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October 2022- Market Commentary
I am writing to you quite humbled by the market events of 2022. Liquid portfolios (i.e. portfolios without Alternatives) for Q3 and YTD will be stark reminders to investors of the crazy days of 2008. We should take comfort that even from that period when the global financial system was at genuine risk of imploding, portfolios did recover and continued to make money.
Following the Global Financial Crises of 2008, it took investors 2 to 3 years to recover their losses. I estimate that the recovery period for 2022 will most likely be more like that period and not like the weeks it took to recover following the March 2020 Covid shock. Looking back to 2008, I was more worried then than I am now. Maybe I am more experienced now, but then it felt like the financial system was collapsing. No one knew which bank to trust. Now at least, we have a lot of comfort that most banks are very strong. What we are experiencing in 2022, with rising inflation and interest rates, is a scenario that markets have faced before and overcome.
In 2022 in relative terms, our liquid portfolios have done reasonably well, but that will be little comfort to investors facing painful absolute numbers. There has been no safe haven this year as bonds (where investors flee to in times of heightened uncertainty) have had a torrid time in 2022. Adding significant alternatives to your portfolio was the only way to avoid losses in 2022, as all major liquid asset classes are showing substantial losses. In the commentary below, we will try to make sense of it and, more importantly, future challenges.
The above table illustrates just how difficult it has been to protect wealth in 2022. All major asset classes are deep in the red. Alternative funds, i.e., lending, property, and some hedge funds, did manage to hold their value and some even returned modestly positive returns. However, these funds have limited liquidity, higher minimums and are only available to qualified investors so they don’t suit all clients.
Bonds Bonds Bonds
Over the last few years in our letters and webinars, we have been saying how difficult it has been to make money from investing in bonds due to ultra-low interest rates. In such an environment, the risk-return profile was tilted to the downside – too much risk for insufficient return. Look at the table above, and you will see that the three-year returns for the primary bond indices are significant negative numbers (in contrast to equities), and most of the damage was in 2022. From this we can see just how little money was made prior to 2022 by investing in bonds. Ironically bonds are used in portfolios because, generally speaking, they are more predictable than equities. Why did we hold them? Because of their historic predicatbility, they are used by investors and regulators to express low risk objectives. How did we manage the risk? We had significantly shorter bonds than our strategic benchmarks, and this active decision partially protected our portfolios. It should be stated that across the professional world- being short duration was not a consensus view. In retrospect, we should have been even shorter and those asset managers who were long duration have paid an even more painful price this year. The bottom line is that unfortunately, we were not short enough in duration to totally avoid any bond losses, but there is a strange comfort, for me at least , to say that it could have been a lot worse.
The good news is that going forward, we can finally expect to earn the type of returns we have traditionally expected from bonds – that is 4% to 7%, depending on risk level. However, USD investors have a new dilemma fixed deposit cash rates have gone up significantly. These rates are attractive now but we cannot say how long it will last. For example, if you buy a 3-year quality bond yielding 5%, then you can realistically expect to earn 5% per year for three years. If you put your money in a USD fixed deposit at, say 4.5% for 12 months, then when the times comes to renew it - in 12 months, you do not know what the interest rates will be in one year from now. That gives bonds an advantage over fixed deposits in terms of yields. You will also lock up the money at the bank for the duration of the fixed deposit and will not have the daily liquidity offered by the bond market.
How Low Will Equity Markets Go?
The easiest equity level indicator to follow is the S&P 500. Currently, it is at ~3600, down from a high of ~4800. In March 2020, it dropped to 2600 but quickly recovered. Looking at these numbers, we feel most of the pain is behind us, but certainly, lower levels are possible if we slide into a severe recession. Another way to get some comfort from investing in the S&P 500 is that when we look back over the last 100 years till the end of 2021, there has never been a drawdown that wasn’t ultimately recoverred, even faster when you include the often overlooked effect of re-invested dividend income.
We firmly believe that investors must stay invested and not give up. In the words of Warren Buffet which I often repeat and use as a mantra- "we need to be greedy when others are fearful" and look for buying opportunities. The data metrics tell us that it is not yet time to start any significant buying, but we are watching it closely.
