Q&A: Citadel prefers equities to bonds in global markets
Global economic growth, despite slowing down somewhat, will still grow above capacity in the next two years
Earlier this week, Jay Powell, chair of the US Federal Reserve, said it is probably time to “retire” the term “transitory”, a preferred adjective of his and of other central bank governors to describe stubbornly high global inflation in 2021.
The word was meant to convey the message that higher prices are temporary, rooted in pandemic induced supply chain bottlenecks. But inflation continued to surprise on the upside, forcing central banks to tighten earlier.
But the discovery by SA scientists of the Covid-19 variant Omicron has darkened global economic prospects, prompting some investors to wager that it would dampen energy prices and make businesses and consumers delay purchases. Business Day spoke to George Herman, chief investment officer at Citadel, about some of these issues, and the outlook for the local financial market.
What is your view around the persistently high inflation? How far will it go?
The world has been spoilt with emerging markets, especially China, exporting their cheap labour costs via manufactured goods. This served as a disinflationary downforce on global inflation over the last 30 years. That has come to an end.
Now, the reopening of global trade, after the first year of the pandemic, caused a flood of consumer demand, catching the supply chains off guard, causing major bottlenecks globally. This sudden surge in demand on top of already elevated commodity prices caused an inevitable surge in inflation. No surprise then that the current inflation numbers are the highest in — wait for it — 30 years.
Combine this situation with the expectation of continued strong global growth into next year  and no surprise that inflation expectations rise rapidly. However, inflation is by its very nature a mean-reverting data series as it calculates year-on-year change.
Any major disturbance to this series quickly reverts to its long-term mean after the initial disturbance dissipates. That doesn’t mean that prices come down. It just means that the rate at which they increase, decelerates. So the expectation of continued high inflation is exaggerated and that’s exactly why G7 [Group of Seven countries] central banks didn’t react with knee-jerk rate hikes. Headline inflation in the US will be back to around 2.5% by the end of 2023 and hence no reason the Federal Reserve needs to act hastily.
Despite these global risks, the JSE all share reached a record high in November. What were the drivers behind that?
The bull market on the JSE was driven by materials and Richemont. Yes, not often do we cite a single name as a major contributor to a strong market, but when one of the largest stocks in your index rises by 25% in a month, well then it is noteworthy as it contributed to 75% of the all share’s return for November.
Chinese demand for luxury goods has outstripped even the most optimistic expectations during the reopening phase and leaves Richemont just over 80% higher for 2021 thus far. Material stocks also did well on the back of the weaker rand with BHP contributing most to the overall return.
The JSE is currently on very low valuations relative to developed markets, thanks to the huge earnings from materials companies.
Do you think Omicron will cause a full reversal of global reopening (recovering) efforts, or can countries get through this period without turning back the clock to the dark days of early 2020?
We do not think that Omicron will cause a full reversal of the global recovery at all. The globe is far better prepared for new bouts of the virus thanks to the social, economic, and medical lessons learnt during the severe original 2020 social restrictions.
Politicians are more sensitised to society’s issues with “control”. Medical personnel have much more confidence in their treatment protocols and central banks are well prepared for monetary responses required to neutralise negative shocks to the global financial system.
If anything, Omicron causes a small and temporary slowdown in the first quarter of 2022, but doesn’t upset the medium-term projections. That is, of course, with the current data available on the variant’s health effects.
What are your expectations for global financial markets moving into the new year?
Markets have flourished in the warm embrace of super accommodative monetary policy for the last 18 months. All risk assets have performed spectacularly but so too have safe-haven assets which are usually inversely correlated to risk assets. That’s because this updraft in valuations wasn’t brought about by normal economic cycles, but by artificially low interest rates causing a reflation of all asset markets.
That leaves the world at a precarious place where economic growth needs to continue expanding while central banks start removing monetary stimulus. This presents a high-wire balancing act and is exactly why the markets reacted so nervously to the appearance of Omicron.
We do believe that global economic growth, despite slowing down somewhat, still grows above capacity into 2022 and even into 2023. This creates the environment where earnings can keep on supporting equity markets, despite some rate increases, both by central banks and in the long end of the yield curve. We thus still prefer equities over bonds in global markets.
How about local markets and the factors that affect them?
In SA, we’ve mentioned that equity valuations are quite attractive. As long as SA can keep growing, the outlook for equities are still positive. The risk here is that the structural reforms hoped for materialises too slowly or not at all and SA falls back into its low-growth trap with the economy expanding slower than population growth.
The MTBPS [medium-term budget policy statement] indicated only 1.7% growth projected for 2022 and 2023, which is disconcerting indeed. SA bonds are caught between very attractive valuations and growing fiscal risks on the horizon as the sovereign’s debt obligations pose a massive risk down the line.
For 2022, though, SA bonds look like a very attractive opportunity as much of the risk factors are priced in right now.
Is there anything you would like to mention that we haven’t covered?
The rand will be very important in SA’s monetary and fiscal trajectory. The rand’s fortunes, however, are not actually determined much by domestic issues, but much more so by global factors. Overall risk sentiment; where the dollar goes; what happens to commodity prices and what happens with other emerging markets. These are some of the external, global factors that drive the rand.
Currently, the rand is hurt by a strong dollar and a very weak emerging market picture as our peers, like Turkey, are not covering themselves in governance glory. Unless emerging markets keep on misbehaving, the world should keep on growing strongly. In that environment, commodities can stay supported and the dollar will give up some ground and the rand could strengthen somewhat.
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