Current market complacency creates a window of opportunity for investors

Current market complacency creates a window of opportunity for investors

The global economic system periodically undergoes profound inflections. We might be at such a point now.

We may be at one of the most consequential turning points in history, and yet markets seem calm with many equity indices near all-time highs. In addition, portfolios are full of yesterday’s winners. From our perspective, this signifies that investors are betting that the future will look like the past, indicating a high level of complacency. Why is this the case?

Why investors may be slow off the mark
There may be a natural psychological bias at play. We are wired for continuity, not change, and as such we tend to remain focused on linearity and extrapolate current conditions far into the future. Our predictive ability often fails us when we need it most: at turning points, and at times when the popular consensus cannot be trusted. New paradigms feel like noise until they’re undeniable.

We believe we are potentially nearing the end of a 15-year bull cycle in US markets and the US dollar. The strength of US assets and the dollar has been underpinned by multiple factors, but at least two of these, the shale oil boom and a narrative of US exceptionalism (higher growth and better performance in periods of market stress) – appear to be peaking at the same time. Indications are that productions from oil shale fields may be on the decline, while the US dollar has seen one of its weakest periods in several years since US President Donald Trump’s ‘Liberation Day’ tariffs. These factors supported the last decade’s deflationary, US-led boom, and both are now fading — which opens the door to something new: higher inflation, greater volatility, and different leadership. As we elaborated on in The risks of the US exceptionalism narrative, there are multiple reasons to believe the tailwinds of US economic dominance over the past few years may be tapering off.

Differing macro regimes deliver different market outcomes
From a broader, cyclical economic perspective, each decade has had its dominant macro regime: from deflationary busts to inflationary booms and stagflation. These regimes inform which investment styles tend to do well and which styles don’t. Typically, passive investing and growth stocks thrive in Goldilocks environments. But in volatile, inflationary or stagflationary regimes — like the 1970s or the one that most likely lies ahead today, active management and value outperformance tend to shine. Thus, understanding which macro regime you are experiencing, is crucial when it comes to achieving your long-term investment objectives.

Indices entrench a US-skewed worldview
Many investors, perhaps unknowingly, are anchored to the recent past − a time of low inflation, falling rates, US dominance, and passive investing success. These conditions translated into the outperformance of a defined set of asset and investment strategies, as highlighted above. Consequently, global portfolios today are highly concentrated in US equities. The MSCI World Index has a 71% weighting to the US. As such, investing in the index at this point in time does not achieve diversification. Rather, it’s a bet on the continuation of the US exceptionalism narrative, at a time when it is already wearing thin, and we see many indicators that we may be in the midst of a fundamental market recalibration.

At the same time, the S&P 500 Index is still richly valued, implying that the market believes that little can go wrong. At the other extreme, many emerging markets (EMs) are attractively priced, and we are finding excellent opportunities in Brazil and South Africa in particular.

Assets suited to tomorrow’s environment present a buying opportunity when investors need to consider them most
Portfolios that succeed in the next decade will look nothing like those that won during the last one. Real assets, like resources, are historically cheap versus financial assets, and offer inflation protection and geopolitical resilience, making them more attractive in an uncertain and a fractious world. Add to this a constrained supply side, and we see continued scope for long-term support for commodity prices despite short-term headwinds due to a tepid or slowing global economy.

Equities will remain key in an environment that is likely to be marked by higher inflation — but which equities investors include in their portfolios will matter more than ever. We continue to find South African assets attractive. They trade at wide margins of safety, and are well-positioned to deliver acceptable returns even if growth remains low, and are also poised to be beneficiaries of the EM and commodity cycles. Importantly, improved sentiment has the potential to deliver a dramatic rerating, as we saw in 2024 following the outcome of the national election.

The world is changing – is your portfolio positioned for it?
We believe the world is undergoing a global macro inflection. Investors largely remain complacent, positioned around consensus views in the assets that have worked for them over the past decade or more, while we see great opportunities to position into portfolios built around the next generation of winners. Many of these future winners are to be found in the less crowded areas, and are still trading at reasonable valuations, providing a precious window of opportunity for investors to recalibrate their portfolios for a changing global reality.

Our portfolios are intentionally positioned to reflect our views on the changing global environment. We consciously include a well-diversified mix of EM exposure, SA secular winners, overlooked global value shares, and real assets that offer inflation protection. This coupled with much-needed, more predictable returns from EM and local bonds, and dry powder in the form of cash, provides a resilient portfolio that we believe will suit our investors well in a challenging and an unpredictable environment.

Dirk Jooste is a Fund Manager at PSG Asset Management.