January post-mortem

January 2022 was one of the worst months for developed market shares in a long time. The S&P500 and MSCI World are down a little over 5% and on a sector basis the Nasdaq did even worse with a close to 10% correction. South Africa lost all the gains for the month and ended flat, which is still much better than the developed world. It could have been much worse had the strong comeback in the last trading day or two not happened; and we have seen this recovery continuing into February. On an individual share basis we have seen some carnage ripping through the expensive, unprofitable companies like Peleton (-24%), Shopify (-35%) and even profitable ones like Amazon (-12%).

Why has this been happening? Well, as we have mentioned on multiple occasions, when interest rates start going up, equities start going down (at least in the beginning). And that is exactly what has been happening now. The Central Bank in the USA indicated that they would be raising interest rates much more aggressively than had been anticipated and the market got spooked. The expectation is for four to five interest rate hikes of 0.25% each during 2022, and the termination of quantitative easing where the Central Bank buys government bonds to help keep interest rates low and boost liquidity.

So why the sudden change of heart by the Central Bank regarding the interest rate policy? Well, just look at the attached graph. We see an exploding debt number, historically high inflation and very low interest rates. The most effective way to lower inflation and get debt down is to raise the cost of money, i.e. interest rates, and for the Federal Reserve to stop buying bonds. You might ask why inflation is so high in the first place and the answer is simple: governments have been distributing bailouts to those unable to work and earn because of Covid lockdowns; worldwide supply chains of products have been interrupted, also because of Covid; and the price of natural gas and oil has risen substantially owing to geo-political issues and, once again, Covid restrictions.

The fact of the matter is that the low interest rate environment created too much money chasing too few goods and services, resulting in inflation, but this is coming to an end. We will see profitable, well-managed companies bounce back and continue creating wealth for their shareholders; but those lazy, obese companies that never added much fundamental value will suffer. Growth is key to any successful business and going forward we will see companies being valued on earnings per share again, and not just on sales.

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