the important structural shifts that have changed our long-term trajectory.

When Jacob Zuma took office, it took him more than a full term to consolidate power and to sow the seeds of corruption, which eventually accumulated into, among others, state capture. But when Cyril Ramaphosa took over in 2019, another shift occurred. Not only did we now have a leader who understood wealth creation, rather than merely living off of the rents of others, but also one with fewer skeletons in his closet. Please bear in mind that perfect “hero leaders” only exist in fairy tales. When we refer to “President Ramaphosa”, we are using this as a collective term for everyone who supports him and his policies.

The next big shift was to build on the work done by the Public Protector who helped us to get rid of Zuma. Ramaphosa (the collective term) cleverly used different independent inquiries to stop the rapid rate of spreading corruption. It started with exposing the Guptas and all those involved with state capture. Later, many heads rolled: Gigaba, Nene, and even Magashule. Afterwards, Zuma ended up in prison. Even if it was only for a few days, no one really believed that it would ever happen.

Another important structural shift occurred in government finances. The state privatised a poorly run state-owned enterprise (SOE) and reduced its wastage on the rest. To this end, South African Airways was privatised, just like alternative energy sources are now also being privatised. Privatisation, smaller wage increases, and the recent announcement that certain SOEs will not need to procure from black economic empowerment (BEE) suppliers indicate a potential and very important shift away from social upliftment (redistribution policies) towards economic upliftment (wealth-creation policies).

An important underlying social shift also occurred: South Africans have grown tired of social injustice and a poorly performing government. South Africans have not only started to vote accordingly but they have also started to band together across different races. When riots hit the heart of Pretoria, and while the devastating riots in KwaZulu-Natal were underway, it was not merely the police that jumped in but South Africans from all races. Although racism is still a very real problem, doing something about a poorly run government and widespread corruption, that is costing lives and livelihoods, has become a point of agreement and co-operation among South Africans.

Of course, much more work is still needed. Leaders in the public and private spheres must be held accountable. Destructive redistributive policies, like BEE, and the protection of employees at the cost of employers, must be better aligned with economic development goals. Government spending on education and healthcare must be improved, and spending on economic upliftment must be increased. But what is clear is that a growing remnant remains in SA that has helped to shift the economy onto the correct trajectory.

China’s Yue Fei moment may be upon us… Again!

– Dr. Francois Stofberg, with specialist input from Renier van Zyl

Yue Fei, the son of an impoverished farmer from Northern China, is one of China’s most decorated and celebrated war heroes. As the Jurchens invaded Southern China in the 1130s, it was Yue Fei who showed tremendous courage as he and his troops fended off the advancing army. He was so courageous that he once, with only 500 men, defeated 100 000 Jurchen soldiers. To this day, Yue Fei is a national symbol of hope during difficult times.

As Southern China looked to Yue Fei then, the world looks to China now to save it from slow growth because of difficult times. It has been a little over a year now that the world has struggled with higher prices, which Generation Z, or even Generation Y, has not seen in their lifetimes. As central banks hiked interest rates to fight inflation, economists and investors grew increasingly concerned about slowing global growth. The International Monetary Fund recently estimated that the global economy will grow by only 2.9% this year versus a 60-year average of 3.5%; Chinese growth could account for two-fifths of that percentage.

This feels like déjà vu from the late 1990s and 2000s when China personified Yue Fei to the world. After the 1997 Asian financial crisis, the Chinese economy helped to stabilise the whole of Asia. Then, a decade later during the 2007 financial crisis, China’s growth again helped to stabilise the world. In these instances, China’s economy could routinely deliver between 12% and 15% annual growth, enough to contribute up to 2.5% to global growth. The expectation in 2023 is for China to grow by 5.2%. Even though this percentage is lower than in the recent past, it is still a big improvement from last year’s 2.0%.

