Financial markets had their worst year since 2008, with equities and bonds ending deep in the red and shedding some $30 trillion in 2022.
In the US, the S&P 500 ended almost 20% off for the year, the Nasdaq 33% lower than it was at the start of the year, and the Eurostoxx 50 notching up a double-digit decline of 11.7% for the year. Only the UK FTSE 100 managed to eke out a 0.9% gain for the year. In the East, Japan’s Nikkei shed 9.4% for the year, and China’s CSI 300 fell 21.6%.
Sticky inflation, hyper-hawkish central banks, an uber-strong dollar and a slowing economy dominated investor attention during the year. But it was also a year during which a series of strange-but-true events rattled the markets, including the war in Ukraine, Lizz Truss’s shortest stint as UK prime minister and the undoing of the crypto market in the wake of market leader FTX’s fall from grace.
Russia’s invasion of Ukraine in February signalled that it was going to be another challenging and unpredictable year. Developed markets responded by imposing unprecedented financial and economic sanctions on Russia, with Russia responding by using energy as a bargaining point and tightening, and then closing, the taps that supply European gas. Oil and gas prices soared to stratospheric highs, and European’s dependence on Russian fossil fuels threatened the region’s economic stability.
Food prices also soared as the war drove home the reality that Ukraine and Russia hold the keys to food security, particularly in Africa, because they supply most of the world’s fertilizer and grain, making the two countries the bread basket of the world.
Thus during the first half of the year, inflation marched to ever-higher levels that have not been seen in four decades, prompting central banks to embark on a steep interest rate hiking cycle. The US Federal Reserve set the pace – eventually imposing a series of 75 basis point increases and raising concerns that a 100 basis point hike may be in the offing.
Concerns about the impact of a complete turnaround in monetary policy after years of massive liquidity underpinning the global economy and financial markets saw investors bail out of stocks and set a bear market in motion. Technology and growth shares were hardest hit because it was no longer sufficient to see the promise of earnings to come.
As the year progressed, fears mounted about central banks overdoing it and pushing the global economy into recession – taking the world back to the harsh stagflationary conditions, where stagnating growth and high inflation coexist, in the 1970s. Global economic forecasts were downgraded repeatedly, and by the end of the year, IMF was predicting global growth to slow from 6.0% in 2021 to 3.2% in 2022 and 2.7% in 2023, which, it says, is the slowest growth since 2001, barring the 2008 and Covid crises periods.
The UK became a case study of an economy in crisis and what not to do when Liz Truss became Prime Minister disregarding the fiscal realities of government finances and promising to slash taxes to grow the economy. Investors revolted, pushing bond prices off a cliff and putting pensioners’ retirement money at risk as retirement funds battled to reposition their portfolios to cope with the panic in financial markets. Her time in Downing Street was short-lived and Rishi Sunak, who is primarily seen as a steady pair of hands, took over but has had to contend with mass strikes arising out of the cost-of-living crisis.
Meanwhile, crypto markets were decimated by the shock of market leader FTX going into bankruptcy and evidence shows how badly, if not fraudulently, the business was managed. Customer money was used to plug gaping, multi-billion dollar holes in the balance sheet – highlighting the risks of investing in an industry that is so lightly or not regulated at all. The bitcoin price, has fallen more than 60% from peak.
The dollar was the only financial instrument to withstand the challenges of 2022 and benefit from a global environment of rising interest rates. The greenback gained more than 12% during the year against a basket of currencies before retreating towards the end of last year.
China had a torrid year all round. The government’s zero-Covid policy damaged the economy, shutting down entire cities for extended periods and disrupting manufacturing when a structural property market crisis was already taking its toll on growth. It then abruptly reversed its policy late in the year even though Covid cases were on the rise again. Investors, hoping government would lift the restrictions in a patient and measured way, worried the swift changes would adversely affect the Chinese, and thus global, economy’s prospects.
ESG investing also had a challenging year, as high-profile cases of greenwashing made the headlines and undermined confidence in responsible investment products. Vanguard was wrapped over the knuckles for misleading investors into thinking it didn’t invest in tobacco companies. BlackRock was subject to criticism by a small activist shareholder concerned that the investment house wasn’t walking the talk and HSBC was taken to task for calling itself a green bank without evidence backing up its claim.
Looking forward to 2023, it is expected to be a year of two halves: the first potentially painful and volatile and the second better. Key risks that lie ahead are that interest rates remain elevated as the Fed continues to fight inflation. The risk of a recession in the US remains high and the housing markets in the US and Canada, which were the hardest hit sector in 2022, are likely to remain under further pressure.
While most of the world has gone back to business as usual after the pandemic, Covid variants are still emerging. Last year, the highly transmissible Kraken variant was identified and is believed to be the dominant strain in the US now. The war in Ukraine has been raging for almost a year now, and there are few signs of any diplomatic exit from the hostilities.
Against this backdrop, the outlook for stock markets remains pretty gloomy, and the TINA (there is no alternative) narrative that has played out over the last few years has disappeared. Thus equity investors could still be subject to the great unwinding, namely the reversion to the mean of stock prices that are still a lot higher than they were in 2019.
Although the Nasdaq lost a third of its value last year, the tech-heavy index is still 80% higher than it was in 2019. Tech stocks are also still trading at a premium to the rest of the market of about 30%, although that is down from around 50% at the same time last year. The big question is whether such a premium is warranted. Growth has come in slower than expected, and some tech firms are being realized for what they are, simple entities that need to make a reasonable profit.
Against this backdrop, it’s no surprise that value stocks have performed relatively well versus growth stocks.. Goldman Sachs strategists believe that the margins of big-cap technology stocks could remain under pressure, and that commodity prices and real interest rates will continue rising. Higher rates tend to take their toll on growth stocks because the present value of their far-off future earnings and cash flows are discounted more.
When it comes to investing in general, it is essential to surround yourself with individuals who keep you grounded in rational thought. Doing so is enough to satisfy the need to be open to new ideas and thoughts, while maintaining a balanced mindset. In the uncertain market conditions that still prevail, it is crucial that investors avoid being influenced by those operating purely out of exuberance and outright misguided beliefs.
While there are opportunities in all markets, some present more than others. During the stimulus-driven Covid period, stock valuations ran too high, increasing risks. As asset price bubbles deflate, there will likely be an overshoot to the downside, thus creating potential opportunities for more reasonable returns going forward. One thing is for sure: the markets will not cooperate entirely with our expectations, hence the importance of managing risks along this potentially volatile path.
Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at firstname.lastname@example.org