Investing in 2022: Difference between good business and good investment
Did inflation make investing challenging during 2022? And what does 2023 have in store?
Investing in 2022 was not for the faint-hearted as investors learned there is a meaningful difference between a good business and a good investment in the current economic environment.
As for 2023, the best advice is to expect the unexpected.
Investing in 2022
The majority of the world still faces stubbornly high inflation, aggressive interest rate hikes and geopolitical tensions brought on by the war in Ukraine.
“Some of these events were foreseeable, some perhaps not so much. One thing is certain, in 2022 investors have learnt that it is entirely possible to lose money by investing in good businesses if you overpay,” says Adriaan Pask – CIO at PSG Wealth.
At the beginning of 2022, most people were unsure about where global interest rates would go, but the consensus was that they would increase, although very few expected rates to go as high as they have or as quickly.
“Our view at the beginning of the year was that inflation would be a lot stickier than expected at the time and the logical implication was for interest rates to surprise to the upside,” Pask said.
He explains: “As interest rates increase, valuations start to matter a whole lot more. Growth comes into focus, fears around recessions develop and stocks derate in price in line with the elevated risks in the macro environment”.
Therefore, it was no surprise that counters that came under strain in 2022 were high-duration, high-growth stocks, or stocks that are pricing in elevated levels of growth for a very long period.
Pask says these were typically tech companies, which had high-profit margins.
“These companies were priced as if they would sustain those margins and growth rates for a very long time and over the last few months, these companies started to sell off. A key lesson here is that there is a meaningful difference between a good business and a good investment.”
Pask points out that none of these tech companies are bad businesses; they do not necessarily make for good investments in the current environment.
“The time will surely come around when the environment normalises and valuations for these counters become attractive again.”
Inflation and increasing interest rates
Persistent inflation and rising rates also made PSG cautious of developed market bonds.
“We felt that the yields on these bonds were very low, even after the pandemic and essentially could only go up from there.”
Therefore, 2022 was very painful for investors as both developed market bonds and equity sold off heavily during the year, which subsequently caused the performance of offshore portfolios to suffer.
Pask says China was also another key influence on markets during 2022.
“China is a key consumer in the global environment and the health of the Chinese economy is important for commodity producers like South Africa.
“Despite seeing slower growth out of China, compared to what we have been used to over the last 20 years, it remains relatively high compared to the rest of the world. There are also existing supply chain constraints, that was the key driver behind elevated commodity prices that were positive for South African capital, especially our mining stocks.”
Investing in 2023?
Pask says PSG will keep a close eye on company margins: “We expected margins to come off as the cost of capital increases as interest rates increase, because that is when the sentiment will start to turn further against tach companies.
He adds: “We have seen some of that start to come through already, but margins are still a lot higher than we think they will be during a recessionary environment.”
PSG expects that United States interest rates will peak next year and that it will result in interesting investment opportunities.
It is not clear whether we have seen the bottom yet, but we are increasingly seeing quality businesses trading at attractive ratings, he says.
“We also believe that more conservative asset classes will start to contribute to portfolios again in 2023. In a higher interest rate environment, bonds and cash have a supporting role to play in a diversified portfolio again which will be positive for clients in these strategies.”
According to Pask, another key theme for 2023 will also be dollar weakness and the impact that will have on portfolios and asset classes.
“Our view is that the dollar is unsustainably strong and could weaken over the short term. This translates into a stronger rand and our bonds and companies incorporated in South Africa will react positively to this development.”
Pask says that people must be realistic about the uncertainty around the global political environment.
“You would be naïve to position a portfolio that will not be subject to some political turbulence. I think politics will continue to have a big impact, especially over the short term, where sentiment can influence asset prices.”