Recession looms but offshore investors’ pain may ease

Laura du Preez | 09 November 2022

Laura du Preez has been writing about personal finance topics for more than 20 years, including eight years as personal finance editor for two leading media houses. 

After an extraordinarily brutal first three quarters and despite the threat of a global recession ahead, investors in offshore markets should expect things to get better from here on, three asset managers say.

If you have money invested in offshore markets, it has probably lost 20 to 30% of its value in the first nine months of year.

Morningstar’s latest report on the performance of global funds available to South Africans shows average drops in value of more than 27% for unit trust funds investing in equities for the first three quarters of the year, while asset allocation funds are showing an average drop in value of between 20% and 24%, depending on their exposure to equities. Read more: How can I invest safely offshore?

The normalisation of interest rates has had enormous ramifications for financial markets, Peter Vincent, regional head of client investment solutions EMEA at Franklin Templeton, told the recent Morningstar Investment conference.

It has been felt across equities, currencies and the bond market. There has been nowhere to hide and no free lunch from diversification across the asset classes, he says. Read more: Why should I diversify my investments?

In 2022 there was an outsize loss from both bond and equity markets – something only seen five times in the past 74 years, he says. 

A great year for returns in 2021 suddenly turned in 2022 into a very rough ride, Duggan Matthews, investment professional at Marriott, told Smart About Money.

Since the 2008 crisis up to the end of 2020, the developed world has pumped $17 trillion into the global economy – $10 trillion in 2019 and 2020 alone - to help avoid a protracted downturn. The price of this, however, was inflation, he explains.

This inflation was fuelled by food and energy shocks after Russia invaded Ukraine in February this year, the managers say.

Record inflation

Vincent says inflation is now at 30-year highs in many parts of the world, resulting in a full-blown cost-of-living crisis. Read more: The real-life financial horror story.

This squeeze on real income is starting to stunt consumption and Franklin Templeton believes there is a 70% chance of a global recession in the next 12 months, Vincent says.

The US Federal Reserve will have to pull levers very hard to make an impact on inflation as US inflation is high and unemployment is low, he says.

While the World Bank labelled 2021 the most robust post-recession recovery in 80 years, 2022 has seen the steepest economic slowdown since 1970, Matthews adds.


Slowdown exacerbated

The economic slowdown is being exacerbated by China’s zero tolerance of outbreaks of Covid in that country and its property market bubble, the managers say.

China is an engine of growth for the global economy, Vincent explains.

The country is the workshop of the world, producing 30% of its goods, Jeremy Gardiner, director at Ninety-One told the recent Actuarial Society of South Africa convention.

In addition to the highly detrimental lockdowns, China is walking a tightrope between over-stimulating the property market and the risk of widespread defaults impacting the banking system, Vincent says.

China is likely to be one of the few countries with positive economic growth over the next few years, but it will be markedly slower than in previous years, providing considerable headwinds for the rest of the world, Vincent says. 

Gardiner says the Word Bank believes China will be lucky to get 3% economic growth this year. Emerging markets like South Africa, however, would benefit from higher growth in China.

Recession is still coming

Vincent says markets typically reach their lowest levels – or trough – around the same time as the macroeconomic data confirms a recession. The global economy, however, is not in a recession yet.

Markets can recover before the end of a recession but they are highly unlikely to trough before the recession starts, he says.

Equity markets drifting lower in the coming months would not be unlikely, he adds.


Some positive signs

Central banks are laser-focussed on taming inflation and there are signs that inflation may be peaking as certain industrial and agricultural commodity prices have declined, Vincent says.

You should therefore expect the economic cycle to slow and gradually bring inflation back to more normal levels, he says. The recession in the US, at least, will be reasonably shallow, he adds.

Gardiner says inflation appears to have peaked in the US and is likely to peak in Europe this quarter or early next year.

The good news is that as the world slows, so too will the oil price and interest rate hikes, he says.

Matthews says investors should expect tough times for longer. Central banks appear to prefer to grind away at inflation – rather than kill it abruptly - which is likely to result in a milder recession lasting three to five years, he says.

The bargaining power of labour and Europe’s reliance on Russian gas will be key to how long inflation takes to normalise and there may regional variations, Vincent says.


Huge impact on markets

Rising interest rates mean less liquidity in financial markets.

A return to more normal interest rates will continue to be painful for markets which will no longer be driven up by central bank policies, Vincent says.

They will be much more beholden to corporate and economic factors and failing companies will now be allowed to fail, he says.

It will be a much more discriminating market than what we have experienced for the past 14 years, but it will offer great opportunities for skilled investors, he says.


Take heart

The market expects inflation will come under control by early next year and the Fed will then turn its focus to growth again, Vincent says.

Historically a peak in inflation has heralded a strong period for bonds, he says.

The normalisation of interest rates should also see asset classes performing well at different times and a return of the benefits of diversification, he says.

As the world pulls out of recession there are likely to be good opportunities for investors who focus on fundamentals, Vincent says.

While you need to be cautious in the short-term until inflation peaks, you should look forward to being able to take on investment risk again thereafter, Vincent says. Read more: What do I need to know about investment risk?

Gardiner says the remainder of 2022 and next year should be a bit better for markets.

Matthews says in tough economic times like these, markets favour stable blue chip quality companies that have products and services that remain in demand. These companies have pricing power and pay reliable dividends.