It has been a whirlwind of a year.
In 2022, we’ve seen markets tested as the US Federal Reserve and other major central banks took aggressive steps to raise interest rates, in a bid to cool raging inflation. Global inflation, already coming to a head on Covid-19 supply-chain constraints and a tight labour market, also surged this year as a result of the Russia-Ukraine military conflict in late February.
This year has been a time of reassessing the tech sector — the darling of the bull run — with the industry also beset by multiple tech layoffs as lofty demand projections failed to materialise. The most dramatic layoff of all came from Twitter, as Tesla owner Elon Musk unleashed a 50% slash in staff count.
Meanwhile, the crypto market is under fire, mired in fraud allegations — and some have dubbed this period as its “Lehman moment”.
Endowus reviews five big things that happened in 2022.
Market turmoil: the 2022 edition
It has been a difficult year for investors, with a combined US$36 trillion lost from both the Bloomberg Global Aggregate Index and the MSCI All Country World Index over the first three quarters of 2022. To be sure, markets gained some ground in Q4 — the S&P 500 has just about 2 weeks to snap its three-quarter streak of losses in the final quarter of this year.
Coming off years of easy liquidity, this hefty pullback is faster than that seen during the Global Financial Crisis. What was lost in nine months had also been accumulated over about twice the number of months.
The big plunge includes the biggest challenge to the bond market in decades. It hit the worst for the US market since 1969 (then at -8.1%), according to Vanguard’s figures that stretch all the way to 1926 (with reference to S&P’s High Grade Corporate Index from 1926 to 1968). The Bloomberg Global Aggregate Index — a benchmark for the investment-grade US bond market — is down about 20% year-to-date as of September 2022.
From TINA to BARB
But as Dimensional notes, although 2022 saw the worst start to a year in history for many bond indices, the year-to-date experience for a 60/40 portfolio has held steady relevant to the five deepest drawdowns of the last century.
Because bond prices and interest rates move in opposite directions, higher rates have led to lower prices. Bond managers then actively trade in the bond market to capture more yields from sold-off bonds. This means investors are seeing an alternative beyond stocks. That’s why commentators are bidding farewell to the concept of TINA (there is no alternative), a term used in the last decade or so to explain why investors have gone all-in on stocks in the erstwhile low-rate environment. Instead, this season we welcome BARB — bonds are back.
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Deflated by inflation
Why has the Fed been aggressively hiking rates? Because the job of a central banker is to fend off runaway inflation, before prices spiral out of control. Simply put, if the rice you put on the table keeps getting pricier every few weeks, you’d be quickly depleting your take-home pay since it cannot keep up with the spiralling costs of daily necessities.
When the Fed raises interest rates, it ups the cost of capital (price of money). Rising interest rates lead to larger mortgage payments and less available credit to purchase things, and the higher cost results in people consuming fewer goods and services.
Put another way, raising interest rates is one way to fight inflation by curbing consumer demand, particularly in the strong labour market seen in the US. If demand falls and leads to a recession, it will take time for supply to adjust, during which consumer prices can drop.
On 2 Nov 2022, the Fed announced a fourth consecutive “jumbo” 0.75 percentage-point rate hike. This came as the year-on-year inflation rate stayed stubbornly high in the US, despite having eased from a 40-year peak of 9.1% in June. The consumer price index rose 7.1% in November from a year ago.
At the Fed’s final meeting of the year, on 14 Dec, policymakers agreed to raise the central bank’s key interest rate by 0.5 percentage point — a smaller increase than the 0.75 percentage-point hikes seen at the previous four straight meetings.
There have been hopes that the Fed could ease off the pedal on rate hikes as US inflation may be peaking. November’s core Consumer Price Index (CPI) — which strips out energy and food prices due to their volatility – made its smallest advance in 15 months. The overall CPI also registered its slowest annual increase in nearly a year. Rates hikes are meant to bring down inflation by making the cost of capital — or credit — more expensive. Mortgages, a big household expense, have surged.
Indeed, Fed chair Jerome Powell warned at the December meeting that more rate hikes will be necessary next year to rein in the rapid increases in consumer prices, even as the economy slips into a possible recession.
With a gain of 7.1% in November from a year ago, US inflation may be down from the 7.7% surge in October, but is also assuredly above the 2.1% average rate in the three years before Covid-19 struck.
“We still have some ways to go,” Powell said at the press conference after the final FOMC meeting on 14 Dec.
Where will inflation be in 2023?
Economists and market commentators are watching to see whether inflation has peaked. Some charts to look at include wage growth, and the composition of inflation (and the ensuring factors that would bring it down), as this Bloomberg article details.
No surprises, then, that a Bloomberg poll of 134 fund managers showed that stubbornly high inflation or a deep recession are the two top concerns for large money managers. Investors today are living through the age-old lesson: don’t fight the Fed.
