[TOP STORY] Market expectations for 2023 vs 2022

SIMON BROWN: I’m chatting now with Simon Fillmore, who is CIO at Independent Securities. Simon, I appreciate the early morning time.

In a note that you sent out – lots of stuff we want to go through – but what I want to touch on first upfront is a great point that you make there. [There’s] no statistically significant correlation between GDP growth and stock markets. You make the point [that] if I knew what SA or US or EU GDP was going to be for 2023, it wouldn’t help me one inch in making money in 2023.

SIMON FILLMORE: Yes, that’s a very good point. I think often investors and people in financial markets forget that fact. The stock market is all about what’s going to happen in the future. It’s a discounting mechanism and tends to discount any of that bad news in advance. And what surprised us quite significantly this year was just the amount of negative rhetoric coming into this year about how the US is going to go into recession and how bad that will be for financial markets.

SIMON BROWN: Moving on to sort of the harder data, we had some US inflation out yesterday – 6.5%, exactly as consensus was. It is falling relatively fast, although that tends to happen sort of as the tail falls out. You can see inflation coming through. Does this remain one of the key issues – inflation in the US – and then of course how the Fed responds with their interest rates? We’ve got an FRMC [Federal Records Management Council] announcement on February 1.

Read: US inflation cools again, giving Fed room to downshift on rates

SIMON FILLMORE: Yes. What happens with inflation this year, certainly I think in the first half of the year, would probably be the most significant fact for the market. What’s interesting about yesterday’s print, if you in fact take the data over the last six months and you analyse it you come out with a figure of 1.9%. It clearly shows that there’s an embedded trend of inflation declining quite significantly.

And our anticipation is that that 6.5% we saw yesterday will just continue to fall as we get more and more data over the next couple of months. In turn I think the Fed will have to reappraise the hawkish stance that they’ve taken, and they don’t want to be too destructive in terms of economic growth.

SIMON BROWN: Yes. My next question – because at one point their target is 2% and I appreciate we are fiddling with the inflation data, but I have no doubt that the Federal Reserve is doing the same … the idea of Fed minutes in saying 5%, that really does then look at probably the worst-case rate for the US this year. And, if anything, we might get pleasantly surprised with maybe only, I don’t know, 4.5%, 4.75%.

SIMON FILLMORE: I agree with that, and we’d be very surprised to see it go above 5%. Perhaps there’s another 50 basis points, at most, that they need to act on, but I think that’s probably pretty much done and dusted for this cycle. And then I think that’ll just give the market visibility in terms of that, and it’ll have a positive flow into risk assets, specifically equities.

I think the other important thing about the inflation data is that that has a direct bearing on input costs.

If inflation is coming down input costs are coming down, and that can only be positive for margins in companies, which in turn is supportive for their earnings.

So we think corporate earnings this year will also be supported by that lower inflation data as it means their input costs will be lower.

SIMON BROWN: One of the things you mentioned as well is that we’ve seen corporate cost-cutting, not just staff layoffs. But corporates have responded fairly aggressively in some cases over the course of the last year to their cost base. And then if we start seeing some sort of input pressure subsiding, it puts a lot of corporates in, frankly, not bad positions.

SIMON FILLMORE: Definitely one of the standout features from corporate news over the last couple of months is the depths that they’ve gone to in terms of corporate cost-cutting, and pretty much a day doesn’t go by where we don’t get an announcement from some sort of company that that they’ve embarked on a programme to reduce costs. I think earlier this week it was [US-based software company] Salesforce indicating that they’re going to reduce their [employee] base.

SIMON BROWN: It was almost weekly. This week it was Salesforce, last week it was Amazon. And so it goes.

Let’s turn to some asset classes and some valuations. Global equities– we’ve certainly seen the first bear market in a long time. They’re cheaper than they were in October 2021. I’m not sure that they are necessarily massively cheap and that we’re going to repeat the performances of the previous decade necessarily.

SIMON FILLMORE: We saw [that] the long-term average is probably about 8% for US equities, and we’ve seen that number over the last decade go above 10%. So I don’t think that number will be repeated.

But because valuations have come down significantly with the S&P down 20% last year and the Nasdaq down about 30%, we still think there’s a good opportunity in equities, and they’ll certainly reward investors in terms of the outperformance of inflation.

There are a couple of interesting statistics around that, where it’s very rare to get two bad years in a row. In fact, it has only happened three times over the last century. So we think because of that we are unlikely to have a repeat of last year. And then there’s also some other quite fascinating statistical data on the first few days in the market. The stats are like if the first five days are greater than 2%, then over the last 50 years, 16 out of 17 times the market has been higher, and that’s averaged 17.8%.

So in essence what it’s saying is if the first couple of days are quite good on the stock market, then that tends to [bode] very well for the rest of the year.

SIMON BROWN: Yes, I actually heard that one yesterday, and it was quite an astounding data point.

SA equities?  I think the conventional wisdom from everyone, the consensus, is they are cheap, very cheap. Of course there is load shedding. Corporate SA survives in spite of load shedding and our politicians and the like. But it does create a sentiment concern, perhaps.

SIMON FILLMORE: Yes. I think if we look globally, SA equities have to be one of the cheaper equity groups out there, the forward PEs below 10 times; actually very-high quality companies in that.

But the Achilles’ heel for South African equities over the last eight years has been foreigners on our market. In fact they’ve been net sellers over the last eight years; that creates a very significant headwind or ceiling on South African equities, and that’s largely because of the political situation.

So if we see some positive announcements in that regard there’s certainly a lot of upside in South African equities because of the low valuation base.

Of course there are shares like the commodity companies – Naspers, Richemont, British American [Tobacco] that aren’t as impacted by South African politics because the businesses are primarily based offshore.

SIMON BROWN: And because even our politicians can’t afford the Richemont watches. You mentioned commodities there. They had a lacklustre 2022 but, again, that was after going absolutely crazy in 2021. Do we see another sort of drifting maybe even a little bit weaker, or does the China reopening benefit commodities markedly?

SIMON FILLMORE: There’ll probably be a couple of tailwinds for commodities this year, the first being, as you mentioned, the reopening of the Chinese economy. We’ve seen strength in prices in copper over the last couple of weeks on the back of it.

Two other factors. The one would be our view is that the dollar is likely to weaken over the course of this year as interest rates peak and potentially come down in the US. And then the other fact is just the structural tailwinds that we’ve seen in the transition to clean energy.

I think a combination of those factors will probably mean commodities will have a fairly good year.

There might be some – specifically like the bulk commodities – that don’t fair as well.

SIMON BROWN: We’ll leave it there. That was Simon Fillmore, CIO at Independent Securities. Simon, I really appreciate the early morning insights.