Dollar Relativity

It’s been a tough year for stock market investors. The MSCI World Index has returned -25.6% in 2022 (measured in USD), on track for its worst year since 2008 and its 2nd worst year since the index started in 1970. ‘Measured in USD’ is an important consideration though – more so than usual – as the Dollar Index has risen 17% YTD. This is one of the biggest and fastest changes in the Dollar Index over the last 30 years. (The Dollar index measures the USD’s performance relative to a basket of major currencies.) The Rand has lost 12% against the Dollar in 2022, less than the 17% change in the Dollar Index. In other words, the Rand has strengthened against most other currencies. The Euro has lost 14% in 2022, the Pound 17% and the Yen a massive 20%.

The following table shows the year-to-date performance of the MSCI World Index (the global stock market) measured in these major currencies and in ZAR.

MSCI World Index 2022
YTD Return -25.6% -13.5% -9.6% -6.4% -15.6%
America vs the World

What in USD appears to be serious bear market, appears in most other currencies to be a ‘normal’ correction. How you perceive the current market movement has a lot to do with where you live and spend your money. If you’re in America, spending USD, then 2022 has been a bad year. If you’re in Japan, spending Yen, you’ve barely felt it.

The strengthening USD has been a trend since the financial crisis back in 2008. The following graph shows the performance of the MSCI World Index measured in different currencies, adjusting for the countries’ different inflation rates. This effectively measures how the market has performed relative to the cost of living in these countries.

There is a notable difference between the real USD return since 2008 and the real return measured in various international currencies. The difference between USD and EUR/GBP/JPY is far greater than the difference between ZAR and EUR/GBP/JPY. America has diverged from the rest of the world. What this means, in practical terms, is that the global stock market has done a lot less for Americans over the last 14 years than for people living in other countries, including South Africa. Relative to their cost of living, Americans have gained only 40% since 2008, while the British have gained 114%, the Europeans 138%, the Japanese 151% and South Africans 117%.

As South Africans we often think of the investment world in terms of domestic and offshore. This is a big mistake, in part because South Africa represents less than 1% of the world economy, but also because ‘offshore’ isn’t one big homogeneous basket as we so often imagine it to be. For starters there is a major distinction between the United States and the rest of the world. There is also a distinction between developed markets and emerging markets. The world is a big and diverse place.

So what can we take from this? 
  1. For international resident investors (including South Africans), the market movement in 2022 has been less severe than for American resident investors.
  2. We South Africans often measure ourselves in absolute terms relative to the USD, which paints a very bleak picture. While we do have severe domestic problems, if our currency were ranked on an international leaderboard (to borrow golfing terms), we’d be making the cut, not just in 2022 but even since 2008. There are bigger global forces at play than our local issues
  3. Key point: The global investment space is much bigger than America and the USD. ‘Offshore’ is not homogeneous. When you invest globally you are buying an internationally diversified portfolio with various underlying currencies, many of which are cheaper than the Rand. Don’t let one number – the USDZAR exchange rate – dominate your decision-making process when it comes to deciding whether to take money offshore. Consider the bigger picture.

Finally, we are constantly on the lookout for opportunities to invest in good businesses at attractive prices, wherever they may be. We’ve maintained significant USD cash balances throughout 2022. We’re well-positioned to take advantage of further market weakness. Far from being a disaster, the current market conditions are finally beginning to offer us a very welcome opportunity to deploy excess cash balances.

Effect and Cause

The MSCI World index lost 15.7% in the second quarter The ongoing conflict in Ukraine has continued to put pressure on global supply chains and commodity prices. US inflation increased to 8.6%, while the Federal Reserve rate increased from 0.5% to 1.75%. Consensus estimates are for a further 75bps increase at the end of July. There is also talk of a looming recession. So what do these indicators mean for the stock market? As investors, how should we respond to the economic data?

Should we time the market?

For many, the holy grail of investing is to find a reliable leading indicator for the stock market. Let’s say you had $ 10 000 to invest in 1970. Suppose you had a reliable indicator that could tell you in advance whether the stock market would earn a positive return or not in the following calendar year. Your strategy would simply be to hold either stocks or cash for that year depending on the indicator. If this was possible, then today (in 2022) your $ 10 000 would be worth nearly $ 7.3 million. If you’d simply held the stock index your $ 10 000 would be worth $ 800 000. That’s pretty good, but it’s only 1/9th of $ 7.3 million! You can see why the temptation to try and time the market, however futile that may be, is so powerful.