The Fed’s action can trigger a recession — in fact, by the intent of its aggressive rate hikes, it theoretically should (or at least, bring about a slowdown in growth). The silver lining is that earlier stagflation risks have eased off. While the structural issues in this economic cycle will differ from that of other cycles, PIMCO’s research shows that historically, recessions have been a natural part of the economic cycle, occurring every 3.25 years in the US. Between 1945 and 2019, the average US recession lasted about 11 months, while the economic expansion that followed stretched for an average of 65 months.
Fed officials trimmed their 2023 GDP growth forecast to 0.5%; they now expect the unemployment rate next year to rise to 4.6%.
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Russian-Ukraine Conflict
The human tragedy also impacts other economies and markets, given Ukraine’s importance as a resource exporter, and Russia’s key status as a major supplier for oil, among other commodities. The European Union (EU) used to get nearly half of its natural gas imports and almost a quarter of its oil imports from Russia.
Dozens of countries have imposed sanctions against Russia, such as by cutting their energy imports, halting shipments of key products such as semiconductors, and blocking financial transactions. From 5 Dec this year, the EU has banned seaborne imports of Russian crude oil, as part of efforts to slash Russia’s oil revenues and limit its ability to fund its military actions against Ukraine.
The military conflict has heightened global geopolitical risks, increased volatility in the financial and commodity markets, exerted a drag on the global economy, dampened consumer sentiment, and driven up energy and commodity prices sharply.
That has in turn intensified global inflationary pressures, which then impacts the Fed’s decision in determining how aggressively it should hike rates. The decision comes down to the composition of that inflation — how much of it is driven by supply curbs, and how much of it is driven by the strength of consumer demand.
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Tech investing gets a rude re-rating
Dominating news headlines in late 2022 were layoffs in the tech sector as earnings slowed or missed lofty expectations. Twitter’s new leader, Elon Musk, slashed headcount by a brutal 50%. Meta — which owns Facebook, Instagram, and WhatsApp — has cut 13% of its staff.
Sentiment has also been affected by aggressive hikes in interest rates. In the previous low-rate environment, it was often read that earnings from technology and other growth companies were “priced for perfection”, which refers to a time not too long ago when investors bought into high valuations on grand hopes for future earnings. But future earnings in themselves are calculated based on the cost of capital — that is, interest rates.
Interest rates and technology
To understand it in fuller terms, the valuation of a company is based on the present value of its future earnings. This means that rising interest rates make growth stocks less attractive in the short run, as the present value of the company’s cash flow from its future earnings is worth less than before due to the higher borrowing costs today.
When the cost of capital rises, it becomes harder for growth companies to justify astronomical valuations. The markets are less forgiving, in particular, of loss-making companies that were used to burning cash in pursuit of growth. With markets worried about an impending recession (triggered again by higher interest rates), there are further risks of a business slowdown.
As of 31 Oct, equity markets have declined 17.2%, but the technology sector has had a much tougher ride with a decline of about 26.8%. The Endowus Investment Office believes that the technology sector as a whole would benefit when interest rates start to peak and central banks stop their rate hikes. The sentiment towards growth-oriented tech stocks should also start to become more positive.
Market commentators say this is a time to be more discerning of the tech picks, with loss-making companies particularly hammered for their unsustainable business models in these times. But the technology trend will endure. Notably, the broader challenges that companies face today will only motivate more reinvention, a recent report by BlackRock points out. With a tight labour market and rising input costs, companies will be more incentivised to hunt down innovative solutions.
Read more:
- Why growth stocks have lost shine against value plays
- Is the latest tech rally a bull trap or a new bull market?
Crypto collapse
The big collapse of crypto platform FTX — and after the earlier blow-up of stablecoin Terra ($UST) and relevant token Luna — has been labelled as the speculative investment’s “Lehman moment”.
For about a decade now, billions have been poured into cryptocurrencies as their prices reached eye-watering levels (and fell in equally dramatic fashion). The industry was apparently once valued at about US$3 trillion; as of mid-December 2022, it was about US$850 billion.
Amid this crypto winter, both FTX and the key people behind Luna’s Terra are under fire and investigation for alleged fraud and mismanagement. In December, former FTX CEO Sam Bankman-Fried was arrested in the Bahamas after US prosecutors filed charges.
Hard to “hodl” on
While crypto values have plunged, it’s hard to have conviction that crypto is now cheap to “hodl”. There is no intrinsic value behind this so-called “liquid gold”, when it could easily evaporate. Cryptocurrencies also showed high correlation to equities and traditional financial markets, further weakening their case as a financial asset that offers diversification benefits.
Investing is not speculation. Endowus advocates a disciplined approach to building your wealth. Decades of scientific research provide a stronger conviction that if you stick to investing in a regular manner, you stand a much higher chance of building your wealth in the long term.
It might seem boring compared to the wild ride that cryptos may take investors on, but we are assured of landing safely and surely on our feet when we get our fundamentals right. To get started with Endowus, sign up to our early access list here.
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From all of us at Endowus, thank you for your trust and support for the Endowus team. We remain committed to doing what is always in the best interest of our clients, and to help you achieve better investing outcomes. We wish you a restful end of 2022.
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