Jump, Skip, Pause and heightened volatility

The second quarter of 2023 was filled with positive surprises. Global equity markets rallied and domestic equities eked out a mildly positive return. All this while the US Fed remained hawkish.

At times the intensity of market movements and fluidity of narratives created a visceral sensation of above-normal volatility. 

Would the US Fed keep hiking? Would they pause? Are they skipping, to resume hiking later? Does it matter?

In reality, the quarter was closer to normal. Financial market history suggests that volatility, while elevated, was mostly in line with the past – refer to Graph 1.

In similar fashion, cross sectional volatility – a dispersion measure used to gauge the opportunity set available to generate alpha – declined to 9.6% from 15.2% in the previous quarter. By implication, Q2 was apparently less alpha rich than Q1.

We certainly felt differently. We found ample opportunity in Q2 and thankfully, it played itself out in portfolio performance. Again, a somewhat counter-intuitive statistic when considering the continued elevation in JSE price disparity since 2020 – refer to Graph 2.

As active managers, we synthesize data and fundamental signals. We frame these inputs as a means to calibrate investor expectations and identify security mispricing.

Our ability to navigate Q2 was influenced by the following data and fundamental insights:

• Our Macro Model correctly predicted a weakening global economy, especially in South Africa and the US. Our resulting conservatism enabled us to avoid the subsequent declines within the resources and consumer sectors. 
• Inflation is moderating, especially in the US. We welcome the reprieve but expect much higher volatility in inflation than the previous decade. Our proven ability to track inflation ahead of the official announcements gives us an edge in finding mispriced securities.
• In early May, our data and fundamental models led us to pivot our positioning on gold and related equities. We changed our view after having participated meaningfully in the gold rally since late 2022. The trade remained in place at quarter-end but remains very sensitive to prevailing market conditions.
• The rand (ZAR/USD) started the quarter at R17.78 and hit an intra-quarter high of R19.85. We have extensive experience with abrupt currency moves and were able to look through the near-term volatility and adjust our positioning for a reversal. We do not rule out the possibility of sustained rand strength because of both US dollar weakness and an improving domestic economy.
• Our patience was rewarded in areas where our views were backed by compelling data insights. We have been underweight platinum shares since late January and this view came to fruition during the latter weeks of June. At the same time, our long-held position in Naspers also rallied towards the latter stages of the quarter and remains attractively priced. In contrast, the significant weakness in platinum shares could prompt a change of view, if the data reverses.

The global economy remains weak. China is a recent exception, with encouraging signs of a nascent recovery.

Markets remain finely poised, with a wide range of potential outcomes and after a period of strong returns, we have de-risked our portfolios. As always, we will respond to the incremental data as it emerges.