Start of a bull rally or more volatility to come?

We live in eventful times. During these tough economic times, it can certainly feel like the glass is half empty. The disconnect between the current economic environment and the recent rally in equity markets has left many people scratching their heads. Is this the start of a strong bull market or merely a slight recovery from the aggressive sell-off we saw in March 2020?

The world was overturned in March when outbreaks of Covid-19 started accelerating and affecting most markets across the globe. This saw almost one-third of the world’s population going into lockdown and many companies coming to a complete standstill.

 

During this time most financial markets sold off aggressively due to the uncertainty around the effect on businesses both locally and abroad. This resulted in some of the most aggressive local and global sell-offs seen in history and, in turn, also resulting in one of the fastest sell-offs in history. With this being said – in the weeks post 18 March, markets have also seen some of the strongest returns, resulting in most equity markets clawing back most of its losses.

 

So, the question begs, is the sell-off/risk-off trade done?

Let’s look at previous sell-offs and their subsequent recoveries in the South African equity market, namely 1998 (emerging markets) 2003 (technology) and 2008 (financial crisis) as well as 2020.

 

The graph below demonstrates the four above mentioned crises, the time the sell-offs started and the period it took for all capital losses to be recouped.

 

In other words, if an investor invested R100 on the day the sell-off started, the below graph shows how long it took (measured in days) the investment to reach the bottom (lowest amount) along with the subsequent recovery (in other words, how long it took for an investor to get back to the initial R100 investment). The x-axis signifies the number of days and the y-axis the change in the value of the initial R100 investment.

 

 

From the above graph, it becomes clear that the most recent sell-off was one of the most aggressive sell-offs, but the rebound has also been one of the quickest.

 

So, is it the end? Unfortunately, it is unlikely. Remember that share prices reflect the future earnings expectations of companies. So while prices of shares might have adjusted, companies haven’t realised earnings yet. There might still be some further headwinds that the market will have to digest as companies release their earnings results and the real impact of the lockdown is realised.

 

From the above graph, we can see that it can take anything from 190 days to 600 days to make up previous losses. You can get cycles during a 12-month time frame that feel like they should actually be playing out over the course of 12 years.

 

Once you start digging into the historical numbers you begin to realize the equity market is even more unsystematic than advertised. Surprisingly, huge up and down moves happening in the same year is not out of the ordinary.

 

Investments with more cyclical equities (such as airlines, banks and energy companies, to name but a few) are typically more volatile. That’s because a share’s return is based on the business’ profitability, which is difficult to predict. In uncertain market environments, like the current one, investors tend to be especially pessimistic about how businesses will perform, which can result in an overreaction (to the downside) in the share price.

 

So, why would you want to own equities when there is so much uncertainty? Because you’re likely to be rewarded with a higher return over the long haul if you can remain calm and stomach the volatility and noise.

 

When your portfolio’s value has declined amid this volatility, you might think that you’ve taken on too much risk. However, you shouldn’t necessarily conflate volatility with risk. Risk could be better defined as the permanent loss of capital (which is realised if you exit at a low point) and the chance that you won’t meet a financial goal. Even though a portfolio that is heavily tilted toward equity might bounce around in volatile environments like this, your total portfolio asset allocation might not be overly risky.

 

By reducing your exposure to more volatile or “risky” assets such as equities, you could significantly limit your portfolio’s potential return over the long run. If you have decades left to invest, a lower return could prevent your rands from multiplying at the necessary pace to reach your investment goals.

 

It’s easy to overplay the significance of volatility because it means we can address the overwhelming feelings of anxiety that occur in times of market stress. But with volatility comes opportunity, especially for the patient and sensible investor. Ultimately, equity market gains have offset shorter-term losses during market turmoil, and market volatility can be an opportunity to buy equities at a low price.

Eugene Visagie, CFA®, FRM®

Client Portfolio Manager

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

 

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

Don’t let financial jargon throw you off your game

What to understand about downmarket jargon.

Market downturns leave many investors hopeless for various reasons. Portfolio values and income levels that have declined, the confusion as to what to do about it, a bombardment of information from various sources, and explanations by industry experts using terms you have never heard before. How should you know what to do if you don’t even understand what the problem is in the first place?