There are several reasons for the uptick in Chinese growth. For one, there is the re-opening of the Chinese economy. Investors were concerned that the economy would buckle under the burden of increased COVID-19 cases following the relaxation of China’s year-long zero-COVID policy measures. But there are signs that this is not the case. Although the virus is spreading faster than expected, according to the Chinese government, 80% of the country has already been infected and hospital patient numbers peaked on 5 January. This should translate into increased travelling and spending. Households are also unusually liquid, with bank deposits now exceeding $18 trillion, which includes last year’s $2.6 trillion in savings. These deposits could provide ammunition for a bout of “revenge spending”. And with consumption expected to contribute more than 70% to this year’s gross domestic product, this could provide the necessary boost that the world economy needs.

Conversely, there are also certain elements that could derail China’s growth in 2023. To begin with, no country has rebounded from a COVID outbreak in less than a year. There is always the risk that infections worsen, fatalities rise, and the services and manufacturing sectors close or slow down. Growth in these two sectors is driven by productivity and labour force participation rates. Both of these factors have been on a slowing long-term trend. Should there be a faster deterioration this year, it will have a negative overall effect on growth. There is also the geo-political risk between the United States and China to consider, a risk which could result in legislative and regulatory changes. China’s recent spy balloon is another incident that only seems to have worsened the situation. And finally, there is also the risk that a global recession will spill over into China, or that China’s own debt problems will derail it, which could have a big impact on commodities and China’s property market.

Whether China will be able to pick up the growth baton is unclear, but what is certain is that investors, like us, are siding with the world’s second-largest economy. In January, Chinese equities saw an inflow of $21 billion. This marks the largest inflow since 2014. And that is a big vote of confidence that China will be able to achieve high levels of growth this year as well as in the next few years.

Interest rates: To increase or not to increase, that is the question

Dr Francois Stofberg
Managing Director: Efficient Private Clients

Last week, the South African Reserve Bank (SARB) increased interest rates for the eighth consecutive time since they started their rate-hiking cycle in November 2021. Since then, the prime interest rate has increased by 3.75% to 10.75%, its highest level since 2009. This means that every R1 million debt that a household has, will now be roughly R3 125 more expensive each month; a thought that is keeping many South Africans awake at night. Data shows that the middle class, roughly 4.1 million adults earning between R8 000 and R30 000 per month, are now spending almost two-thirds of their salary on servicing debt. In general, South African consumers seem to be hanging on by a thin thread with very limited room left to manoeuvre in their personal finances. We are, however, confident that we have reached the end of the rate-hiking cycle in South Africa (SA) and that there is, most likely, only one more hike left. The next hike will probably be 0.25% or 0.50% and should be announced in the upcoming months. Our view is also that South Africans can expect to see the first rate cut early in 2024.

But why all these interest rate increases? Interest rate increases are usually applied to dampen demand, which they can do effectively and, therefore, they assist in cooling demand-driven inflation. This is why the Americans have also been increasing interest rates at such a rapid pace. But unlike the United States (US), we do not have enough demand to push prices up. In SA, consumers have been battered by a poor-performing economy and market for many years now. Our economy is not even growing fast enough to slow down the pace of unemployment, which is fast approaching a new all-time high, and our equity markets have been underperforming for many more years.

On the other end, the US economy has only recently come out of its longest expansionary cycle ever; for more than 10 years the US economy grew without a recession. Consequently, US unemployment reached a historic low, US incomes flourished, and household wealth ballooned as property prices soared and the US equity market delivered unbeatable returns. If that was not enough, the US government gave out cash to all US households to support them during the pandemic. So, while excessive demand in the US helped to boost inflation to near 40-year highs, demand in SA has had an insignificant effect on prices. In fact, the current, slightly higher-than-normal inflation levels that we have in SA today have very little to do with what is happening in SA. External factors, such as a strong US economy, put pressure on the rand, which increases all of our import prices, which are more than 30% of our gross domestic product (GDP). Other external factors, such as the war in Ukraine, tensions in the Middle East, oil supply constraints enforced by OPEC+, and droughts in high-yielding agricultural countries, all put pressure on the prices of important necessities, such as food and fuel; the two items that contribute most to inflation in SA. Local interest rate changes have a very limited impact, if at all, on external forces and supply-based inflation forces such as these.

