Market Insight Q4 2022
Market Review and Commentary
December was a disappointing end to a bad year. Investors had few places to hide as traditional safe-haven assets such as bonds fell in tandem with equities. The final month of the year saw negative returns for equities and commodities, and slightly negative returns for bonds as fears that have driven negative investor sentiment for most of 2022 returned: no end in sight for monetary tightening and uncertainty over the duration and severity of the economic slowdown that started in 2022.
The year began with optimism. Most of the world got through the year without a major escalation of Covid restrictions, with the notable exception of China. A monetary tightening cycle was anticipated, but it was expected to be gradual because ‘transitory’ inflation was expected to recede due to improving supply chains. Alas, this goldilocks scenario did not play out. The beginning of a major conflict in Ukraine led to a commodity price shock, exacerbating demand-driven inflation from re-opening economies. Inflation soon reached the highest levels in four decades. Central banks switched from being complacent to being proactive and initiated the fastest monetary tightening cycle in recent history. This led to a substantial economic slowdown, and asset valuations adjusted to the end of the low-interest rate environment that had persisted since the Global Financial Crisis. China experienced a challenging year, keeping much of its economy locked down which depressed economic activity there until protests forced a U-turn late in the year. 2022 was therefore marred by fear and uncertainty over inflation, the monetary response, geopolitical escalation and what could be a looming recession.
What made 2022 different was high inflation forcing central banks to hike even as economic activity cooled rapidly. 10-year yields more than doubled over the year as a consequence and bonds delivered negative returns. The simultaneous declines in stocks and bonds led to negative returns. The pain in the bond markets continued in December, with the U.S. Aggregate Index down almost 13.0% for the year. Since the late 1970s, no other year has come close to experiencing similar pain in the bond market. U.S. bonds are now 18.4% off their peak in July ‘20.
2022 had silver linings as well. Labor market resilience and strong household balance sheets after a substantial tightening in monetary conditions and potentially peaking inflation raises the odds of a soft landing. Supply chains improved substantially, which eased inflationary pressures. The world, including China, has moved beyond Covid restrictions. Firms have found ways to alleviate the commodities shock and reshuffle supply chains. The return of higher rates has begun to clear some excesses from the system. Higher expected returns for most asset classes constitute an opportunity for investors. Uncertainty remains high but there are some reasons for optimism going into 2023.