EPaper

Strap yourself in — volatility and drawdowns have become the norm

Ricardo Smith ● Smith is chief investment officer at Absa Stockbrokers & Portfolio Management (acting), and at Absa Global Investment Solutions.

With seven years of monetary policy accommodation and quantitative easing by most central banks, particularly the US Federal Reserve, it has been a long time since we experienced volatility levels like these under normal circumstances.

After the global financial crisis, with markets looking unstoppable in one of the longest bull market rallies in history, most market drawdowns have been driven by specific geopolitical events.

These have ranged from the European debt crisis led by the so-called PIIGS (Portugal, Italy, Ireland, Greece and Spain), with Greece eventually going into default and complete economic chaos and collapse, to the unexpected Brexit, which led to policy uncertainty in the UK and continental Europe, a surprise Donald Trump victory in the US based on populist nationalist ideals, US-China trade wars, Hong Kong protests, the Nenegate saga locally, which saw three different SA finance ministers over a weekend and fears of credit ratings downgrades — which came and went

— and more recently the Covid19 pandemic.

All these events have driven local and global markets, adding to uncertainty and risk — which ultimately translated to excessive levels of market volatility. The Russia-Ukraine crisis has certainly added to the recent bout of market volatility.

With Russia only contributing about 3% to global economic activity, this is only part of the narrative. This has been interpreted more as a commodity supply disruption by markets, as Russia and Ukraine contribute more to global commodity production than to consumption and economic activity.

However, even stocks largely unaffected by commodity prices have seen their share prices plummet. For instance, Facebook’s parent company, Meta Platforms, is down about 40% on a year-to-date basis and Netflix is down about 70% over the same period.

There are stock-specific issues, of course, like the capital expenditure to build the Metaverse by Meta Platforms, which is expected to remain in the billions of dollars for the foreseeable future. Also concerning is the decrease in Facebook daily active users in the fourth quarter of 2021, due to increased competition from TikTok, and reduced advertising revenue in the first quarter of 2022, on the back of a tougher economic environment.

In terms of Netflix, it has had disappointing results, with user subscriptions decreasing on the back of subscription fatigue and increased competition from Disney+, Apple TV+, HBO Max, Peacock, Discovery and Paramount, which have increased their user base at the cost of Netflix. Furthermore, high costs to generating content with low margins and account sharing has posed further risks to earnings.

MODERATE

Outside some of these stockspecific risks, however, these drawdowns were not limited to these counters, but have been experienced across the market, particularly growth stocks. Sticking to the tech sector, even quality stocks like Microsoft and Apple have seen drawdowns, but much more moderate.

This tells us that volatility and market drawdowns remain the norm in listed equity markets, particularly as the quantitative easing regimes retreat and we move towards more normalised monetary and fiscal policies.

When money starts to feel like an unlimited resource, questions about budget, asset allocation, valuations, quality of earnings and return on capital invested seem to become less significantly important. However, money is not an unlimited resource and this only serves as a reminder.

From an investment strategy perspective, any investor who seeks to grow their wealth in real terms above inflation will have to be invested in a portfolio that is reasonably correlated to equity markets — expected to provide the bulk of long-term real returns at the cost of shortterm volatility. In accepting volatility as a normal component of long-term investing, it is important that we invest in the right sectors and select the right stocks with a good investment case that we believe will outperform those sectors in the long term, and that we maintain a well-diversified portfolio to limit sector, style and stockspecific issues.

We continue to like quality stocks such as Microsoft and Apple and believe they will continue to do well in the long term beyond the noise. On Meta, we continue to have it as a hold due to its dominance and competitive advantage in the social media space, its focus on user satisfaction, strong network effects and improved valuations.

However, on the back of the above-mentioned risks, particularly the uncertain capital expenditure, we continue to expect some volatility over the short to medium term as the outlook becomes clearer.

On Netflix, however, we believe that despite being innovative and a strong driver of non-linear TV, there are better prospects in competitors like Disney. Unlike Netflix, Disney has continued to grow in subscriber numbers where Netflix has been declining, albeit from a lower base. Disney’s model of looking to add localised content and sport in the regions it operates in may prove more appealing, coupled with its strong library of popular franchises, which it can monetise by converting into movies and series.

However, Disney also faces similar challenges on the streaming side, with respect to cost of production and increased competition. It is more diversified with its theme parks, which though only contributing about 30% of revenue, have contributed about 70% of earnings, due to great margins and the opening of the global economy and travel from Covid-19 pandemic restrictions.

THE BOTTOM LINE

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2022-05-20T07:00:00.0000000Z

2022-05-20T07:00:00.0000000Z

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