But suppose your indicator was not so accurate. What if it had you switching between stocks and cash a year late each time? Your $ 10 000 would be worth only $ 230 000. (The result would be very similar if you were a year early each time.) If you’re going to try to time the market, you need to be very accurate and herein lies the fatal flaw. An indicator that is a bit too early or a bit too late is worse than useless – it has negative value.

Economic data make poor market indicators

This is why economic data (GDP, unemployment, inflation, interest rates, etc.) are such poor stock market indicators. They’re always late. Yes, there is a causal relationship between the stock market and the economy, but the stock market reflects the expectations of investors looking at the future economic outlook rather than present conditions. The effect comes before the cause! The stock market is a leading indicator for the economy, instead of the other way around, even though the economy is the cause of the stock market’s returns.

A simple analogy is helpful: Roosters typically start to crow before the sun rises. Even though the rooster crows before the sunrise, it doesn’t cause the sun to rise. Instead the coming sunrise causes the rooster to crow. The effect comes before the cause. The rooster is a leading indicator for the sunrise, even though the sunrise is the cause.

Trying to time the stock market using economic indicators is like waiting for the sun to rise and then expecting the first rooster to crow. By the time the economic data comes, you’ve already missed the market move. The stock market is such a leading indicator that by the time expectations of future economic data have changed, you’ve already missed it.

What about other indicators?

So economic data are a no-go for market timing, but what about other indicators? Some clever analysts may run all kinds of back-tests to find indicators that would have been accurate (with hindsight), but the list of successful investors who have built their track records by consistently timing the market is a very short one. Back-tests and reality are worlds apart. The reality is that there simply isn’t a consistently accurate leading indicator that can tell you when the next stock market drop will happen. Despite this, not a year has passed since the last crisis that some prominent investor hasn’t predicted the next one. A broken clock tells the correct time twice a day, but that doesn’t make it useful.

There are however some useful indicators that can tell you whether long-term returns are likely to be high or low. But since even low long-term stock market returns are usually positive, it makes these indicators of little value for market timing. It doesn’t help being right about below average market returns for the next decade, but sitting in cash and earning an even lower return. Time is not your friend when you’re trying to time the stock market. If you’re a long-term investor the stock market is the place to be.

Time horizon vs. timing

The following table shows the history of returns for the global stock market since 1970. The first row of each block shows the annual return for that year. The second row shows the annualized return for the 7-year period ending in that year. While the 1-year returns are volatile and unpredictable, the long-term returns are more consistent. There hasn’t been a negative 7-year return* since the total return data for the MSCI World Index was tracked in 1970.

* Past performance is not an indication of future performance.

Invest in superior businesses through the cycle

So if these long-term indicators aren’t useful for market timing, or even for timing specific stock purchases, then what are they useful for? They can help us identify superior businesses that are priced for superior long-term returns. The strategy is to invest in these types of businesses over the long-term, through the unpredictable market cycle. This means we need to stomach the inevitable volatility along the way and not panic every time the market drops. Instead use these drops as an opportunity to add to your stock portfolio.

The list of successful investors who’ve built their track records this way is a much longer one. People like Warren Buffett spent little time trying to time the market or predict the economy, choosing instead to focus on business valuations, profitability and balance sheets. These are the same factors we focus on at Bellwood.

So what is the best approach to manage the market volatility? Don’t make investment decisions based on economic data. Follow a risk-based approach to asset allocation instead of trying to predict short-term returns and time the market. This means having enough cash and liquidity set aside to meet near-term and contingent liabilities and investing the rest in growth assets for the long-term, through the cycle.

Once you have this strategy in place, the most important thing is to maintain your discipline, especially when markets are falling. Emotional decisions are seldom good decisions. Don’t deviate from your financial plan. We won’t deviate from our investment process.

Inflation, Interest Rates and Stock Prices

One of the most significant changes to the economic landscape over the last year has been the return of inflation. The US inflation rate has risen to 7.9%, the highest reading in 40 years. US inflation has averaged roughly 2% for the last decade and 3% in the 20 years prior, peaking at 5% in 2008. It remains to be seen whether this spike in inflation is in fact ‘transitory’ or not. Many policymakers seem to be abandoning that view now.