Nevertheless, the SARB has been trying to keep short-term interest rates as high as possible, albeit at a high cost to South African consumers. This is done to attract short-term capital inflows, which can boost the rand’s performance, which, in turn, should help to reduce import inflation. Although, until now, the SARB’s efforts have been as useless as fighting against a tsunami, they should pay off soon. We believe that the rand can strengthen to at least R16.50 against the US dollar in 2023, although it might appreciate well below R15.50 for brief periods. This is not because of a success story in our local economy (load shedding is making that impossible), but because of a slowdown in developed economies, a shift towards emerging markets, a normalisation in global currency markets, and the frontloading done by the SARB to attract capital to our markets. As for inflation in SA, it should gradually decrease as markets grow more certain about external forces, and supply-based forces are resolved.

Opportunities in the equity market

Dr. Francois Stofberg, with specialist input from Renier van Zyl

The market-based losses of 2022 make it tempting to look back in awe, in frustration, and in anger. But do not. The first month of 2023 provided active investors with a glimpse of what might lie ahead in 2023.

Global equity markets got off to a blistering start in January with the MSCI All Country World Index (a globally diversified index) gaining more than 7% at the time of writing this economic update. This strong start revived the question of whether the “January Effect” truly exists, and whether investors can place their faith in the age-old “January Barometer”. Unlike the January Effect, where stock prices tend to rise in the first month of the year more so than in any other month, the January Barometer possesses the ability to predict the overall direction of the stock market’s performance for that year: If January is thus a strong and positive month, the rest of the year will be strong and positive as well. Even though both phenomena lack in-depth research and credibility, investors believe that the January Effect could partly be explained by fresh equity buying activity in January following end-of-year tax-loss selling. Actual evidence to support the January Barometer is, however, much scarcer.

Without wasting any further time on theories, it is safe to say that the strong start to 2023 can be attributed to data suggesting that inflation in the world’s largest economy weakened further in December, while the underlying economy remained resilient. Softer-than-expected retail spending and services data initially served to boost markets as “bad news was interpreted as good news”. This was further supported by a contraction in December’s reading for the Price Consumption Expenditure, the United States (US) Federal Reserve’s preferred measure of inflation. On the flip side, stronger-than-expected data showed that the US economy managed to grow by 2.9% in the fourth quarter of 2022, alleviating some of the concerns around a possible hard recession.

Across the Pacific Ocean, investors were also more optimistic about Chinese equities because of the re-opening of the Chinese economy following extended zero-COVID policy measures. Chinese markets improved by 22% to kick off what could be a memorable year for Chinese equity investors. Companies such as Tencent and Alibaba, which have recently fallen on hard times because of increased regulations and lockdowns, increased by more than 117% and 90% respectively.

Warren Buffett’s ally and friend, Charlie Munger, once said that China “steps on a boom in the middle of it instead of waiting for the big bust”. This is very much the strategy that the Chinese implemented in 2022 amidst their zero-COVID policy measures. While eye-watering levels of inflation spread faster than the Omicron variant throughout the world, China went through this period relatively unscathed, as people and their wallets remained indoors. This essentially places China in a better position to stimulate its economy in 2023 which, together with cheap valuations and a possible weaker dollar, could position markets for a stellar year.

In the US, the picture looks different with volatility set to remain for at least the first half of 2023. It will not be smooth sailing. As a result of tight economic conditions, a great deal of 2022’s fourth quarter earnings reports have already started to undershoot expectations, which could pave the way for more disappointment during the coming months. While we see 2023 as a very challenging year for earnings growth, 2024 should be a strong rebound where positive operating leverage returns, i.e. the next boom. Markets, looking forward, will start to price this in during the second half of 2023, but by then investors should have already capitalised on the vast number of opportunities currently on offer.