While it is impossible to control what happens in markets, you can make sense of these events by gaining a better understanding of relevant investment terms. In the following article, we look at a few financial terms that are often used during market downturns with the hope of assisting investors to make better sense of the myriad of terms being used.

 

Recession

The term “recession” in its strictest definition means that an economy experiences two consecutive quarters of negative economic growth as a result of a significant decline in general economic activity.

During a recession, businesses experience less demand (i.e. they sell fewer products and/or services). These businesses then usually react to this by cutting costs and sometimes laying off staff in order to protect the bottom line and profitability of the business. When staff are retrenched, this leads to higher unemployment rates.

Generally, a recession does not last as long as an expansion does. Historically, the average recession (globally) lasted 15 months, compared to the average expansion that lasted 48 months.

Causes of a recession can vary. While COVID-19 has certainly put a drag on the global economy, it remains to be seen whether it will have lasting effects on economic output. It is important to realise that recessions are a normal part of an economic cycle and every person will experience a few in their lifetime.

 

Bear Market

A bear market is when a market experiences a decline of at least 20%, usually over a two-month period or longer. Bear markets often arise from negative investor sentiment because the economy is slowing or due to the expectation that it will slow down. Signs of a slowing economy may include a decrease in productivity, a rise in unemployment, a decrease in company profits and lower disposable income. When someone talks about having a “bearish” view, it means they have a pessimistic outlook.

While a recession and a bear market often go hand in hand they are associated with different issues. The distinction between a bear market and a recession is that a recession is measured by a decline in economic output (also known as gross domestic product or GDP), whereas a bear market is identified by a decline in stock market values in excess of 20% over a prolonged period as a result of negative investor sentiment.

Some other terms that you might come across when reading up on market downturns include:

  • A pullback, which is a short-term price decline within a longer-term trend of price increases.
  • A correction, which is when an asset’s price falls by at least 10%.
  • A market crash, which is a drastic market decline over a short period.
  • A depression, which is a long-term recession that can last multiple years.

 

Volatility

Markets have been highly volatile of late, meaning equity prices have bounced up and down rather severely from one day to the next. Volatility marks how much an investment’s price rises or falls. If an investment’s price changes more dramatically and/or more often, it’s considered more volatile.

Price volatility is usually expressed in terms of standard deviation, or how much an investment’s price has fluctuated around its average price over a certain period. A higher standard deviation implies an investment’s price is more volatile.

Investments with more uncertain outlooks, like equities, are typically more volatile. That is because equity returns are based on a company’s profitability, which is difficult to predict. In uncertain market environments, like the current one, investors tend to be especially pessimistic about how businesses will perform, which can result in steep market declines.

So, why would you want to invest in a more volatile investment? Because you are likely to be rewarded with a higher return over the long-term.

 

Risk

Volatility and risk are terms often used interchangeably, although they are very different. Risk should be defined as “permanent capital loss” or the chance that you won’t meet your financial goal.

For a retiree, one risk might be not taking on enough risk. By reducing your exposure to more volatile or “risky” assets such as equities, you could significantly limit your portfolio’s potential return over the long run. By remaining in cash for prolonged periods of time you run the risk of increasing your tax bill significantly (due to interest earned being fully taxable) or losing purchasing power due to the eroding effects of inflation.

Even though a more equity orientated portfolio will experience more volatility in environments like what we are facing now, your asset allocation might not be overly risky. If you’re far away from retirement, you have time to ride out your portfolio’s short-term volatility and take advantage of longer-term gains that equity markets will generate.

 

Loss Aversion

Loss aversion is the theory that investors feel more pain when they lose a certain amount of money than they feel pleasure when they gain an equal sum. In other words, you would feel more discomfort from losing R1,000 than pleasure from gaining R1,000.

Time and time again it has been proven that selling your investments in a downturn and giving up on your long-term financial plan is detrimental to a successful investment outcome.

 

So where does that leave investors?

Things might not be so hopeless after all. Recessions, bear markets, drawdowns and volatility are all part of the world of investing and building long-term wealth. What matters most is our actions and habits during this time. These can either hurt you or help you, but most importantly always remember that “this too shall pass”.

Debra Slabber, CFA®

Business Development Manager

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.