Quantitative easing and sustained easy monetary policy have contributed to the potential for higher inflation for some time. But COVID-related supply chain issues and the Russian invasion of Ukraine are the two most immediate causes. The former has resulted in shortages of various goods and higher shipping costs. The latter has led to a spike in global commodity prices, including energy.

Inflation has a direct impact on what we pay for things. It also has a big impact on interest rates. Most central banks aim to curb inflation by raising interest rates. The theory is that when the economy runs too hot, interest rates can be raised in order to cool things down again, and vice versa. The problem is that interest rates are a bit of a blunt tool when it comes to controlling international supply-driven inflation – such as we are now seeing. Higher interest rates in America have little direct impact on the war in Ukraine or shipping from China. They may dampen domestic demand though.

Nevertheless, it seems likely that central banks around the world will respond with higher interest rates. This in turn will have other implications. Our primary concern is how higher inflation and higher interest rates are likely to impact stocks and other assets.

First, higher inflation means higher costs for companies.

However, since the global stock market represents the bulk of the global economy, it stands to reason that one company’s higher cost is another company’s higher revenue. In aggregate, the stock market tends to pass through the effects of inflation. There may be winners and losers depending on the nature of inflation. Good quality businesses are better able to pass through inflation effects.

Second, higher interest rates mean higher debt financing costs.

Companies which have a lot of debt are likely to come under pressure as interest costs mount. The impact of higher interest rates is not so easy to pass through as inflation. In a rising rate environment, overindebted companies will come under pressure.

The low interest rate environment that has prevailed since the ’08 financial crisis has spurred a wave of debt-funded stock buybacks. Companies have taken advantage of the low interest rates to raise debt at almost no cost. They’ve used the proceeds to indiscriminately buy their own shares on the stock market. This has the dual impact of increasing the leverage of these businesses, while simultaneously creating (artificial) demand for their shares. This pushes their share prices higher. It will be interesting to see the effect of this trade unwinding should interest rates start to bite. Not only will earnings come under pressure, but a major source of buying demand will disappear. Should they need to raise equity in order to pay down debt, the effect will be inverted, albeit in a less orderly fashion.

Finally, higher interest rates mean higher discount rates for assets.

When pricing an asset, expected future cash flows are discounted at a rate (the discount rate) to derive a value for that asset. The higher the discount rate, the lower the value of the asset. Central bank interest rates provide a reference point for all other discount rates. When interest rise, so do the discount rates for other assets, implying lower valuations.

The simplest way to demonstrate this is with a government bond. A bond has fixed cash flows on a predetermined schedule with a defined maturity date. This means that the only variable affecting the price of a bond is the discount rate. Higher interest rates => lower bond prices, and vice versa. For any given yield, you can calculate the bond price. As such, bond prices are usually quoted as a yield (which is the discount rate).

Stocks are a little more complicated. Their future cash flows are highly variable and they have no defined maturity date. This means that the discount rate is just one factor. At one time it may be a dominant factor, and at other times be overshadowed by other factors. All else equal, higher interest rates should lead to lower valuations for stocks, which generally means a lower PE ratio.

Interestingly, small changes in discount rates have the biggest impact on valuations when discount rates are very low (i.e. valuations are very high). This makes highly valued assets more sensitive to changes in discount rates than cheaper assets. (This effect is referred to as ‘convexity’ in fixed income management.)

History shows the relationship between inflation and asset valuations.

Since interest rates tend to follow inflation rates, we’d expect to see an inverse relationship between PE ratios and inflation rates over long periods of time. The last 70 years of stock market history demonstrate a weak inverse relationship between the S&P 500’s PE ratio and US inflation. This weak relationship became a lot stronger during the ‘70s and early ‘80s when high inflation was a major factor.

Source: Bellwood Capital, Bloomberg.

Inflation also impacts other assets.

As we already alluded to, bonds are highly susceptible to inflation. This is because they have no mechanism for adjusting the predetermined cash flows to reflect increased inflation. Should we enter a sustained period of high inflation, bond returns are likely to be poor as interest rates rise and bond prices fall.

Property is somewhat similar to the stock market, but since debt-funding is more prevalent, interest rates tend to have a greater impact.

Inflation obviously erodes the value of cash, although higher interest rates tend to compensate for this. (Unless your cash is under your mattress.)

