Anet Ahern, CEO at PSG Asset Management
If you have spent some time with a toddler, you probably know that they can often become very attached to a specific object. Whether it is a favourite soft toy or blanket, small children can often derive a sense of security from this familiar and well-loved object. Woe betides any parent if said object goes missing (or needs to be washed)!
In many respects, markets can behave like toddlers too. The previous time when the US Federal Reserve (the Fed) decided to taper its quantitative easing (QE) policy in 2013 the market responded by throwing a ‘taper tantrum’. In the end, the panic proved to be short-lived, but the deeply emotional response to the ‘loss’ of stimulus the system had come to take for granted, was every bit as intense as the best effort any two-year-old could put forward.
Markets often become emotional when something happens to upset their sense of security, or, to put this in financial parlance, when the fundamental assumptions decision-makers operate on, are called into question. When the emergence of the coronavirus caused economies to shutter across the globe at short notice in March 2020, the local market responded by falling 20% in the space of about 20 days, as expectations for future economic growth evaporated overnight. In this case, the emotional response was disproportionately large, and the market reached its pre-correction point a mere 88 days after the initial crash (JSE All Share Index, excluding weekends). The economic shutdown, although painful, was temporary, after all.
Sometimes emotional market responses can be short-lived, but investors should be aware that the more deeply held the original belief, the more intense the response may be that follows (the difference between the blankie falling out of the crib vs the blankie falling out of the stroller at the mall and being irretrievably lost).
We believe that we are seeing an inflection point in markets that potentially marks a fundamental departure point from the macro environment of the past decade. Many had come to believe the low inflation, low interest rate environment of the past decade marked a ‘new normal’ where growth and long duration assets could continue to outperform indefinitely, driven by a new relationship between risk and return. This ‘new normal’ doctrine became an underpin to the way market participants thought about the performance of various assets and asset classes and was accepted as a ‘conventional wisdom’ security blanket that provided justification for why ‘this time is different (four very dangerous words in investing).
Now that rising inflation and interest rates seem to be more than just a temporary blip, the market is being forced to come to terms with the fact that one of the assumptions on which it had based assessments of risk and return may have been fundamentally flawed. To get back to our earlier analogy: the toddler is slowly waking up to the reality that its security blanket might be irretrievably lost, and a tantrum is sure to follow.
When assumptions fundamentally change, it requires an important rethink of where we are likely to find sources of risk and return. This can be a potentially painful process, as the required recalibration is unlikely to be a smooth transition. We believe we are only at the beginning of what is likely to be an uncomfortable and volatile recalibration process in markets, especially since many investors have failed to appreciate how impactful the current shift is. The assets that have rewarded investors well over the past decade are unlikely to prove to be the winners in the years ahead, and portfolios that still embed the old logic are likely to disappoint investors in their attempts to build wealth going forward.
What is required when fundamental shifts are afoot, is a sober assessment of the beliefs that underpin the portfolio construction process. Letting go of a long-cherished security blanket is no easy task, but we believe investors who are able to do so, are far more likely to succeed in the changing investment environment.
The benefit of partnering with differentiated thinkers should not be underestimated, since relying on conventional wisdom at times like these may lead to disappointing outcomes down the line.