Will Israeli Property Market be the Next Victim?
Significantly rising interest rates and a change in risk sentiment will put a strain on property prices globally. With property, one needs to be careful not to paint it all with one brush, as different geographies and segments will respond differently. In Israel, the property market has some unique features that may protect parts from this global down turn. Firstly, there is still a very high demand for property and we have a back log of many years of built up excess demand to work through. Secondly, higher-end properties tend not to be leveraged, and therefore, are less interest rate sensitive. Furthermore, immigrant buyers using USD can benefit from the weakening USD/shekel rate, making them less price sensitive. In my opinion, apartment prices in certain geographical areas and price points - where buyers are dependent on mortgages (whose cost has risen sharply) - are more vulnerable. In addition, this segment is the part of the market where more properties are being built, which will increase supply as long- term construction projects finish. Therefore, a slight softening of demand in the 3m to 5m NIS price range is reasonable to expect. However, I don’t feel it’s a bubble about to burst.
One of the most striking issues of 2022 is the USD's strength. Most of this, we believe, is because of the interest rate differential. Significantly higher interest rates in USD has attracted money away from all other currencies. Even developed world currencies like the Euro, Yen, and Pound all reached record lows not seen for a generation or more. This provides a fantastic opportunity for USD investors to convert money to Shekels to reduce their USD loss. We expect that when markets recover and interest rates around the world close the gap with the USD, which is anticipated in 2023, then we will see a gradual reversion of this trend. Pound-based investors will need to be patient before converting to Shekels. USD investors disappointed with their USD perfromance who have a long term need for Shekels can use the more attractive rates to convert their USD and "recover". For example, if you had $1,000,000 at the beginning of the year (which was then worth 3.1m Shekels), by the end of September, market falls would have reduced the portfolio to $850,000. However, this $850k is now worth about 3m NIS at the current exchange rate. So a 15% negative USD return can be (in appropriate circumstances) 3% Shekel loss.
If 2022 can be blamed on one thing it is probably inflation. At this juncture it would seem to us that inflation has peaked and is going to come down. The pace of this is uncertain and the technical details about the make up of inflation matter which makes it complex. The inflation number you read about in the press as a headline number may not be the same number that economists and market participants are looking at. This explains why last week (Mid October) the September inflation number was higher than expected but the market has responded quite positively. For example, durable goods are firmly in delationary territory and support the transitory inflation version we believed in last year. I believe it is fair to say that the conflict in Ukraine signifiacntly affected the path of inflation in 2022. If we blame 2022 on inflation there is some cause for optimisim here, as it would appear that inflation has indeed peaked and this supports the view that investors need to be patient to ride this out.
The information mentioned above is not a substitute for personal Investment marketing, which takes into account the particular circumstances and special needs of each person. The views expressed in this review should be considered market comments for the short term for information purposes only. As such, the views herein may be subject to frequent change, are indicative only, and no reliance should be placed thereon. This review does not constitute legal, tax, or accounting advice, any investment recommendation, or any offer to buy or sell financial instruments of any kind. It does not take into account the investment objectives or needs of specific investors. Although this review has been produced with all reasonable care, based on sources believed to be reliable, reflecting opinions at the time of its writing, and subject to change at any time without prior notice, neither Pioneer Wealth Management nor any other entity or segment within the Pioneer International Group makes any representations or warranties as to the accuracy or completeness thereof and accepts no liability for any loss or damage which may arise from its use. The writer and the company are unaware of any conflict of interest at the time of publishing the above commentary.
Mike Ellis Thursday, 20 October 2022. Quarterly, half year and year-end review
About the Author
Director and Chief Investment Officer
Mike Ellis, originally from South Africa, joined Pioneer in March 2000 after working in the Private Banking & Trust industry in the UK. At Pioneer he was the group CFO for the better part of the last decade. Today Mike serves as a director and is the CIO.
Mike is a Chartered Accountant, a CFA charter holder and received his MBA from Tel Aviv University & Kellogg Business School. Mike is also an Oxford University Alumni having participated in the Said Business School's Global Investment Risk Management Program. In addition, Mike is a licensed Portfolio manager by the Israel Securities Authority.