Gold is considered to be an inflation hedge, but with a lot of volatlity (much like other commodities). Over long-periods of time however, gold fails to match the returns offered by productive assets.

There are several implications for equity investors.

Although high inflation is not a good thing for stocks, stocks remain the best long-term inflation hedge. This is because of their ability to pass through inflation over time. The best ways to mitigate the impact of high inflation on your investment holdings are to:

  1. Maintain a reasonably diversified portfolio of high quality businesses, which can pass through the cost pressures of high inflation;
  2. Avoid over-indebted companies, which may become distressed as a result of higher interest rates;
  3. Avoid over-valued stocks where small changes in discount rates will have the greatest impact on valuations.

These three points really sum up our investment process: Acquire and maintain a diversified portfolio of profitable businesses with strong balance sheets at attractive prices.

Remember, inflation is notoriously difficult to predict. We don’t know if we’re headed for a repeat of the ‘70s/’80s, but we can and should always follow a robust investment philosophy and process.

Mind the Gap

In 2021 we worked through a total of 1 927 companies across the globe. These are largely representative of the global opportunity set and include just about every major listed company in the world. These 1 927 companies have a combined market cap of $78 trillion. For each company, we estimated an expected return, which updates in real-time as prices and underlying fundamentals change. By aggregating this data, we can draw some inferences about what the global stock market looks like today, from a bottom-up perspective.


Generally, investment managers derive their market views from a top-down perspective. In other words, they make macro growth forecasts for entire countries/regions and industries. They then allocate capital accordingly working their way down to the individual businesses. We work from the opposite perspective. Since our aim is to invest in a portfolio of individual businesses, we don’t usually spend much time building views on overall markets. Nevertheless, it can be instructive to examine the results of such analysis and assess prevailing macro conditions.

Developed vs Emerging Markets

One such condition is the valuation gap between developing and emerging markets. Top-down economic analysis suggests that developing markets (the US in particular) have the most favourable economic conditions for investment. However, this ignores the underlying asset valuations, just as it did a little over a decade ago when the macro conditions were the opposite. What is important is not prevailing economic conditions, nor recent returns, but future investment returns. A decade ago, emerging markets had outperformed, conditions looked favourable – but returns have since disappointed because valuations were too high. Today, it would appear, we are seeing the opposite extreme:

Estimated Return is based on Bellwood Capital’s aggregated analysis of long-term return prospects for companies and is not guaranteed.


What is immediately clear is that our expected returns for emerging market assets are much higher than our expected returns for developed markets*. This is consistent with the relative valuations. Our portfolio weights are also tilted towards emerging markets. We also hold a significant amount of cash in lieu of developed market exposure. Remember that we do not target regional exposures based on macro forecasts. We look at individual opportunities and maximize exposure within our risk management framework. The overall weights come out in the wash, so to speak, but it is reassuring to see the consistency.


* This probably understates the gap since we tend to use conservative inputs when assets appear cheap (i.e. they’re competing for a place in our portfolios) and a more optimistic inputs when assets are wildly overvalued.

Valuations drive returns for broad markets

Looking at the above data, one could conclude that our expected returns are simply a function of valuations. This would be overly simplistic because growth rates (and yields) are just as important as valuations. Return = Yield + Growth + Revaluation. When we’re dealing with individual companies a difference in growth rate often outweighs a difference in valuation. But when we aggregate entire regions, differences in long-term growth rates tend to be a lot smaller. Most of the variation in long-term returns is attributable to differences in valuation. This impacts not only revaluation, but also yield. For this reason, the inverse relationship between valuation and expected long-term return for a region tends to be very strong.


It’s also important to note that our exposure within developed markets is not the average of those markets. The United States and Europe are enormous opportunity sets. Even though they are expensive in aggregate, there are still good individual businesses that are priced for high returns by our estimation. We do not allow our macro views to dictate where we invest, nor do we invest in aggregate markets. We invest in diversified portfolios of individual businesses, based on their individual merits, from around the globe.


The valuation gap (and hence the expected return gap) between developed and emerging markets is very high at present. While recent returns and macroeconomic forecasts appear to suggest the superiority of developed markets, it is valuations that will likely drive long-term returns in the future. We are comfortable to maintain our tilt towards emerging markets, while adhering to the limits established in our overall risk management framework.