The folly of forecasting market movements

VICTORIA REUVERS Reuvers is managing director of Morningstar Investment Management SA

2022-05-14T07:00:00.0000000Z

2022-05-14T07:00:00.0000000Z

African News Agency

http://capeargus.pressreader.com/article/282080575433310

PERSONAL FINANCE

THERE is no shortage of things to worry about at the moment. As with all things unknown and uncertain, it is human nature to speculate on how things will pan out. However, humans are notoriously bad at correctly forecasting the markets. In the words of Warren Buffett, “forecasts may tell you a great deal about the forecaster; they tell you nothing about the future”. The mathematical equation for forecasting is actually quite straightforward and consists of only two factors. The big trick is you must get both factors right to succeed. First, you need to predict the event itself. Second, you must predict how the market will react as a result of the event. Let’s say you are exceptionally good at predicting and you get it right 70% of the time, the odds are still the same as flipping a coin, as can be seen in the equation below: Probability of predicting the event correctly x Probability of predicting the market’s reaction correctly = 70% x 70% = 49% (same odds as flipping a coin) Statistically, the chance of getting the right answer from speculation and forecasting (even if you are pretty good at it) is very low: 25% in fact. At Morningstar we pay little attention to forecasting. We don’t try to predict outcomes; instead, we focus on facts. Let’s look at some factors South African investors could find themselves speculating about. Is local lekker or not? In our opinion, local is very lekker at the moment. Even amid factors such as the invasion of Ukraine by Russia, US inflation sitting at over 8% and the possibility of a global recession, things are looking up for South African markets. At the end of 2019, a big concern for investors was whether South Africa would be downgraded to junk status by the major ratings agencies. Shortly into 2020, South Africa was downgraded to junk status by the last of the ratings agencies, Moody’s, with further downgrades to sub-investment-grade territory occurring subsequently. In the past two years, we have seen some improvements – for example, Moody's recently revised South Africa's outlook from “negative” to “stable”, noting that South Africa’s fiscal position has “markedly recovered”. Factors that contributed to the change in sentiment and improved outlook for South Africa were driven largely by the amount of tax revenue collected as a result of strong commodity prices and increased demand for resources (of which we have a lot). In fact, the South African Revenue Service broke a record and collected more than R1.5-trillion in revenue in 2021/22, a 25.1% increase from the previous year. South Africa is a net exporter of commodities and precious metals and has been a net beneficiary of the supply shortages experienced due to the current sanctions being imposed on Russia. Demand for what we produce has increased and supply has been cut, meaning that prices have risen. In March, we also saw manufacturing sentiment rise to its highest level in almost 23 years. South African asset classes Over the first three months of the year, we saw global equities fall by 13% in rands (5% in US dollars) versus South African equities, which are up 4% in rands. While some of the easy money may have been made by now, we are still seeing good value in select shares and areas of the market. South African government bonds are offering investors a yield of around 9.5%. Compare this with cash where you can get 4% in the bank while inflation is currently 5.9% (and on the rise). Then there is the rand. It has been a slippery downward slope for the rand against major developed market currencies – it’s hard to fathom that 11 years ago a dollar cost just over six rands. While the first quarter of 2022 saw the rand strengthen against the US dollar, we anticipate that in the long term, based on the fact that we have structurally higher inflation than most developed economies, the rand is likely to weaken over the long run. Medium-term movements are largely driven by our terms of trade – in other words, how much we export versus import. Right now, given the demand for commodities and the increased prices, terms of trade are in our favour and support a stronger rand. Inflation on the rise Despite the good news on the ground in South Africa, we are certainly not immune to what is happening globally. The first and obvious impact is the rise in the price of oil and its effect on consumers’ pockets and inflation. Being an emerging economy, we are very dependent on oil and it makes up a large portion of the Consumer Price Index basket. Over the past two years, we have witnessed record low interest rates and inflation. As energy prices soar, we are seeing this gnaw away at consumers’ pockets through higher transport costs, higher food costs and higher electricity costs. Unlike interest rates that have a delayed impact on consumers, the oil price has a direct and immediate impact. If it costs you R500 more to fill your car per month, that is coming straight out of your pocket. The effect of higher oil prices will mean inflation is likely to peak at over 6% this year. This means that the South African Reserve Bank is likely to hike interest rates, which will put further strain on an already strained consumer. Add load shedding to the mix and these are real headwinds that pose a threat to the good news listed above. When inflation is high, real assets such as commodities, materials, gold and inflation-linked bonds tend to perform well. Profitable companies that generate good free cash flows also fare well in this environment. While we cannot predict where the oil price will settle and how events will play out, what we can do is build inflation hedges into portfolios through exposure to assets that tend to perform well in times of rising inflation. In closing You should remember that returns don’t happen in a straight line. Often the most beleaguered investments turn out to be a great opportunity for future returns, as investors can access these investments at a good price. Volatility creates opportunity, and short-term underperformance can translate into a solid, longer-term upside. A well-diversified portfolio designed to meet your investment goals while remaining within your risk tolerance is far more likely to result in long-term investment success than trying to buy yesterday’s winners. When it comes to investing, patience is rewarded.

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