Difference between a good business and a good investment



Investing in 2022 was not for the faint of heart as investors learned that there is a significant difference between a good business and a good investment in today’s economic environment.

As for 2023, the best advice is to expect the unexpected.

Invest in 2022

Most of the world is still grappling with stubbornly high inflation, aggressive interest rate hikes and geopolitical tensions caused by the war in Ukraine.

“Some of these events were predictable, some maybe not so much. One thing is certain, in 2022 investors have learned that it is entirely possible to lose money investing in good companies if you overpay,” says Adriaan Pask – CIO of PSG Wealth.

Stickier inflation

At the start of 2022, most people weren’t sure where global interest rates would go, but the consensus was that they would rise, although very few expected rates to rise as high as they have or as quickly .

“Our view earlier this year was that inflation would be much stickier than expected at the time and the logical implication was that interest rates would surprise on the upside,” Pask said.

He explains: “As interest rates rise, valuations start to matter a lot more. Growth becomes evident, fears develop around recession and shares fall in price in line with the high risks of the macro environment”.

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Companies with a high profit margin

So it was no surprise that the counters that came under strain in 2022 were long-duration, high-growth stocks, or stocks that were priced at high levels of growth for a very long period.

Pask says they were typically technology companies, which had high profit margins.

“These companies were priced as if they would maintain these margins and growth rates for a long time, and over the past few months, these companies have started to sell off. A key lesson here is that there is a significant difference between a good business and a good investment”.

Pask points out that none of these tech companies are bad businesses; They don’t necessarily make good investments in the current environment.

“There will surely come a time when the environment normalizes and the valuations of these counters become attractive again.”

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Inflation and rising interest rates

Persistent inflation and rising rates also made PSG cautious on developed market bonds.

“We felt that the yields on these bonds were very low, even after the pandemic, and could essentially only go up from there.”

Therefore, 2022 was very painful for investors as both developed market bonds and equities sold off heavily during the year, causing the performance of offshore portfolios to suffer subsequently.

Pask says China was also another key influence on markets during 2022.

“China is a key consumer in the global environment and the health of the Chinese economy is important to commodity producers like South Africa.

“Despite seeing slower growth outside of China, compared to what we’ve been used to over the past 20 years, it’s still relatively high compared to the rest of the world. There are also existing constraints in the supply chain, which was the key driver behind the high commodity prices that were positive for South African capital, particularly our mining stocks.”

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Invest in 2023?

Pask says PSG will keep a close eye on corporate margins: “We expected margins to narrow as the cost of capital rises as interest rates rise, because that’s when sentiment will start to turn even more against tac companies.

He adds: “We’ve already seen some of that start to come out, but margins are still much higher than we think they will be during a recessionary environment.”

PSG expects US interest rates to peak next year and that will lead to interesting investment opportunities.

It’s not clear whether we’ve seen the bottom yet, but we’re seeing more and more quality companies trading at attractive ratings, he says.

“We also believe that more conservative asset classes will start contributing to portfolios again in 2023. In a higher interest rate environment, bonds and cash have a supporting role to play once again in a diversified portfolio that will be positive for clients in these strategies. “

Dollar weakness

According to Pask, another key theme for 2023 will also be the weakness of the dollar and the impact it will have on portfolios and asset classes.

“Our view is that the dollar is unsustainably strong and could weaken in the near term. This translates into a stronger rand and our bonds and incorporated companies in South Africa will react positively to this development.”

Pask says people need to be realistic about the uncertainty surrounding the global political environment.

“It would be naive to position a portfolio that would not be subject to any political turbulence. I think politics will continue to have a big impact, especially in the short term, where sentiment can influence asset prices.”

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