2022 was a difficult year for investors with equities and bonds (the two main asset classes for any investor) both falling. However, as you can see below, what made the year unique was not necessarily the fall in equity markets. Equity returns were disappointing, but not particularly extreme for UK investors given the effects of a weakening pound, which cushioned falls in overseas shares (sterling was down more than 11% against the US dollar and more than 5% against the euro). All told, since 1976 there have been 5 worse calendar years for global equities in pound terms.
What made 2022 unique was the fall in bonds. Their 12.2% fall is something we haven’t seen in 50 years.
Data Source: Financial Express. Equities: MSCI World Total Returns in GBP, Bonds: Bloomberg Barclays US Aggregate from 1976-1990 in USD as a proxy for currency hedged (Blue) and Bloomberg Barclays Global Aggregate Hedge GBP from 1991-2022 (Orange)
The reason for the sell-off in both bonds and equities was aggressive increases in interest rates by global central banks led by the US Federal Reserve. They were, of course, acting to try to stem the most extreme inflation seen since the early 1980s, fuelled in part by an energy squeeze caused by Russia’s war in Ukraine.
In many ways, the movements seen in 2022 was simply the deflating of a number of excesses in the market. Bonds started the year very expensive (with yields close to zero) and equities began the year on very rich multiples of underlying earnings (very high price to earnings, or PE, multiples). Interestingly for equities, prices fell in 2022 without corporate earnings falling, leading to dramatically better valuations.
So, whilst 2022 was unpleasant, the good news is that the falls in bond and equity prices have made them much more attractive on a forward-looking basis. The big risk for equities in 2023 is that we start to see corporate earnings decline (as you would expect them to do in a recession, which is the likely outcome for many countries in 2023) but lower markets should have in effect ‘priced-in’ a lot of trouble from here so there is a margin of safety.
2023 begins with a lot of uncertainty around inflation (how quickly will it fall?), global growth (how low will it be and how many countries will enter a recession?) and geo-politics (what happens from here in Ukraine? Will we see further moves from China on Taiwan?). But asset prices are not high anymore, and indeed there are many pockets of good value in markets. And that is quite a reassuring position to be in for a long-term investor.
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