2022 – A Year to Forget
There Was Almost Nowhere to Hide
Market Review 2022
After healthy returns in 2021, the S&P 500 Index (S&P 500) finished the year down 19.4% in 2022. In Canada, the S&P/TSX Composite Index (TSX) was down “only” 8.7% in the same period. The chart below shows the relative year-to-date return of the S&P 500 and TSX for 2022.
Source: FactSet Dec 31, 2022
Of all the major stock markets around the world, not one had a positive return in 2022. The main culprit of was the stubbornly high inflation, and higher interest rates in an attempt to combat the former. Normally, when there is a correction in the stock market, bonds hold up well and mitigate losses. However, the effect of higher interest rates depressed bond prices too. The next chart shows that amongst various asset classes, crude oil had the best performance last year as a result of the shortage created by Russia’s invasion of Ukraine. Even gold, the traditional hedge against inflation did not shine.
Source: Bloomberg Dec 31, 2022
A matter of perspective
It is easy to focus on the short term which is what the media reports on. The Canadian stock market declined at the start of Covid related lockdown in 2020, and in 2022. But it has advanced 12.9% over a three-year period from January 2020 to the end of 2022.
Source: FactSet Dec 31, 2022
While downturns are hard to stomach, we always need to look at a longer-term perspective.
What Does 2023 Hold?
At this time of the year my Inbox is inundated with articles and reports on what to expect in 2023. A quote attributed to baseball player turned philosopher Yogi Berra, “it’s tough to make predictions, especially about the future” rings true. While my clients do not expect me to have a crystal ball, I see it as my responsibility to read the weather forecast and prepare for a range of possible outcomes.
Interest rate policy
Central banks have taken aggressive action in the past year in an attempt to bring down inflation. There are signs that inflation has peaked, though staying high by recent historical levels. Consensus amongst economists is that the Bank of Canada (BoC) and the U.S. Federal Reserve will raise rates in the first half of 2023 to stamp out any embers on price pressure. When they start to cut rates is less certain.
Likelihood of recession
One of the most reliable predictions of a recession is when short-term bond yields are higher than long-term bond yields. Six to 12 months later – summer of 2023, a recession may occur. A recession usually means slowing economic growth, higher unemployment and declines in corporate earnings. This may lead to an equity bear market.
Unknowable Geopolitics
The late U.S. Secretary of Defense Donald Rumsfeld coined the term “unknown unknown” to cover the things that we don’t know that we don’t know. It has come to light that political and military leaders in Ukraine did not believe Russia would mount a full-scale invasion. Intelligence has its limits. Some events have huge implications but are simply difficult to foresee.
Weather forecast
An optimistic view is for a so-called “soft-landing” in which inflation returns to earth, without triggering a recession. A pessimistic view is for a long recession accompanied by an equity bear market. RBC Global Asset Management has pegged the probability of a recession at 70% in 2023.
How to Invest
Prepare for a range of outcomes
We need to prepare for the possibility of a recession and further markdown in equities. Stock valuation as measured by price divided by earnings has declined significantly in 2022 which may soften the downside. History tells us that stock prices are forward-looking and that a rally usually starts before the end of a recession. To extend the weather analogy, we do not have to stay indoors, but may need to dress for the weather.
Look for resilience
There are businesses whose earnings are not as sensitive to economic growth as others. My equity portfolio includes Fortis, a utility, and Waste Connections. Customers still need electricity supply and garbage collection in a recession. The iShares MSCI Minimum Volatility exchange-traded fund (ETF) provides diversification and aims to capture upside with less exposure to downside.
Reset asset allocation
Last year was a rare instance where bonds declined in sync with equities. The silver lining is that after the correction, bond yields are now in healthy territory. The 10-year U.S. government bond yield rose from 1.5% at the start of the year to end at 3.9%. Many corporate bonds now trade at a discount to par value, thus also offer a potential for capital gain. After a tumultuous year, it is important to adjust your asset allocation to its strategic mix.
Diversify with alternative assets
Aside from cash, bonds and equities, alternatives is the catch-all category for everything else. Adding alternatives to a portfolio may dampen the volatility or enhance its return, or both. A hedge fund has the ability to invest in a stock or short it (sell without owning it) which may allow it to make money even when the broad market is down. Institutional investors such as the Canada Pension Fund allocates a significant portion of the fund to real assets and infrastructure such as a toll-road or wind farm, some of which are privately held. The purpose for alternatives is for diversification.
Shiuman’s Corner
A Year in Books
Some of the books read in 2022 (Photo: Shiuman Ho)
For years I have tried to read more books. With work and family, finding the time was a constant challenge. It is inspiring to read some famous people’s lists of favourite books of the year. How many books does one have to read to have a list of top 20? So I set myself a target or two books, one fiction, one non-fiction each month. I would read for half an hour most evenings after dinner or during the day at weekends or holidays. Some months I fell behind either due to my schedule or a long or difficult book. To track my progress I made notes about each book in a journal. It should help jog my memory in the future and gives me a sense of achievement. By the end of 2022 I had completed 20 books, four shy of target. My process is simple. I keep a list of books that I’m interested in based on recommendations, and I like to browse in bookstores. Hager Books in Vancouver is one I frequent as I like to support local businesses. There is always a pile of to-be-read books in my bedroom. This way I never run out of books to read; when I finish one, I simply pick up another one from my personal library. I don’t have a list of recommend-ations as such, but I did enjoy “Becoming” by Michelle Obama, who offers a different perspective than her husband’s memoir of their time in the White House and the preceeding years. On the fiction side, I was happy to have discovered a new author Chris Pavone in my favourite genre, the spy thriller. See Addendum for my complete list.
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