As we turn to a new year, investors look to position portfolios for 2023. At the beginning of every year, approaching Chinese New Year, our team hosts an annual virtual investment presentation to discuss the key indicators to track, the opportunities to spot, and the hurdles to be wary of. This year, the presentation will take place on January 21st (English) and January 28th (Chinese). To register as a client or a guest, kindly connect with your team contact or click here for general inquiries.
Reflecting on last year's presentation, we humbly discern what we got right and what we got wrong in 2022.
What we got right
We proposed to clients that the majority of the downside should be seen in the first half of the year as investors grappled with inflation concerns, pending interest rate increases, supply chain glitches, labour shortages, mid-term election uncertainty, and volatility in the technology sector which is highly weighted in the overall index. We also felt the second half of the year is where markets would stabilize as investors should see inflation flattening out and supply chains improving faster than expected. Indeed the first half of the year is where most of the declines occurred. And although investor sentiment worsened throughout the back half, market indexes did “stabilize” by trading sideways, albeit in a wide range. Our recommendation for long-term investors was to rebalance portfolios and right size any overweights back to more modest levels.
We also suggested that 2022 would be an extremely difficult year for bonds. To us, this asset class appeared to be headed into a “heads you lose, tails you lose” paradigm. Unfortunately, a stronger economy would pressure central banks to raise rates more and hurt bond prices. On the other side of the coin, a weakened economy would cause credit spreads to widen, and that would also hurt bond prices. By the end of the year, bonds indeed experience their worst performance in the last 97 years. Treasury Bond indexes fell 15%, and investment-grade bond ETFs like LQD fell 20%. Our recommendation was to hold cash, shorter-term bonds, or fixed income alternatives through hedge funds to help outperform the broader bond market.
As for thematic recommendations, we recommended an overweight in energy due to what we felt could be a multi-year lift for the sector based on the structural undersupply of oil and more disciplined capex policies adopted across the industry. By the end of 2022, energy had an eye-popping 60% return. We also recommended investors reallocate more to the TSX and Canadian stocks as relative valuations to the US market were at record lows. The Canadian market also had more resource exposure, higher dividends, and a bias towards “value” that could lead to outperformance. By the end of the year, the TSX performed relatively well, falling -8.5% versus the -20% and -33% of the SP500 and Nasdaq.
What we got wrong
What we clearly got wrong was how much the Fed would raise interest rates. At the beginning of the year, the Fed predicted that they would raise interest rates to 0.9% by the end of 2022. Needless to say, with the Fed rate currently between 4.25 to 4.50%, the initial guidance provided by the Fed was ill-advised. Indeed, high inflation led to a front loading of interest rate hikes that were originally planned to occur over 2-3 years. These higher rates led to tighter than expected financial conditions and a murky investment outlook, which swiftly corrected asset valuations.
We also did not foresee how strong the labour market would remain. Although inflation has already begun its descent, unemployment remains at record lows, and job openings at record highs. Our view was that in the face of normalized demand, job openings should tumble, unemployment should rise, and wages would trickle lower. Altogether, this would provide further relief to inflation. However, the labour shortage persisted, potentially due to the lack of pressure to return to work from a consumer that had been supported by government stimulus for too long. Moreover, employers have shown to be reluctant to lay off workers after spending so much effort to secure workers during the pandemic. Moreover, the retiring “Boomer” generation only exacerbated the labour shortage. Overall, this labour dynamic leaves wage growth high, which infiltrates and props up inflation. For this reason, the Fed appears to be more hesitant to declare a victory over the latest drop in inflation until they have seen a decisively moderating labour market. This continues to hold back stock markets from breaking out of the trading range.
Finally, we did not foresee China’s COVID response to be so markedly different from the rest of the world. While most countries were able to lift restrictions and re-open their economies, China remained in a state of lockdown, which persisted much longer than expected. This negatively impacted global demand and trade logistics for companies doing business with Asia. As a result, corporate earnings became choppy and less predictable. Moreover, we were wrong to think that the strong fundamentals of the blue chip technology companies would be able to withstand the valuation compression that occurred indiscriminately throughout the sector. We benefitted from starting the year with an underweight in technology and continually decreased the weighting throughout the year, however, a swifter cut would have led to greater outperformance.
In all, we recognize that it is nearly impossible to call everything correctly. For investors, regardless of one’s views of the market, their portfolios need to be positioned to manage unforeseen risks. Looking at your portfolio, ask yourself, ‘what if I’m wrong?’. Doing so will encourage you to be more balanced and disciplined, which can help moderate large swings. In this year’s seminar, we seek to provide you with our outlook for 2023 and how to best position a portfolio for both opportunities and risks. We hope you will join us.