[Column] Luigi Marinus: Positioning portfolios during market volatility
Thus far, 2022 has been a challenging time for investors. Geopolitical tension, central banks globally aggressively hiking rates to curb multi-decade high inflation, and a lacklustre global growth outlook. But what does this mean for investors and portfolio positioning?
Little respite in markets
During the third quarter, we saw a continuation of the negative trend in market returns. The FTSE/JSE Capped SWIX, which is a representation of the SA market, saw a further 2.4% decline, due to financials (-4.6%), resources (-2.1%), and industrials (-1.5%), highlighting the broad-based nature of the negative sentiment. SA property declined by 3.5% while the fixed-interest asset classes of nominal bonds and cash experienced a modest uptick of 0.6% and 1.3%, respectively. Inflation-linked bonds, which have provided protection from the recent increases in inflation, delivered a return of -1.0% as inflation expectations moderated somewhat towards the quarter end.
The US dollar strengthened by 9.7% against the rand for the quarter, as global investors chose the safe-haven status of the reserve currency, as yields increased in the US. The rand depreciation was a tailwind for SA investors with offshore exposure, as foreign equities increased by 2.2% in rand with developed markets up 2.9% and emerging markets down by 3.0%. Global listed property continued to decline (-3.1%), while global bonds, measured by the World Government Bond Index, were up 1.4%. Although these returns were positive in rand terms, the negative market sentiment is apparent from the weak returns when measured in US dollars.
In terms of portfolio positioning, medium-term risks are still to the downside even though there may be evidence that short-term news flow could surprise the upside. This is premised on the possibility that forthcoming US inflation prints may be lower than market expectations due to the pace of recent interest rate hikes. While this does tempt an increase from the current underweight global equity allocation, the consensus view of no recession being priced in leaves no margin of error. US interest rate expectations are realistically priced in a continuation of the hawkish stance of the Federal Reserve which could influence a recession should this result in a greater slowdown to demand than planned. While this may provide an opportunity to increase a global bond allocation, there is a high risk of yields continuing to rise.
In terms of SA equity, the forward price-to-earnings (P/E) ratio was about 8 at the end of the third quarter and while price volatility, especially in sympathy to global markets, may materialize, strong long-term returns have historically manifested from these starting valuation levels. The steep yield curve and double-digit yields on offer in the SA bond market make it attractive. Even at the current high inflation level, the SA 10-year government bond is offering a real return of more than 3%.
Global and local listed real estate remain lacklustre as macroeconomic conditions, particularly increasing interest rates and the risk of recession, do not favour the asset class. The diversification benefit of holding cash has proved advantageous over a volatile quarter and, with continued market uncertainty, it remains a buffer to potential volatility.
Asset allocation decisions that are not too different from long-term strategic levels become more appropriate when market uncertainty is heightened. This allows for material adjustments when a directional view is taken without compromising the risk-return profile of a portfolio over the shorter term. In addition, as a multi-manager, there is a diversification benefit of the underlying managers who, as a blended solution, we believe will deliver competitive returns regardless of the market outcome.