Coming into 2022, the global financial markets were riding a wave of low interest rates, fiscal stimulus through government grants and the largest monetary stimulus (quantitative easing) packages released by central banks in history.
The equity markets were riding the Tina wave (there is no alternative), in reference to the idea that equities were the only option for investor returns given that alternatives such as bonds were providing zero, and in some cases negative, yields.
By the end of 2021 equities, particularly growth shares, were trading far beyond what could reasonably be expected under normal market conditions. Similarly, global bonds were at their most overvalued in history, often referred to as return-free risk investments.
The conditions were therefore ripe in early 2022 for a significant market correction, which quickly turned into a bear market, the catalyst being the rise of rampant inflation. The coronavirus pandemic-era combination of supply shortages and high demand pushed up inflation and saw the US Federal Reserve pivot from viewing inflation as transitory to aggressively pushing up interest rates to curb runaway inflation. The Russia-Ukraine war also had a major effect on energy costs for the whole of Europe, contributing substantially to inflationary pressures.
These interest rate and inflation dynamics have put downward pressure on consumer spending, company valuations, the real estate market and corporations that are refinancing their debt levels at higher interest rates.
The change in the macroeconomic environment from stimulatory to restrictive led to a rapid change in sentiment towards equities and bonds simultaneously. The S&P 500, which measures the stock market performance of the top 500 companies in the US, has come down about 17%. The Bloomberg Barclays US aggregate bonds index has had an equally poor year, with a drawdown of about 16%.
However, both have recently bounced off their bear market lows in the latest response to what seems to be a softening in the inflation outlook. One of the few assets that has provided protection has been cash, within the safety net of a strong dollar.
The standout sectors that performed poorly during the year were mostly the companies in the growth sector that were deemed Covid beneficiaries, which saw their share prices rise by many multiples at the beginning of the Covid pandemic only for many to fall 70%-90%. Examples include Coinbase, Robinhood, Carvana and Zoom, with the companies hardest hit being those that are unprofitable with a low chance of becoming profitable any time soon.
Emerging markets also came under pressure, with Chinese technology companies, in particular, selling off dramatically, shedding more than half their market caps despite showing signs of value. The retreat of growth shares saw a rotation into value shares, many of which are deemed “old” economy shares, such as banks and oil producers, which had underperformed in the prior years as growth and innovation shares in the software and technology industries gained favour.
These value sectors performed relatively well despite the broad weakness across asset classes. The energy sector stands out as one of the best performers this year, led by oil and gas companies. Certain commodities in the mining sector have also seen significant gains. Coal has been a major gainer in terms of both the rise in the price and the substantial upward move in coal miners’ share prices.
Defensive sectors were also relatively strong performers, with pharmaceutical companies being a good place to be invested in for 2022. Similarly, tobacco companies produced decent returns as investors searched for cheap defensive sectors that had predictable demand and cash flow.
Banks fared better than the broad market as they benefited from the rise in interest rates after many years of artificially suppressed yields. The rise in interest rates benefited banks both from a global and SA perspective as net interest margins expanded, adding to banks’ earnings despite an environment of pressure on the broader market’s earnings growth.
An interesting aspect that emerged from analysis of the sectors that performed well is that many of the underlying stocks can be viewed as undesirable based on low environmental, social and governance (ESG) factors. Energy companies are likely the most controversial in this case given that their business agendas are contrary to what global governments are trying to achieve in fighting climate change and adhering to the UN’s sustainable development goals.
However, their performance is not surprising given the global backdrop, in which the Russia-Ukraine war has disrupted the entire energy supply system and created a profound supply and demand mismatch. As a result, the shift to a future that is free of fossil fuels has primarily been shifted out as countries are forced to rely on “dirty” fossil fuels.
The dramatic shift in the levels of interest rates in 2022 has created a situation in which investors had more choice, particularly those looking for yield. This is evident particularly for pension funds or older investors who have a focus on income. They could shift capital from expensive equities to cash, which now, after many years, provided some low-risk yield in the face of falling bond and equity markets. This tactical asset allocation adjustment also influenced the capital flows within markets in the short term.
Investors should continually evaluate and reflect on their investment processes as well as their investment holdings. The dramatic changes and market moves globally during 2022 provide a great opportunity for reflection given the extreme tests that have been imposed on portfolios during the year.
Markets work in cycles, but forecasting these cycles is exceptionally difficult so it is important to ensure that your portfolio is maximised not only for returns but also for risk.
• Santangelo is portfolio manager at Independent Securities.
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