2022 - hell and back

In Focus – review of 2022

We’re unlikely to miss you…

2022 cemented the impression that we are indeed living through a kink in our times. War in Europe, soaring inflation and interest rates, convulsing politics, and the slow-motion implosion of a mega bubble in Chinese property, are just some of the ‘high’-lights. However, viewed from the (hopefully) relative calm of the future, this may also be the year chroniclers record the populist fever beginning to break. Various liberal democracies continued to muddle through their respective nativist challenges, providing some cause for muted cheer. The appeal of a system that ultimately sells itself on being able to move bad leaders on, was burnished considerably by the primary tragedy of the year – the ongoing war in Eastern Europe. Below, we review some of the ups and mostly downs of a year many of us are unlikely to miss.

Inflation

For investors, it was inflation that dominated the agenda. Inflation was seen as a transitory phenomenon by most at the beginning of the year. A briefly annoying artefact of various pandemic-related distortions. However, war in Ukraine helped to consign such confidence to the bin. A year that was expected to see around 75bps of US interest rate rises, will end up with c.450bps. This unexpected interest rate burden proved a lot for investors to choke down, as the asset class returns pay testament to (Figure 1). Beyond the patchwork quilt for traditional asset classes, the allure of positive real US interest rates was part of the force pulling the rug from under many crypto currencies, growth stocks, precious metals, and more besides (Figure 2).

However, the actual economic effects of this harsh central bank medicine have been slow to show up. Lags in the system mean that the hangover from a party many never actually managed to get into, will begin in earnest next year. The path of lagging indicators, from wages to inflation, will continue to have a say in the weight of the monetary punishment. The more price pressures refuse to lie down, the more interest rate rises central bankers may feel compelled to inflict on their charges.

To that end, we still worry for stocks in the immediate future. There are paths ahead where the worst cases are avoided. The US and global economy could dodge outright recession. Perhaps US job openings fall without a major sustained slump in unemployment. The inflation threat finally recedes and something approaching normal business resumes. However, the odds of a ‘soft landing’ appear to still be exaggerated in market pricing relative to darker scenarios.

The lead indicators are now more appreciably dimming, as we should expect given the change in monetary policy seen this year. A daunting fiscal headwind is admittedly now behind the economy, however a likely necessary rise in unemployment still lies ahead.

If that recession begins to look a bit more likely to others in the market, we should see another leg lower in stock markets, with earnings forecast cuts doing a lot of the work (Figure 3). The same applies to long bond yields as it goes, where we still feel strongly that investors are considerably overestimating how long central bank interest rates will remain at their coming peaks. It sounds ridiculous to even say it after the inflation forecast bonfire of 2022…however, sharply slower global growth and the lapping of some of the giant price hits of this year should mean inflation falls back towards target next year (Figure 4).

There are other areas where the tactical investing team currently see opportunity. However, these positions necessarily do not rely on a single outcome in the quarters ahead.

The year that broke populism?

There were some cautiously celebrating the potential breaking of the populist fever this year.[1] From patterns of candidate success and failure in the US mid-terms to the rapid collapse of Prime Minister Truss’s Conservative administration, some are arguing for 2022 as a potential turning point – a moment when the perceived madness passes, and politics can get back to being a little more boring. Whether or not this proves to be the case, 2022 has certainly been a year which tragically demonstrated the weakness of some alternatives to liberal democracy. 

The daily horrors in Ukraine continue. The augurs of dramatic escalation are no longer as visible, but there remains little hope of a meaningful improvement either. The depth and breadth of this European winter will be watched more closely than most in the context of the evolving supply constraints (Figure 5). Nonetheless, that mostly pales to insignificance relative to the plight of many ordinary Ukrainians as the temperatures continue to drop.

China – out of road

Even in the context of the epochal events in Europe and elsewhere, China’s year stands out. There has simply never been a property bubble of the size that Chinese policymakers have been deliberately trying to deflate. (Figure 6) The fact that this has coincided with the latest extremely transmissible variant keeping much of the economy on zero covid ice, has added significant further complication (Figure 7). Images from the last few days highlight just some of the difficulties facing China’s policy makers.

The best information we have currently suggests that the re-opening of the economy is likely a next year story, probably second quarter. Even beyond the battle with covid and growing societal unrest, the outlook is precariously perched. China’s spectacular economic success of the last few decades is heavily entwined with the growth of its leviathan property sector. The next stage of development has simply never been attempted by a country of China’s size and complexity, operating under a comparable set of political and administrative institutions. Strong views should be left at the door. However, for the short term, we continue to see China and emerging market equities underperforming their developed world peers in the first part of the year. Slower global growth is a further hindrance to Asia in particular, where the global trade cycle looms so large.

Investment conclusion

2022 shall perhaps first and foremost be remembered as the year when war returned to the European continent. However, for much of the rest of the world, 2022 was defined by the cost-of-living crisis that followed. The resulting unexpected surge in US interest rates and dollar were the wrecking balls for many diversified funds and portfolios this year.

However, for those able to invest beyond the confines of stock and bond markets, there was shelter to be found in some hitherto unexpected places. Commodities, a diversified asset class that delivered little but disappointment for much of the last decade has proven its diversification weight beyond gold. Our best thinking funds and portfolios in Barclays UK have performed impressively as a result this year. Note, as usual, that past performance is not a reliable guide to future performance.

For those looking ahead, this year has at least served to remind us that there is little point relying only on the recent past to inform you what the future might look like.

[1] Ganesh, Janan – ‘This was the year liberal democracy fought back’ – Financial Times, November 15th

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