Active investors must remember the words of William Arthur Ward: “Opportunities are like sunrises. If you wait too long, you miss them”. High-quality opportunities, such as Microsoft, Accenture, and Amazon, are trading at valuations below their long-term averages. For long-term investors, these opportunities will most certainly bear fruit and, who knows, they may even turn into a “tenbagger” according to legendary investor Peter Lynch.

Will the world enter a global recession? Probably not

Dr Francois Stofberg
Managing Director: Efficient Private Clients

Global markets were all over the show the past week, trying to digest the myriad of, often opposing, data that was released from all around the world. When considering the likely growth trajectory of the global economy market, observers turn towards the large economic blocks: The United States (US), Europe, and China (which is often also used as a proxy for growth in Asia). Data from the US and China stole the show last week. Jobs cuts from large corporations, a plunge in manufacturing data, and a slowdown in job creation numbers, highlighted the bumpy road ahead for the US, the world’s top economy. However, optimism around inflation and the interest rate outlook improved. Meanwhile, China, the world’s second largest economy, will attempt to increase its economic output after a dismal 2022.

Analysts have been warning that there are still plenty of bumps in the road ahead for the world’s leading economies, with concern now turning to the effect that higher interest rates will have on corporate earnings. It was, therefore, no real surprise when Goldman Sachs, a banking titan, released weak earnings results, but they were not the only ones. Google’s parent company, Alphabet, announced plans to cut about 12 000 jobs worldwide, propelling shares up by nearly 6%. The move came a day after Microsoft said that it would be reducing its staff complement by 10 000 in the coming months. Similar layoffs by Facebook owner Meta, Amazon, and Twitter have also been announced.

US nonfarm payroll numbers boosted riskier assets with slowing wage growth, helping to temper expectations about the size of the upcoming US Federal Reserve (Fed) interest rate hikes. Many expect the Fed to only increase interest rates by 0.25% at its next meeting. Although the recent job number was robust, the trend in the US job market is that of a slowdown as is evident from the layoffs at large US corporations. It is, however, worthwhile to note that the US economy added 4.5 million jobs last year, the second-best year on record, after 2021 when 6.4 million jobs were created. These large increases led to the multi-decade low unemployment rate of 3.5%. For this reason, a slowdown is probably a natural occurrence. But a persistently strong labour market also means that the Fed needs to keep interest rates higher for longer, despite the cooldown in other macro-economic variables. The reason we say this is because we believe that central banks’ attitudes are changing.

The global financial crisis did not result in a new Great Depression, but central banks have become much more sensitive to the risk of deflation; for more than a decade they have reacted to every shock with overwhelming monetary easing. Similarly, the recent inflation surge will not result in hyperinflation, or even in a 1970s-style inflation spiral, but it will make central banks much more sensitive to the risk of entrenched higher inflation. Central bankers now understand that prolonged loose monetary policy contributed to the multi-year inflation overshoot that we are currently experiencing. We are, therefore, likely to see a structural change in central banks’ attitudes, that is, their safety nets might be less supportive than in the past and that, in turn, will force investors to recalibrate how they price assets.

Nevertheless, hopes for China’s recovery continues to provide much-needed support to the global economic outlook. Last year, when the Chinese economy grew by only 3%, the economy expanded at its slowest pace since 1976, excluding the pandemic-hit 2020. Looking forward, we expect to see a sustained economic recovery in 2023 because of the re-opening from the zero-COVID stance and policy stimulus. News is also starting to emerge that the clampdown on the internet sector is drawing to a close, offering the prospect of an end to two years of uncertainty sparked by regulatory interventions, including gaming restrictions for minors and online tuition. Overall, while attempting to see through all of the noise of the data that was released last week, we believe that the world will, most likely, not enter a recession.